How you could invest in the next Facebook before it goes public

Start-ups are risky – but the rewards could be huge

Sensible investing is about getting rich slowly. You save every month, you diversify, and you invest for the long run, using cheap tracker funds where possible.

But we all dream of investing in one of those life-changing stocks – a company that multiplies your money many times over, turning even a tiny speculative punt into a small fortune.

If you want to make those sorts of big returns, you have to take big risks. And the riskiest businesses of all are those at the earliest stages – the start-ups.

Facebook is a good example. One venture capital firm invested $90m in the social media giant back in 2009. That stake is now worth around $3.5bn.

I’m not suggesting that all start-up investments will perform as well as Facebook. Far from it. In fact, most will fail. That’s why you should only ever speculate with money you can afford to lose.

But if you like the idea of using a small part of your investment portfolio as your very own venture capital fund, then I might just have the answer for you.

It’s called equity crowdfunding…

How equity crowdfunding works

Equity crowdfunding is new and risky – let’s be clear about that. But the potential returns are big.

Here’s how it works. Young companies effectively advertise for investors on one of the crowdfunding platforms. The best known UK platforms  are Seedrs and Crowdcube.

If you’ve ever used a peer-to-peer lending site such as Zopa, it’s a similar idea. But rather than a loan, these companies are looking to raise equity.

The young companies say how much money they’re looking to raise, and how big a stake in the company the new investors will receive in return.

For example, right now a company called AngloBuddy is looking for investors on the Seedrs platform. AngloBuddy wants to create new video content for people who are learning English around the world. It is seeking a total investment of £25,000. In return, the new investors as a group will get a 10% stake in the company.

A company needs to raise its target investment within 90 days of appearing on the Seedrs site. If the target is missed, no investments are made, and investors keep their cash.

Investors don’t have to pay any upfront charge when they invest. Instead, the entrepreneurs have to pay a 7.5% charge once their cash target has been hit.

If any shares in the investments are sold at a later date, Seedrs will take a 7.5% cut from the investor’s profits.

Crowdcube operates in a similar way. The great thing about both sites is that you can invest as little as £10 in any one company. Looking at the sites right now, I’m drawn to several potential investments.

On Crowdcube, I especially like Habhousing, which has been founded by Kevin McCloud of Grand Designs fame.

Then on Seedrs, I particularly like goCarShare which makes it easier for drivers to share their car with other users and cut their travel costs.


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What are the risks?

The small minimum investment level means that you can easily spread your money around ten or even 20 investments without betting the house. That means there’s a decent chance that at least one of your investments will prosper and you could potentially make an overall profit.

That said, there’s also a decent chance that all of your investments will fail. And even if you invest in a company that succeeds and becomes profitable, you could still lose out.

That’s because other investors may come in at a later stage and dilute your shares down to a ridiculously small percentage of the total share capital.

The Financial Conduct Authority (FCA) is certainly aware of these risks, but the regulatory picture is a little confused at the moment. As things stand, most crowdfunding sites insist that you’re a sophisticated investor before they’ll let you part with any money.

And in response to regulatory pressure, Seedrs encourages investors to invest at least £1,000 in total across a range of companies by the end of their first year. It may start reviewing client portfolios in the future to check that investors are hitting that target.

However, the FCA will report the results of a consultation later this year. I think there’s a good chance we’ll then see simpler rules across the whole industry.

Which sites are best?

It’s worth looking at two other crowdfunding sites: Syndicate Room and Crowdbnk.

Syndicate Room differs from the rest because its minimum investment size is much larger at £500. That makes it harder to reduce risk, but the attraction is that all investments on this platform have an experienced business angel as a ‘lead investor’ on the project.

So if you invest via Syndicate Room, you know that at least one experienced angel is positive about the investment.

Crowdbnk is interesting because it doesn’t just offer equity crowdfunding. There are some potential investments on the site where you’ll receive a ‘reward’ rather than shares in return for your cash. So if, for example, you invested in an art gallery, you might get discounts on any art that you bought from the gallery.

