The Wisdom of the Crowd May Not Be All It’s Cracked Up to Be

We know that crowdinvesting is a more inclusive way of providing capital to startups than what we had before.

But is it smarter?

Put another way, does the crowd have capabilities to discern winners that elude venture capital and angel investors?

I believe crowd wisdom is real in some cases. In others, not so much.

I believe in it the same way one of my closest friends believes in it.

He’s a political risk analyst. He used to quote a dozen polls whenever we discussed the most likely outcome of an upcoming vote.

Now he quotes the crowd. Well, a surrogate for the crowd – tens of thousands of gamblers.

When he told me his prediction as to whether England would stay or leave the EU, he didn’t quote the polls. He quoted the British betting shops that said England would stay.

So much for crowd wisdom?

Even those who believe that crowd wisdom is real don’t claim it’s always right.

Brexit aside, he won me over. I’ve stopped following the polls in the U.S. and started following the betting crowd through PredictWise. It adds information from betting markets to make predictions.

Right now, it’s showing Trump’s chances of winning the presidency at 16% and Clinton’s at 84% – a bigger gap than most polls show.

(By this time next week, we’ll know how accurate its numbers are.)

The Old-Fashioned Way

As for investing in startups? I’m more old school. I rely on research derived from several conversations with founders and what I’ve dug up on my own.

That includes looking at the Q&As available on most startup sites – questions asked by interested investors and the answers given by the founders.

This is a form of crowd wisdom – hundreds of eyes focused on a single startup. Those answers often lead to other questions which are then answered to the satisfaction of others… or not. If not, more questions are asked… and answered.

And so the onion is peeled, layer by layer, to get at the truth.

I’ve often wondered how everything would have turned out if Theranos had been subjected to the curiosity of the crowd. Would its “not-quite-ready-for-primetime technology” have been discovered years earlier?

As I asked in an earlier post, would investors have noticed the several caution flags flapping in the wind?

The Crowd vs. the Herd

Unfortunately, what I’ve just depicted doesn’t show the entire picture.

Here’s the thing…

The crowd may more often than not morph into its dreaded doppelgänger, the herd. You know, those sheepish folks who are constantly looking over their shoulders to see what everybody else is doing.

Investors don’t operate in a vacuum – guessing the number of coins in the proverbial jar. It’s the real world, full of white noise and hype.

In the real world, crowd wisdom can quickly turn into crowd stupidity.

Willy Braun, the co-founder of the venture capital firm Daphni, agrees with me. He talks about “correlated errors.”

“If people hear each other, the estimate ends up totally incorrect because we tend to conform, hence getting a… correlated error.”

The crowd is at its best when weighing an outcome dispassionately.

Case in point: Startup Estimize crowdsources earnings estimates for stocks. About 3,000 analysts and 15,000 community members provide the data. It says its predictions are more accurate than Wall Street’s 69% of the time.

The crowd versus the herd? Which one is destined to define startup investing? And does it matter?

I’d like to believe that at the end of the day, startup investing will be a dispassionate exercise guided by the “objective” wisdom of the crowd. But who am I kidding?

Founders Love a Passionate Crowd

That’s not what crowdinvesting is.

At this stage of the game, crowdinvesting is still best understood as a step up from crowdfunding. Think Kickstarter and Indiegogo. Companies turning future customers into current financial backers (without the benefit of equity).

The name of the game has been to create a high level of excitement.

With equity crowdinvesting, two things have changed. Companies’ future customers have become current customers. And those customers’ money now buys shares (i.e., real equity).

What hasn’t changed: The name of the game is still about generating excitement.

The more they generate, the more successful the fundraise is.

Unfortunately, the more passionate the crowd is, the less predictive it is.

And this is why I’m still old school, relying on my own research (and making this research available to premium members).

Will the day ever come that I’ll be willing to meld my due diligence with the singularity of an all-knowing crowd consensus?

Right now, I’m skeptical.

I’ve spent decades keeping my distance from the herd and its sheepish behavior. As far as I’m concerned, it’s the Dark Force.

I know it can seemingly take the shape and form of the fearless crowd. And now you know it too.

Invest early and well,

Andy Gordon
Founder, Early Investing