Thursday 14 January 2016 5:20 am

The certified investor: IW Capital and Money&Co’s Luke Davis on how to avoid a regulation deluge in the crowdfunding industry

Before crowdfunding, plenty of private equity and investment firms were already helping their clients to raise money and make investments in smaller firms via the Enterprise Investment Scheme (EIS) tax relief. Now, some of the individuals involved have branched out into crowdfunding.

Meanwhile, the newest entrants into the crowdfunding market, particularly within equity, are structuring themselves in a very similar way to private equity houses – but are using technology to make the investment process faster, and more democratic.

By the age of 26, Luke Davis was a partner at Charles Street Securities, specialising in financing startups that qualified for EIS. Now, he is chief executive of private equity house IW Capital and co-founder of Money&Co, a debt-based crowdfunder he runs with noted fund manager Nicola Horlick. A key focus for him is greater investor protection; I caught up with him to find out more.

How have you seen the industry evolve?

I set up Crowdfinders, a crowdfunding events firm which gives individuals the opportunity to discuss the industry, because the notion of raising money, people via people, is brilliant. But there are problems and, as the market grows, we’ll see increasing backlashes against platforms that don’t offer sufficient due diligence and adequately protect investors. But that’ll mean new and better models that are geared towards quality, rather than quantity. That’ll also see more extensive voting rights for retail investors, and better valuations – more platforms taking a VC approach.

Will that come at the expense of the average retail investor?

Not at all. The beauty of the alternative finance industry is its accessibility to all types of retail investors. Crowdfunding platforms are an ideal investment venture for retail investors looking to direct a small volume of personal capital into a newly-established company. For the high net worth investor, tax incentive products such as the EIS which we manage at IW Capital are ideal.

Evidently, alternative finance is a young industry which has organically evolved to meet investor and company needs. The risk of the UK finance market being flooded by alternative platforms is a viable concern, which is why the government needs to proactively introduce policy that ensures that alternative platforms become a long-term, concrete pillar of the UK finance industry.

What are your thoughts on inflated valuations within the industry?

It’s no secret that valuations are overcooked. The problem will obviously be felt on exits. It’s over-inflating the cost of raising money and, therefore, the price for the ordinary investor. He or she is getting shares with no voting rights. I can see why platforms want to create volume and encourage SMEs to come on, but we’re just storing up a problem for later. When a company comes to Series B, investors will just get diluted – and not be able to do anything about it.

And another stored up problem within equity is marketing spend. A lot of platforms are spending a very large amount on marketing. The average investor is going to diversify their portfolio, maybe have six to 10 investments. They’ll hope, during a five to 10-year journey, to see some results. But during that time, a lot will stop investing and sit on their hands. As and when platforms and private equity houses stop throwing money at marketing, they’ll have to rely on the quality of their investments. You’ll see a lot contract because of that.

Do you think the government has optimised EIS/SEIS reliefs?

No. On the one hand, the message from government is that investing in early stage businesses is fantastic and should be encouraged. On the other, we’ve had the tightening of regulation around EIS, which makes it harder for a company to qualify. Management buyouts, for instance, no longer do. EIS came in at £1.5bn in 2014 – 50 per cent up on the year before.

Over this year, I expect the relief to go backwards for the first time. That’s not a good thing. Management buyouts and ins were becoming a bit of a niche for our business. Overnight, several deals were made unviable, and there are tens of other firms where that will have been the case too.

On the lending side of things, what changes do you expect to see this year?

Again, it’s a case of growth and evolution. There’s more than enough room for others besides the big players that have emerged. This is a sector with 40 per cent quarterly growth; that’s insane, and a good thing all round.

Another element is the relationship between P2P lenders and banks. The latter don’t want to lend, but they can still have good relationships – and I think we’ll see far more looking for partnerships, particularly in the UK.

What about consolidation? Will we see some small platforms bought up this year?

This is definitely likely, though the extent is yet to be seen. Smaller platforms have their advantages, and consolidation risks them having to compete on a different field with larger players. What I can say is that the number of lending platforms in the UK will grow significantly, perhaps more so than in any previous year.

Within lending, what would cause a crunch point in the industry?

As with any rising industry, my main worry is alternative finance outpacing government policy and regulation. We know that, when governments witness a phenomenon they do not fully understand or control, there is a tendency to over regulate. I, for one, support policy that promotes due diligence and facilitates smooth transaction of capital between investors and companies. EIS and SEIS should be seen as the beginning of tax relief policy, not the end. More needs to be done. Of greater concern is the current EU proposal to limit EIS only to young companies. This would be a step backwards not only for UK SMEs, but the alternative finance industry itself.

You’ve spoken before about practical ways to offer retail investors further education. Can you talk through that?

The confidence that early adopters have placed in the crowdfunding industry has been integral to its success. Yet at times, it leads to recklessness. People self-certifying as sophisticated investors are doing so subjectively, meaning that investments are less informed and subsequently more frivolous. Combine this with a medley of online platforms that facilitate loosely governed “click-investments”, and the waters become choppy.

To mitigate this, I think we need to implement more than a legally worded splash screen on crowdfunding platforms and start to gradually phase out self-accreditation. The introduction of an investor training process that is measured against an industry-recognised scale is key to ensure safe levels of growth.

If more platforms and industry bodies – myself included – lobbied for the FCA to back a certification process, we can establish an infrastructure that protects the retail investor – according to their actual level of investment knowledge. I am an advocate of the fintech revolution and its immeasurable impact on the UK private sector. But it is essential that we establish a safe and responsible environment that protects all those that benefit.