This article first appeared in Wealth, The Edge Malaysia Weekly on April 24, 2023 - April 30, 2023

If you thought investing in public equities was risky, private equities could be even more so. I was in a front row seat when a company I had invested in through an equity crowdfunding (ECF) platform went belly up. Sad to say, RM2,000 went up in smoke after several years of investment.

From the start, I was aware of the risks and was prepared for the worst. But there were investors who had put in big sums and they, understandably, were hugely upset.

In private equity, good entrepreneurs are key. But sometimes, even the genuine and best of them can run into problems. The thing is, we must learn from such experiences. I consider myself lucky to have gone through such an experience — it allowed me to learn more about investors’ rights and exercising them when necessary.

There was talk that the company wasn’t doing great during the pandemic, so I was not surprised when my phone screen lighted up one day with a WhatsApp notification of an investor briefing session that would be held over the weekend by the company. I quickly signed myself up for it and appeared at the venue on time.

The small meeting room, lit up by yellow track lights above, looked like a mini art gallery. It was half full — about 20 investors were there. The young chap sitting beside me was a software engineer. Rather nonchalantly, he told me that it wasn’t the first private company he had invested in that had failed. Sitting nearby was a familiar face — a videographer working for another newspaper, whom I had met years ago.

One of the business owners started his presentation when everyone was seated. He touched briefly on how the company lost its key customers during the pandemic and its local business operation, for which it had raised funds, was running at a loss. He took immediate action to secure new clients and explore new business segments, but it was not enough to turn the tide.

The company had to cut costs by closing down branches, letting go of employees and selling assets. As the losses dragged on, creditors chased for money and lawyers were hired. The business owner tried hard to secure a white knight for a fresh capital injection, but that also did not pan out. There was little choice but to wind up the company.

A little piece of good news is that the business owners would set up another entity and allocate some shares for existing investors as compensation. The details, though, were scant as many things had not been finalised. The whole session took about 30 minutes.

It was hard to see the facial expression of the investors, but the room was quiet and the atmosphere felt heavy. A middle-aged uncle fired the first salvo during the Q&A session. He turned out to be a friend of the business owner’s father, and had invested a huge amount in the company on behalf of his family’s private vehicle. He raised three key questions.

The first: Why hadn’t he received an audited financial statement of the company? The uncle was unable to explain to the directors of his family vehicle about the company’s performance when the matter was raised.

He was particularly unhappy about the briefing as it did not address in detail how the business had failed. He noted that some businesses in the sector were thriving, and the company shouldn’t pin everything on the pandemic for its failure.

Second question: How was the valuation arrived at and why was it so high? And lastly, he questioned if the ECF platform was responsible for any of these issues. Is the onus on them to ensure investors receive the necessary reports and documents on time? Should they be standing up on stage to help companies market their business potential? What if those businesses they said so many good things about failed?

What did I learn from the various briefings held by the business owner and his responses to the questions from investors?

The takeaway is that it is true that when a person makes such an investment, it is not just investing in a company and business, but also in the people. Capability, tenacity and business acumen are some of the traits that should define the entrepreneur. Blaming external events and luck may not be acceptable to investors.

The question on valuation is a trickier one as investors are informed about it before they make an investment decision. Companies could be overvalued. But nobody points a gun to the head of the investors to force them to chip in money.

Investors should do their own research before making a decision. One of my LinkedIn contacts, a seasoned private equity and venture capital investor, uploaded two posts on such a matter early this year.

The first post mentioned that most companies debuting on ECF platforms “appear to be highly overpriced”. He suggested those platforms should give more investing lessons to the public with a focus on company valuation and valuation benchmarking.

In his second post, he pointed out that a waste oil recycling company that was fundraising back then was valued at RM15 million. It had an estimated revenue of RM2 million and estimated net profit of RM141,000. In short, the company was valued at 7.5 times its revenue multiple and 106 times its price-earnings multiple. The latter was unreasonably high, given that it wasn’t a tech company with a highly scalable business model.

He wasn’t the only person who pointed out the valuation issue in ECF. At least two other people, another seasoned investor and a lawyer whom I had spoken to, shared similiar thoughts.

I agree that investors should be better educated on valuation so they can make better decisions and be more prepared for the eventual outcome. This can only be good for the investors and the ECF ecosystem over the long term.

Perhaps, ECF platform operators should be more cautious about promoting the companies they raise funds for. The more funds they raise, the higher their income. But what if a company they had heavily promoted to investors ends up closing shop?

Lastly, the use of “IPO” ­(initial public offering) has been too excessive on some platforms to promote fundraising companies. It is as though any business can get listed in three to five years, which may not be the case.

The bottom line? Platform operators need to tread a fine line between fundraising/marketing and educating the investors.

Save by subscribing to us for your print and/or digital copy.

P/S: The Edge is also available on Apple's App Store and Android's Google Play.