The Equity Dead Zone: Why Crowdfunded Deals Can Be Quality Deals

posted in: Crowdfunding | 3

When we picked a target market segment to start our business, we chose real estate developers doing projects that need up to $7 million in equity. Many investors and pundits are skeptical of crowdfunded deals because, as a recent GroundBreaker user put it, they could end up “being subpar because the best deals usually get gobbled up fast without needing to use a website.” I think it is about time to do away with this misconception.

A deal being crowdfunded (or offered online) has nothing to do with quality. Yes, quality deals sell well, but only if you have (a) at least somewhat decent salesmanship and (b) an audience to reach. Absent (a) or (b), your deal is a no-deal. Things, especially investment “things,” don’t sell themselves. They never have and never will.

So, why is this guy wrong? Because our target entrepreneur (again, the guy doing projects that require up to $7 million in equity) is in a particularly dangerous zone, which I have come to call the equity “dead zone” for real estate financing.

The Dead Zone. Photo by Ikhlasul Amal.
The Dead Zone. Photo by Ikhlasul Amal.

The Institutional Problem

To the north of the equity dead zone are institutional investors. Institutional investors have large mandates (usually 9-10 digits). These funds need to deploy lots of money quickly to achieve their target double-digit returns. They want to do this with an efficient and streamlined operation so they can maximize profits.

Institutional investors have to devote the same amount of time and resources to a $3 million investment as to a $30 million investment. An institutional investor will therefore want to avoid the deals in the equity dead zone: if I need to deploy $300 million dollars, I’d rather do it across 10 deals than across 100 deals. The latter would just be an administrative headache and would cost me lots of money in operations.

A second reason why some institutional investors do not invest in smaller deals is the lack of audits, which most public funds require, but that small deals cannot offer (the cost is prohibitive).

Finally, some institutional investors want only to invest in their peers’ “institutional” deals because they think it would make them look bad to invest in a small project sponsored by someone without the Wall Street credentials to tout. It’s basically a good ol’ boys club of mutual recognition and pats on the back. They operate in a circle of mutual approval and do not look beyond.

The Friends and Family Problem

To the south of the equity dead zone are friends-and-family networks. The problems with these are more obvious. A developer’s network may be limited because:

  • He is still establishing his business (it takes many years to do this)
  • He may be raising funds for a larger-than-usual project (and his network is not large or does not have deep-enough pockets)
  • His network may already be tapped out (i.e. he has too many projects going on at once and again his network is not large or does not have deep-enough pockets)
  • He may be an amazing developer who happens to enjoy staying at home and reading stories to his kids rather than meeting new investors
  • He may not have gone to the right school, joined the right country club, etc.

The Bottom Line

Developers on GroundBreaker are almost invariably in the equity dead zone. This is a very nasty place: too small for institutional, too big for friends and family. It is not because of lack of quality that their deals are not getting gobbled up. It is because they do not have an audience of investors.

This is the problem that GroundBreaker is here to solve.

3 Responses

  1. Great post Stefano!

  2. I agree with your post, 100%!! The equity “dead zone” exists in other market segments as well. In the oil and gas industry, typically any deal less than $20M is considered too small for institutional consideration. It would be great to have a Equity CrowdFunding Platform for smaller (quality) deals in the petroleum energy sector. I might build one… call it PetroShares, and offer passive investors access to pre-vetted oil deals from selected smaller independent operators with good reputations and successful track records.

    • Great idea Joel. While we focus on real estate, we might be able to help you get started with your platform. Call me to explore: 305.962.3156