By Ayan Mitra
Sentiment is a bad thing in investment. So say experts in behavioural finance who warn investment decisions based on feelings and emotions are flawed, misleading, and even downright dangerous. But sentiment does play a significant part in our industry for several reasons, and that’s not necessarily a bad thing.
Firstly, the rapid growth of alternative finance has been in part fuelled by sentiment, in particular the common mistrust felt towards traditional financial services institutions in recent years. Instincts have mattered here, since many people started to look for new types of investment due to their distaste for behaviour in the financial world before the economic downturn and, indeed, since. What they’ve found is a form of innovative finance untainted by the perceived greed of the mainstream - a fresh and transparent way to invest.
Secondly, crowdfunding does rely to some degree on investors being drawn to a company, and following their gut that it could be the next big thing. As I’ve said many times before, they should temper this enthusiasm with some plain, old-fashioned number-crunching to ensure there’s some substance to an enterprise. But one of the great things about crowd platforms is their open nature, allowing friends, family, and enthusiasts to give their backing to new concepts in their early stages, be they craft brewers, tech firms, or green energy businesses.
Tapping into the excitement of a start-up and the ability to be a part of its development are some of the joys of this type of investing. But no one should be carried away by hope and optimism. I’d always strongly recommend an investor builds a diversified portfolio to spread their risk and increase their probability of making a decent return. And, of course, it’s essential to deal with a responsible crowdfunder, which does the necessary groundwork and testing of a business before putting any deal to potential investors. We’re back to my favourite topic of due diligence – be fired-up and enthusiastic about a project, but always ensure both you and the investment platform have really held a company’s feet to the fire over their business plan and projections.
Lastly, don’t overlook how sentiment and crowdfunding are combining elsewhere to help important causes. I speak now about donation-based crowdfunding, not equity-based platforms like ours, but the recent terrible earthquakes in Nepal are a good example of how our young industry is also changing how people give money to disaster relief and other favourite charities. Crowdfunded campaigns look set to raise millions for the Nepalese crisis. Nesta’s recent report into alternative finance showed that donation-based crowdfunding has grown by 77 per cent each year on average, with those giving donations saying they like the ability to communicate with fundraisers, and see where their money is being spent.
I would conclude sentiment is neither a good nor a bad thing in the context of crowdfunding - it’s there whether you like it or not. But investors must be aware where the boundaries between emotion and rational thought lie. Often, sentiment is getting people engaged in the industry in the first place, and it’s what drives them to consider backing a particular business. But they need facts as well as stories before committing to invest. Our industry must provide that information and rigour. And we must also do all we can to live up to people’s expectations if the current positive attitude towards crowdfunding is to continue into the future.
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Please note: The contents of the article are the author's opinion and have not been approved as a financial promotion by Resolution Compliance Limited.