Investors are pouring into the crowdfunding arena. Barely five years old, the sector is growing in the UK at an annual rate of more than 200 per cent, according to research organisation Nesta. The think tank Massolution says the global number of crowdfunding sites, in a variety of forms, grew from 308 in 2013 to more than 1,250 last year.
Whatever the exact numbers, equity crowdfunding — in essence, attracting private investors direct to capital-hungry smaller companies via the internet — is the talked-about new thing in the money world. To its advocates, it’s exciting, democratic and socially valuable, in the sense that it channels under-utilised savings towards high-growth businesses. To the entrepreneurs behind those businesses, it is rapidly becoming a more accessible path to growth than the traditional cap-in-hand approach to City brokers and institutions. But to observers of a nervous disposition, it’s a formula that can too easily tempt novice investors to back ventures of which they know little, at valuations that make no sense.
The biggest equity crowdfunding platform in the UK, with 51 per cent of the market, is Crowdcube, which set up shop in 2010. In September it reached a milestone of £100 million raised: some 200,000 investors have funded 290 businesses. Currently 32 ventures, from online estate agent eMoov.co.uk to ‘ethical pet accessory brand’ Love Thy Mutt, are looking for capital through Crowdcube’s site.
Other big names include Seedrs, the first equity crowdfunder to pick up an FSA licence in 2012, and Syndicate Room. Seedrs doesn’t say how many investors have signed up, but chief executive Jeff Lynn says companies pitching on his site are securing around £4 to £5 million each month — just behind Crowdcube, which raised around £50 million in the first eight months of this year. Syndicate Room is smaller but boasts that not a single company it has allowed to pitch on its site has yet gone bust.
So far, so good. But the first sticking point is that there has only been one successful crowdfunding exit in the entire global market. It happened in July, when E-Car Club — the UK’s first all-electric car-sharing venture — was sold to Europcar. Back in 2013, the club raised £100,000 from 63 Crowdcube investors before going on to secure institutional investment from Centrica-backed Ignite Social Enterprise, the country’s first ‘social impact fund’ targeting energy-related ventures.
Europcar’s acquisition of a majority stake has given E-Car Club’s Crowdcube investors a ‘multiple return on their investment’. Crowdcube won’t say exactly what that means, but Emanuela Vartolomei, founder of crowdfunding analysis firm AllStreet, believes the return was three to four times the initial investment. Crowdcube does reveal that the average sum invested was £1,500, and the most put in by any individual was £15,000. Citing Nesta figures for the average return to business angels in the UK at 2.2 times their investment capital, Vartolomei reckons the world’s first equity crowdfunding exit was above that average.
But before you get carried away enough to cash in your pension pot and start following the crowd, consider that the returns to date can be presented in a far less favourable light. Crowdcube also says the average number of companies invested in by its E-Car Club investors was 12. If those investments were equal in size, and the return on E-Car Club was a multiple of three times, it follows that they will need at least two more successful exits at similar multiples before they break even.
But seasoned venture capitalists probably wouldn’t consider that an adverse ratio. Jean Miller, chief executive of equity crowdfunding platform InvestingZone, says experienced investors typically aim for a portfolio of ten companies and expect to lose money on eight but make it back, and more, on a couple of winners. ‘Crowdfunding can only ever be as good as the underlying investment selection,’ she says. ‘Pick your portfolio carefully and don’t get caught up in hype. Remember that companies that have mastered the art of self-promotion and social media may very well lack substance. So don’t follow the crowd, follow the experts.’
And bear in mind that there is not yet a secondary market for investors to trade out of crowdfunded equity stakes before the investee companies reach the point at which they list on an exchange or are bought by a third party — though Crowdcube chief executive Darren Westlake says he expects the industry ‘or maybe us’ to develop a secondary market within the next two years. What investors should really be doing, he adds, is looking for companies that can ‘deliver returns of eight or nine times the original investment. Their success would make up for the failure across the rest of your portfolio. How do you spot them? Well, if I knew the answer to that I’d be a lot richer.’
This is the crux of equity crowdfunding. It’s a high-stakes gamble. You’re more likely to be investing in a concept than in the assets or cashflow of a proven business. To stand a chance of making a return, you should only invest what you can comfortably afford to lose, do your research, spread your risk in modest bets across a number of different ventures and sectors — and think hard about the value in each proposition. Professional investors are sharp-pencilled about what they’re prepared to pay in relation to past and promised performance of young companies. A key challenge for crowdfunding investors is that valuations can sometimes start very wide of the professional mark.
