High growth startups scaling at a rapid pace are faced with a fork in the road, particularly in the tech industry. Start-ups invariably tread one of two paths: either develop a viable product to commerciality on a shoestring with a view to a trade sale, or scale up through a series of funding rounds before looking to enter public markets. For the latter, there is the inevitable question of identifying and mitigating risk. How does the average punter, the high net worth (HNW) sophisticated investor or the fund manager accurately gauge the risk they are taking on these fledgling startups, many of whom are armed with compelling pitches about their future growth prospects, future P/E ratios and targeted EBITDA?
Ideally, you would look for analyst coverage on a promising company, particularly if they seem credible, with considerable revenue growth and robust executive management. Analysts and house brokers cannot realistically write about target startup companies in any depth as it is a problem of scale and limited supply – there are simply too many startups and too few analysts to write about them with the necessary information to be credible.
Startups such as Crowdmix, the social networking app which fused music streaming into its platform, raised £15m from big hitting private investors in the City and then went into administration eight months later. The burnt fingers of various private City investors could be attributed in part to asymmetrical information and a lack of effective due diligence in the Company. However, it is prototypical of the problems that private investors face when weighing up the possibility of investing in fast growing companies with minimal track records looking to fundraise.
Companies like Wheatfromchaff are positioning themselves as the fintech disruptors offering an independent screening and rating product, CrowdRating, which bridges the gap between investors and early stage companies. It uses a checklist driven scoring process to produce objective, standardised ratings across the key areas of management, product and investment returns. It looks increasingly likely that such services will become inherently part of the narrative of burgeoning startups caught in the funding ether: either too small a market capitalisation to be considered worthy of research or too large that the potential for multiple returns is diminished. CrowdRating’s main point of differentiation is that it helps solve asymmetries of information for both sides of the equation: for private retail investors, institutional investors and broking houses.
It seems unthinkable that technology can ever truly replace the knowledge and cumulative experience of a broking house, and therefore CrowdRating should not be seen as a like for like replacement for the traditional research analyst. But with the investment research industry set to be profoundly affected by the regulatory reforms that are being enforced by the second EU Markets in Financial Instruments Directive (MiFID II), sites like CrowdRating can act as a technological supplement to traditional equity research and, in so many words, sort the wheat from the chaff.