The growth rate of equity-based crowdfunding has been impressive. Research by Judge Business School and EY has shown that, between 2012 and 2014, volumes grew from €5m to €111m in the UK, rising four-fold last year. But while more and more individuals are considering both equity and debt-based crowdfunding as a novel but viable investment option, the high valuations of some companies seeking finance in the industry have raised a few eyebrows, with questions over whether a crowdfunding bubble is looming.
Do investors really know what they’re getting into? Will such ambitious figures seriously limit the upside of the investment? And what will happen when the defaults come? I spoke to platform founders James Codling and Dillen Iyavoo to get an insider perspective.
|James Codling is co-founder and managing director of VentureFounders, formerly of JP Morgan and Montagu Private Equity|
|Dillen Iyavoo is partner at BellHouse Capital and co-founder and chief executive of Funding Tree|
What is your response to the bubble argument? Are valuations too high?
JC: Where entrepreneurs and companies are setting investment terms through broker-based equity crowdfunding platforms, there is a natural risk that their valuation expectations will be over-inflated. However, it is our opinion that, in general, entrepreneurs looking to raise money via the crowd are not overly mis-pricing their valuations and that the crowd does a relatively good job of keeping valuations in check by voting with their feet.
But there has been a worrying trend in recent months towards more consumer facing, celebrity-led brands using crowdfunding to push the valuation boundaries based on the hype that they can generate around their product or service. In our opinion, these investment opportunities tend to appear overpriced. Early stage investing is notoriously risky and we firmly believe that risk should be priced appropriately. Many of these campaigns have offered investors an entirely inappropriate level of return for the risk that they are taking.
DI: Valuations on crowdfunding platforms are indeed big. But we believe they are warranted. It’s when you start looking at the complex network of stakeholders in the platforms that you see where the value lies. Many platforms are designed not only to take the place of banks in supporting businesses with loan deals, but also to provide a completely new approach to business investment by having equity deals as well. This enables us to support businesses through their whole life cycle, from equity investment for startups, to loans for SMEs.
Are would-be investors being sufficiently briefed before investing?
JC: People are often blinded by the headlines rather than looking at the detail. Investors should treat crowdfunding like any other investment they make and give it due care and consideration. However, sometimes it is not easy to access the information you might need to be able to make an informed decision about an investment opportunity.
DI: Businesses seeking funds should be put through a rigorous assessment process. Like other platforms, we include all the documents and presentations they give us as part of the pitch on our platform, giving investors the same access that we have. This kind of transparency means everyone is reading from the same page, and investors are able to see all the information for themselves. If they’re not happy with anything, they can simply ask a question to the business directly.
How can an armchair investor reduce risk on investments?
DI: A diversified portfolio and investing an amount relative to income is the truest sign of a savvy investor, because they are the ones that understand that business investment carries risks. Looking at both debt and equity models opens up possibilities of creating extremely diverse portfolios.
JC: Equity crowdfunding can be a part of a balanced portfolio, but it is important to make sure that you have a balance that ensures long-term growth. Investors should be encouraged to diversify their investments over a number of opportunities, given the risk profile of the asset class.
What should would-be investors be asking businesses and platforms?
DI: They should be asking about average interest rates, in the case of debt platforms, to see if the rates match their ambitions as an investor. They should also only ever use FCA-regulated platforms. For people who prefer to invest in equity, they should be clear that some platforms don’t allow them to own shares directly – typical of platforms with nominee structures. It’s not always a good thing to have a platform in the middle as it adds a layer of risk. A share certificate will give a physical representation of an investment.
They should also ask about what protections are in place should a platform itself fall by the wayside. If we were to stop trading, for example, we have debt companies that would come in and continue to act as intermediaries for businesses and investors.
And what about the prospect of widespread defaults?
JC: This market is risky; that is why the government has provided tax incentives to encourage investor involvement. Due to the risks, there will undoubtedly be defaults, but this is why platforms need to communicate the benefits of a diversified portfolio of investments, and ensure that investors have the appropriate protections they need in place.
A nominee structure enshrines investor protections such as voting rights and anti-dilution. And having experienced investment teams and a senior adviser panel that provides ongoing support and guidance to the businesses after the funds are raised are, we believe, crucial. After all, it’s incredibly important that we are supporting entrepreneurs through the good times and the bad.
City A.M. has partnered with Crowdnetic for the launch of its suite of UK crowd finance data. It features real-time information on private, UK-based companies publicly raising capital online through securities-based crowdfunding portals.