The Camden Town Brewery recently pitched via Crowdcube for £1.5 million of capital. The company was initially valued in the pitch at £75 million, which some investors questioned, given its turnover of £9 million. To put that valuation into context, the established Adnams brewery in Southwold turns over around £60 million and made net profits of £3 million in 2014; listed on the Plus market, its market cap is around £30 million.
Camden’s valuation was later adjusted down to £50 million — and the final sum raised soared past £1.5 million to reach £2.75 million. Then there is the case (recently referred to in The Spectator by Martin Vander Weyer) of the Yorkshire-based healthy food chain Filmore & Union, which sought £500,000 through Crowdcube on an initial valuation of £5 million, having achieved turnover of £3.1 million the previous year. Private-equity pros tend to raise their eyebrows when a young company, however promising, is valued at significantly more than one year’s historic sales: sure enough, the value of Filmore was reduced to £3.75 million, and the fundraising was not only completed but increased to £932,000, from 317 investors.
The finger-in-the-wind first valuation seems to be a regular feature of the crowdfunding mechanism, and potential investors should not hesitate to say so when they think an otherwise interesting offer is overpriced. But perhaps the moral is that for investors risking small sums — minimum investment is £10 at Crowdcube and Seedrs — valuation isn’t everything: the reward for a £100 investment in Camden was a free special edition bottle of beer plus a 5 per cent discount at the bar.
And it’s too sweeping to claim that overvaluation is a problem particularly afflicting equity crowdfunding, according to Dillen Iyavoo, co-founder of Funding Tree, an equity crowdfunding website that also allows its investors to engage in peer-to-peer lending. ‘There are always questions of valuation, even when you’re investing in big companies. What we’ve got to deal with, however, are more shades of grey… Some companies only have big ideas. Others have meticulous business plans.’
Emanuela Vartolomei says investors should keep four key points in mind before choosing a company to back. ‘Only invest in a business you understand, which means knowing how it will make money. Always swot up on its market and competition. Understand where it’s heading by nailing down its strategy. Bear in mind that more than 50 per cent of companies go bust within three years.’
Investor protection is another important consideration. Danny Cox, head of financial planning at Hargreaves Lansdown, is sceptical of the sector’s ability to protect amateur investors. ‘During the investment period, how does the investor ensure there is fair and appropriate ongoing governance of the business and that growth benefits shareholders and is not simply spent on higher salaries, benefits for directors or majority shareholders?’ he asks. ‘At present, [crowdfunding] seems ripe for minority shareholders to be ripped off at every stage of the transaction.’
Jeff Lynn from Seedrs responds that investors need to look into the level of protection offered before signing up to any crowdfunding platform. Seedrs runs a nominee structure of share ownership, holding and managing the shares of start-ups on behalf of its investors — and says the advantages of this include giving every investor voting rights as well as protection from future dilution.
‘Private companies can give very few rights to investors. Not all platforms have shareholder agreements in place and without them this can lead to potential investor abuse,’ Lynn says. ‘Our approach is that business angels and venture capitalists use shareholder agreements and so should equity crowdfunders.’
So is equity crowdfunding a suitable home for your spare cash? Danny Cox says ‘in principle, when done well’, equity crowdfunding could potentially be used as a top-up to your more secure savings and pension arrangements. Only crowdfunding projects that offer genuine investment equity should be considered, he adds. ‘Many of these have either SEIS or EIS status, which provide additional tax benefits such as income tax relief of up to 30 per cent, no capital gains tax and exemption from inheritance tax if held for two years.’ In general, however, ‘Equity crowdfunding cannot provide any certainty and should only be considered as a high-risk and small part of an overall portfolio.’
But if you’re still tempted to try equity crowdfunding — and you’ve done your homework properly — don’t be put off by too many caveats. According to Dillen Iyavoo of Funding Tree, ‘It all boils down to whether or not you want to get involved with a company while you can still afford to and before the institutional big boys come in.’ That can be a fascinating and rewarding journey, and crowdfunding has made it more accessible than ever before.
Crowdcube’s most notable deals
Pitch that raised most: JustPark.com, a peer-to-peer parking service that matches people with spaces to rent out to drivers in need
Raised: £3.7 million
Number of crowdfunders: 2,900
When: March 2015
Pitch that attracted the biggest single investment: Sugru, an adhesive business that makes ‘a mouldable glue designed to fix almost anything’, named by Time magazine as ‘one of the 50 best inventions in the world’.
Raised: £3.5 million
Biggest single investment: £1 million
When: July 2015
The only successful exit to date for a crowdfunded venture: E-Car Club, the UK’s first all-electric car-share club.
Raised: £100,000 in 2013
No. of investors: 63
Exited: July 2015, sold to Europcar