Why crowdfunders need to focus on finding the best deal for investors rather than offering the highest valuation for companies seeking finance

Luke Davis
(FILES) A picture taken 17 April 2007 in...
Alternative finance has a key role to play in the long-term growth prospects of SMEs in the UK (Source: Getty)

In Britain, small to medium-sized enterprises (SMEs) account for 99.9 per cent of the nation’s private sector businesses, employing 15.6m people and boasting a combined annual turnover of £1.8 trillion.

Worryingly, however, despite their importance to the British economy, more than half of these SMEs will fail within the first five years of establishment, with insufficient capital cited as one of the most common reasons for failure.

Read more: SMEs have a gloomy view of the economy

In the challenge to support the long-term growth prospects of SMEs in the UK, alternative finance has a key role to play.

In particular, the equity crowdfunding market is a fantastic way of getting capital to the small businesses that need it quickly, while also promoting the company’s product or service to a large number of its target demographic.

However, there are a number of issues that need to be addressed so the equity crowdfunding model can endure and evolve; surviving the backlash that a number of industry leaders predict is on the horizon.

The industry is experiencing rapid growth, which involves platforms securing significant market share as quickly as possible. In order to do this, the platforms need to acquire large amounts of investment, with most of this coming from well-known players in the private equity arena.

Read more: Why growing businesses should have a lead investor when crowdfunding

The issue that is arising is that some platforms are neglecting investors and are instead focusing their efforts on attracting more SMEs to the platforms by offering exaggerated valuations.

In my experience, an average investor will build a diverse portfolio of between 10 and 20 companies over a period of two to three years and then wait for a series of successful exits before re-investing any gains.

I fear that, because valuations on companies seeking finance via equity crowdfunding platforms have become increasingly inflated, more investors will find themselves unable to exit within the usual timeframe, in turn meaning they are unable to re-invest as quickly as hoped.

This could mean that platforms will have to focus their efforts on attracting new investors in order to compensate for the loss of first adopters who drop out of, or get stuck in, the investment cycle.

To do so, both financial and personnel resource will have to be spent on marketing to potential new investors.

Read more: This fintech firm just smashed crowdfunding records (and that's a problem)

It is at this point that we could see a problem; the marketing spend from platforms will not last forever and they will ultimately have to rely on a positive track record to attract new investors.

Fortunately, recent research commissioned by IW Capital found that 71 per cent of investors with more than £40,000 worth of investments stated that they were confident in SMEs’ ability to drive economic growth, with 43 per cent saying they would consider investing in small businesses over the next five years.

It is important that platforms take advantage of this burgeoning investor interest and confidence in SMEs rather than relying too heavily on the existing collection of equity crowdfunders.

Ultimately, to safeguard the future of equity crowdfunding, there should be more focus on finding the best deal for the investors as opposed to offering the highest valuation for companies seeking finance.

It comes back to the old cliché of quality over quantity – platforms must prioritise vetting potential deals rather than relying on volume.

There are a number of platforms that are already addressing these issues, but for the equity crowdfunding sector to continue growing at such speed these alterations need to become industry standard.

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