This is why Crowdisland can’t crowdfund

Crowdisland promised a democratization of capital – investment opportunities for every man – when they launched their online platform in February this year, but a host of serious obstacles stand in the way of them becoming what they promised to be

Crowdfunding existed long before the word, and is exactly what it sounds like: lots of people pledging little bits of money. The model was popularized by creative people without capital for album recordings or freeware creation: Pledge $5 to a project and get an autographed album for free.

Equity crowdfunding is a slightly different game. It is less simple, and involves a little more money and a lot more risk. Aspiring investors with limited experience in shareholding and not so much cash to throw around start here, while giving a leg-up to startups looking for leverage to scale.

“There is a fair amount of money available to be invested, and there are deserving startups,” Chief Executive of Crowdisland Shehan Ramanayake says of Sri Lanka, “and a crowdfunding platform is a nice digital solution to bring investors and entrepreneurs together.”

Crowdisland was founded by Jeevan Gnanam and Nathan Sivagananathan, who are both very involved in the startup scene, in collaboration with boutique financial advisory and investment banking firm York Street Partners. What it proposed was to fill this new space in the startup market and open the economy to many more players with less buying power than the usual investor: the democratization of capital.

The point of equity crowdfunding is to provide alternative capital to those who are not likely to secure funds through more traditional methods (like bank loans or stock sales), while crafting some wins for investors. First, an easily accessible online public platform for pitching projects gives investors a larger pool of options to choose from, helping create a diversified investment portfolio. Second, it retains the high reward of startup investment, while dissipating the high risk across a multitude of investors. If things went according to plan, an executive with some savings would create an “investor” account on the Crowdisland platform and top up an account with maybe Rs1 million. When he found a project to invest in, the account would be debited by the amount he chose to pledge. The project would get capital and the investor would get shares.

Ideally, PayPal would handle Crowdisland transactions, but the Central Bank doesn’t allow the service provider to facilitate receipt of payments to Sri Lankan businesses. So they opted for the usual credit/debit card payment, which brought them right up against another policy: credit cards can be used only for purchasing goods or services, not securities, because of the risk it entails of pledged investors defaulting. In Ramanayake’s words, their idea is scalable, “but it requires several parties to come together and figure out a way to help this mechanism come to fruition”.

Even if a payment gateway was negotiated and investors were able to create accounts they could credit and debit as they like, Crowdisland still has a long way to go before they become what Ramanayake calls “pure crowd”. Section 31I of the Securities Council (Amendment) Act, No. 26 of 1991 prevents private companies from “inviting the public to invest” in them, and the Companies Act, No. 07 of 2007 requires that private companies “limit the number of its shareholders to fifty”.

In other words, there are still a lot of ways that crowdfunding is technically illegal in Sri Lanka. Deputy Foreign Affairs Minister Dr. Harsha de Silva indicated at the launch of Crowdisland in February that the government is interested in making amendments to the legislation in light of the changing marketplace. But legislature is a sloth to the mushrooming startup ecosystem, and the volatile nature of the startup environment requires that any such amendments will need to include more effective systems than we currently have, to protect stakeholders. Silicon Valley startups have a friendlier legal framework to do business in, but even the JOBS (Jumpstart Our Business Startups) Act of the US SEC imposes limitations on the size of individual investments made.

Crowdisland founders Jeevan Gnanam, Nathan Sivagananathan and York Street Partners understand the risks startup investments entail. Gnanam has entrepreneurism written in his genes, and uses his experience as head of Orion City IT Park, Anton and a number of other businesses including startups to mentor young entrepreneurs through SLASSCOM and similar groups. Echelon’s 40 under 40 no. 1 Sivagananathan, Chief Executive at MAS Holdings and a board member in a number of its subsidiaries, is known for innovating operations at the organization. York Street Partners is a five-year-old financial advisory and investment banking firm pledging 50 years of experience between its partners and making itself known in high-profile investor circles. The three combined immediately establish the viability of the deals on offer at Crowdisland.

Therefore, “[less-experienced] investors are able to make a justifiable assumption that these listings are smart investments”, Ramanayake says, allowing them to be “slightly more detached from the actual business” than a regular investor. “This is not to say the investors are not responsible for their due diligence,” he adds, “but there is a level of credibility afforded to the startups, which is helpful for [investors] not too well established in the startup investment scene.”

This is a logic not unlike the disclaimers strewn across the Crowdisland website. They are very clear that startups will fail, that investors must understand the risk involved, and that Crowdisland is only a platform for investors and startup founders to find each other, and not a financial advisor.

How the website helps less-experienced investors than the founders is by creating a mechanism for filtering the startups that get advertised. The same mechanism also helps startups improve their proposals. “If you have to have a few paying customers and a validated model,” Ramanayake explains, “this is a good way to reach a large audience. We are not someone to back your untested idea.” Startups that are ready to scale sign up for “entrepreneur” profiles on Crowdisland and create “deals” including information on the company and the funds they are seeking. Crowdisland will look at this information and make recommendations to the entrepreneur. These recommendations may include a referral to York Street Partners for “credible valuations”. “We are not going to tell you what the value of your company is,” Ramanayake clarifies, “but you need to be able to defend the numbers you are proposing.”

Once the recommended revisions have been made, Crowdisland puts the startup on their platform and makes the individual deals visible to registered investors. Investors make their pledges, and if the drive hits the target, Crowdisland keeps six percent of the total fund.

Because of SEC regulation, Crowdisland currently has a cap on how many investors can pledge towards a single project, and final transactions take place offline, with face-to-face meetings, real checkbooks and signatures on legal documents.

At the end of the line, Crowdisland manifests as a small group of people moving large amounts of money: in effect, a private investors’ club. But they insist on calling it “crowdfunding” because Crowdisland plans to be right up at the front of the line when the laws become more startup and online-transaction friendly. But as Ramanayake sees it clearly, “there is a lot to do” before they can get there.