Risks and opportunities in crowdfunding start-up cash

Tom Welsh
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WHERE next for crowdfunding? Individuals collectively pooling money to fund ventures isn’t a new phenomenon – the pedestal of the Statue of Liberty was partly paid for via crowd funds. But in its modern incarnation, the idea has quickly moved on from the non-profit world (the charity Kiva has used the crowd to fund microloans to Third World entrepreneurs since 2005) to become an investment tool for start-ups.

Seedrs, the crowdfunding platform launched by Jeff Lynn last July, has just surpassed £1m in the amount raised by companies through its website. Although the Seedrs model involves investors taking an equity stake, this figure is tiny compared to gross lending by traditional lenders (£10.4bn to the manufacturing sector alone in the second half of 2012, according to the Bank of England). As a recent innovation, however, the crowd is now talked of as a realistic alternative for start-ups seeking early investment or funds for growth.

There are dangers to crowdfunding, however, that are only just being properly analysed. First, for company founders, the crowd could create a capital structure that scares off other sources of cash like venture capital or angel investors. Given the perceived risk attached to crowdfunding, if you resort to it as a means of fundraising, you could give the impression that your firm is too risky or too badly-managed to attract larger early investors. You may also make your company unattractive as a future acquisition – it will effectively be owned by many tiny investors.

Similarly, for investors, there is not yet a secondary market for equity purchased via crowdfunding. Anyone with second thoughts after their purchase will have no easy way to unload shares. This is not to say that crowdfunding is fundamentally flawed. Indeed, Seedrs has designed a nominee investment structure that removes the risks attached to individual investors holding shares directly in each investee company. But these kinds of positive steps have not been taken across the board. So don’t run with the crowd without knowing exactly where it’ll take you.

Tom Welsh is business features editor at City A.M. @TWWelsh