CROWD ISLAND’S EPIC FAILURE

Th e firm developed an equity crowdfunding platform so ordinary people can invest in startups only to realise that it was illegal, but that’s not the problem

Crowd Island failed in its quest to democratise the exclusive club of angel investing by opening it to ordinary folks. Soon after launching, it found that existing laws prevented it from operating an online matchmaking and transaction platform or website to link startups with potential investors.

The first problem it discovered was that laws barred it from executing payments.Under Sri Lanka’s fi nancial regulations, Paypal, a service for sending and receiving money across the world, cannot be used to remit money into the country. So, small ticket equity investors are unable to send Crowd Island their equity investment using this method.

Crowd Island is also technically illegal. Th e Securities Council Act of 1991 prevents private companies from inviting public investments, and the Companies Act of 2007 limits the number of shareholders to 50 in a private company.

“We are hoping some regulatory barriers will be cleared soon,” says Chief Executive Chalinda Abeykoon.

But it turns out this wasn’t their greatest challenge. Crowdfunding has been around for centuries, where many people pledge small amounts of money for various causes and projects. Crowdfunding has financed wars (war bonds), supported academic careers, financed musicians’ records and tours, built cooperative societies, raised donations for victims of natural disasters, paid the legal fees for public interest court cases, and funded tech development.

The base on which the Statue of Liberty stands was crowd funded by a newspaper campaign calling on the public to donate small sums of money. A Cambridge University study has estimated that crowdfunding helped raise over $30 billion worldwide for various ventures in 2015.

Equity crowdfunding is more complicated, but allows ordinary middle class folk with little investing experience to own a small stake in startups looking for a leg-up to begin operations. Investing in early stage startups is risky, but rewarding.

“There is a 95% chance of failure and investors risk losing everything,” Abeykoon says.

Most startup investors, also called angel investors, have typically reached the pinnacle of their business or professions. They invest in startups because they are passionate about nurturing entrepreneurship and innovation— critical ingredients that can potentially transform the economy. If startups go belly up, angel investors can absorb the loss given their fi nancial clout. Passion and philanthropy may be the drivers, but returns do matter. “Investors expect a return of at least 3 times their investment,” Abeykoon says.

Angel investors can also be demanding. “Some angel investors took decades to build their own successful businesses, but now they want startups to achieve success in three to four years.”

When investors become hands-on with startups, it can lead to tension and frustrate founders. The best partnerships are collaborative ones. Investors provide the funding, but also open their networks and dispense invaluable advice on how to run a business.

Launching in 2016, Crowd Island promised to democratise the world of angel investing so everyone can enjoy the high returns with equity investments of as little as Rs50,000. Around 250 people signed up, and that’s a crowd. Since then, Crowd Island has raised Rs84 million for seven startups, but only 17 people had actually invested. That’s no crowd! Abeykoon insists otherwise.

“The only crowdfunding element we do not have is the transaction site,” he says.

However, he admits that Crowd Island’s business-savvy founders who were veteran angel investors and mentors made a critical error—one they no doubt urged many startup entrepreneurs to avoid: Building a product no one wanted, at least not yet.

“Crowd Island was an epic failure because we built this entire crowdfunding platform only to realise that no one wants it. The market is just not ready for equity crowdfunding,” Abeykoon says. Legal impediments could be cleared, but Crowd Island’s biggest challenge is to build credibility and public trust.

In the last decade, a number of episodes – including stock price manipulation and failing finance companies – have undermined public trust in capital markets and the financial sector. Abeykoon says Crowd Island has changed track since founding. With the ecosystem already in place, it’s now focusing on building credibility. Investing in startups is risky, and Crowd Island is upfront about that. However, it’s ensuring that startups have the necessary plans and processes in place to achieve success.

“Crowd Island was an epic failure because we built this entire crowdfunding platform only to realise that no one wants it. The market is just not ready for equity crowd funding” Abeykoon says

Founders Jeevan Gnanam and Nathan Sivagananathan understand the risks better than most people. Gnanam is the third generation scion of a successful family business and until recently head of Orion City IT Park, and still chief executive of Anton and a number of other businesses. Sivagananathan is a chief executive at MAS Holdings and well known for driving innovation at the organisation. They, along with Abeykoon, have invested in startups and mentored several entrepreneurs.

In early 2017, Abeykoon changed Crowd Island’s value proposition.

“Entrepreneurs can bring us their ideas, and if they are good, we will help structure the companies, build fi nancial models, put in KPIs and execute feasible business plans,” Abeykoon says.

This process used to take up to six months, but now they do it within three. Once the startups are structured, they are pitched to investors. Investors being able to see plans that are more comprehensive has resulted in transactions gaining transaction.

The current iteration of startup funding sort-of started around 2011 in Sri Lanka. Most investors did it out of passion. Investments ranged from Rs1-2 million.

“Now, people don’t easily make that kind of investment without seeing a workable plan.”

Crowd Island matches startups with investors with relevant industry experience. According to its website, investors provide a lifeline to startups, but it’s their active engagement that takes them over the line. Crowd Island mostly makes its money by charging 4.5% from investments as a fee. One way to success is to increase the quantum of funds Crowd Island raises for startups, which in turn will boost the fees collected. But this isn’t the objective.

“What’s important is picking companies with potential and ensuring that they can grow. When investors see this, it helps build the ecosystem.”

This is why Crowd Island retains a 2% stake in each startup, so it can remain engaged even after the funding round to ensure that investors and startup founders have a smooth working relationship.

A decade earlier, Abeykoon headed a programme at the ICT Agency of Sri Lanka to promote entrepreneurship and build a startup culture across the country’s university system. Most students were not receptive to the idea of starting their own businesses. All they wanted was a job after they graduated. “Now, everyone wants to be an entrepreneur,” he says.

Crowd Island makes it a priority to ensure that entrepreneurs understand the problem they are trying to solve. A startup founder must demonstrate having first-hand experience of the problem. “We see people rushing to build solutions, but few spend enough time understanding the critical elements of the problem. They end up building a product no one wants, not matter how brilliant it is.”

They must also be very specific about their target markets. Identifying a specific demographic is pointless. Abeykoon expects startup founders to describe individual users.

“We want to do a series highlighting the failures we’ve encountered. This is because, when you hear just the good news, people think entrepreneurship is easy; so we see a rush of people eager to launch something,” Abeykoon says.

“Crowd Island is an example of failure because we built the entire platform to do transactions for equity crowd funding only to realise no one is ready. So when we curate startups, we keep pushing entrepreneurs to really understand the problem they’re trying to solve.”

Crowd Island raised Rs4 million in June 2017 and Rs5 million a month later. Three months later, the fi rm raised Rs20 million for its third startup. The next three deals would come about two months apart from each other.

“We had breaks in between deals in the past, but now the deal flow is faster; almost one a month because of improved processes and us getting better at what we do,” Abeykoon says.

Out of the 17 who have invested so far, nine invested in Sri Lankan startups for the first time, while eight are veteran angel investors. Four of the nine first-timers are Sri Lankan expats, the rest are four locals and one foreigner. Of the total invested funds, Sri Lankan expats account for 52%. The lowest investment was Rs700,000 and the largest Rs15 million. Three investors have taken part in follow-on rounds and four have invested in multiple startups listed on Crowd Island’s portfolio.

“These are important numbers because it shows that our strategy of curating startups is helping with investor confidence,” Abeykoon says.