Equity crowdfunding: The 2016 refresher guide for investors

 
Harriet Green
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An increasing number of boutique platforms are offering sophisticated investors direct access to early stage companies (Source: Getty)

Alternative finance has provided us with several new asset classes, and one of them is equity crowdfunding. In 2015, the global crowdfunding industry grew to $34.4bn – more than doubling from a year earlier – according to a report from Massolution. In the UK, research from Alt Fi published in November of last year suggested that the equity crowdfunding sector alone would raise close to £140m in 2015.

A quick reminder

Equity crowdfunding enables retail investors to invest in startups and SMEs in return for an equity stake. According to Alt Fi, 367 startups have raised across the five largest UK platforms, giving them access to capital and investors an opportunity to be involved at the early stages of businesses.

From an investor perspective, there are several things to bear in mind if you’ve decided to put some money into a crowdfunding raise. Any expert will tell you to take your time thoroughly researching the company, its financials and management. Research from the UK Business Angels Association has shown that doing at least 20 hours of due diligence per investment will “considerably increase the chances of a more positive outcome from the investment”.

And this year, as companies age, we’ll see a significantly higher velocity of failures and exits coming out of the industry. Alt Fi’s research found that over 80 per cent of the firms that crowdfunded between 2011 and 2013 were still trading happily at the time of the report, but to date, there have only been two confirmed exits in the UK, both last year and via Crowdcube – E-Car Club and Camden Town Brewery. While some investors will see a sizeable return on their investments, others will see companies in their portfolio fold.

What about the platforms themselves? Their due diligence, compliance with FCA rules, charging structure and investor protection should all be looked at closely by would-be investors. Of the leading platforms, Seedrs, Syndicate Room and VentureFounders all use a nominee structure, for instance, which means the platforms hold shares on behalf of investors. This makes them responsible for administration tasks, but it also means they may advocate for shareholders in certain situations.

There are also different share classes used regularly in the industry. If you have Class B and C shares, you will likely be waiving your voting rights. This may well mean that a company can pass any resolution without consulting you as a shareholder and, in the event of a proposed exit, you won’t have much of a say.

But as the industry matures, the average age of a crowdfunding firm increases (according to Alt Fi, it is now 3.32 years) and crowd experience grows, there are new considerations for investors. Here are a couple of them.

Evolving models

It’s fairly obvious, but new market entrants are bringing variations on the theme to the table when it comes to ways of structuring platforms. We’ve already seen Syndicate Room introduce the concept of a VC or angel lead investor for each funding round, and VentureFounders cultivates a relationship with companies fundraising, supporting them closely over several years.

Next week, a new platform called Growthdeck will launch with a panel of experts attached to each raise. The team has also set a minimum investment level of £1,000 for investors. Increasingly, companies turning to equity crowdfunding have been setting these floors, and the creation of platforms dealing with “tailored crowds” (i.e. fewer individuals putting in more money) is becoming more pronounced.

These platforms can be termed boutique – because they only intend to list a certain number of raises at a given time, while also having a more involved relationship with the firms fundraising. Meanwhile, industry giants Crowdcube and Seedrs continue to grow, providing companies and investors with the benefit of scale and experience.

It’s also worth considering platforms’ charging points. Most platforms to date have levied an arrangement fee, usually of between 5 and 7.5 per cent, contingent on a company being successful in its raise. Some then take small equity options in firms, and others have begun taking a cut of investor profits. Some equity crowdfunding platforms also have or are introducing an annual management fee.

Improving investor protection

On the investor protection side of things, granted, there will be new players whose work leaves something to be desired, but as in any market where competition stiffens, standards will inevitably rise.

Currently, leading platforms do a mix of providing access to Companies House data and offering coverage of companies that fail, and the number of investor events is steadily rising. But Alt Fi and others have already recommended that the role of platforms in investor protection be significantly increased, with them taking responsibility for regular company updates and introducing uniform reporting standards.

I asked Darren Westlake, co-founder of Crowdcube, what the platform will be doing this year to help its 240,000 investors better understand the financial positions of the businesses they have invested in.

In addition to pulling external data from Companies House and Moodys (which it does at present), it will be creating additional analytics tools to “make viewing of multiple data sources easier... and help investors monitor the progress of their investment portfolios over time,” he says. “We will also be looking at making it easier for entrepreneurs to foster a strong relationship with their community of investors and provide them with current data on their performance.” It is likely that we’ll see other platforms follow suit this year. After all, the equity crowdfunding industry is built around the aim of improving access and openness for the average retail investor.

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