There are also crowdfunding sites where investors are lend money to businesses rather than buying shares. Two well-known sites in this sector are FundingCircle and Abundance Generation.

But my personal preference is for equity crowdfunding because that’s where the biggest potential profits lie. Indeed, one report suggests that if you had invested across 1,080 early stage UK businesses between 1998 and 2008, you could have achieved a 22% annual return.

I also like the Seedrs platform because I like the simple nominee structure for investors. In short, you as an investor won’t get voting rights in any company where you invest. Seedrs does all the work for you.

You might see that as a bad thing. But at this level, I think that being represented by the platform itself, rather than scattered among many small individual holdings, means that private investors are less likely to be treated badly by other stakeholders in the business. That at least offers some sort of defence against the risk of dilution.

We’ll be looking at crowdfunding in more detail in a future issue of MoneyWeek magazine. If you’re not already a subscriber, get your first three issues free here.

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10 Responses

  1. 16/09/2013, steveH wrote

    Rather than Funding Circle I’d like to plug thincats (dot com). You make loans to existing companies, typical rates 8-12%, minimum loan £1000, with security (often in the form of directors’ personal guarantees), each company has been vetted by an experienced and known person, and the platform has a Q&A section for each proposition so you can profit from the wisdom of others. For the companies it is an alternative to bank borrowing, perhaps cheaper, perhaps with less hasle and less “blackmail” than you get from banks. And you get to help industry to progress!

  2. 16/09/2013, rjwavre wrote

    A thoroughly poor article. You shouldn’t be advocating such poorly regulated investments as these. They are basically pure punts and offer the allure of the Dragons Den. Why do you particularly like some of these investments – because someone is on the telly? The reason why people are advised to spread their money over a number of investments is so they won’t complain when they lose it. If you say that you should invest in 10 and hope that one pays off it would have to make a return of nine times your investment. Good luck and can you also let me know who is going to win the 2.30 at Doncaster? Shameful.

  3. 16/09/2013, rjwavre wrote

    I presume Steve H works in the industry. If these loans are such high quality why don’t the banks do the business? What due diligence have you done on any of the loans? How do you know if the directors aren’t already encumbered up to the eyeballs? As above if you make 10 three year loans of £1000 at 10% and five go bad how much money have you made or lost? And remember the interest is taxable while there is no relief on losses. Good luck.

  4. 16/09/2013, steveH wrote

    @ rjwavre
    I don’t work in the finance industry, far from it. (I have nothing whatsoever to gain from the plug I gave; I have lent limited amounts on thincats). I worked in actual industry, where you find far fewer villains than in the money business.
    Why don’t the banks do the business? Because they still haven’t the capital to lend anything to anybody. That’s what a credit crunch is!
    Due diligence – you get to see accounts, credit reports and so on. So far they have (can’t be bothered to look up the real figures, something like 5 bad out of 100). If it were as you suggest it would be a bad thing; if you are interested check it out further for yourself and report back.

  5. 16/09/2013, steveH wrote

    @
    ” if you make 10 three year loans of £1000 at 10% and five go bad how much money have you made or lost?”

    I make it you lose 250 if repaid monthly (1750 if term loan) depends mainly on when the bust ones went bust (I assumed after 18months)

    Taking the same scenario, but 2 go bust, I now make it 1700 profit if repaid monthly (700 if term loan)

    A 2.5% savings account interest compounded (as if!) would get you around 770.

    All figures very ish

    • 16/09/2013, rjwavre wrote

      Steve

      f you dont work for them why say I would like to plug the company. If half go bad I would suggest that (using your scenario) you would get interest of £1000 * 10% *3 years = £3000 less (say) 40% tax = £1800 + Interest on the bad loans for 18 months so another £900. Sp £2700 in total (generous assumptions about the bad debts). But you would have lost half your capital. So you would be down £2300.

      You cant do the due diligence so you have to take the word of the loan documentation that you are provided with. As someone once said its not return on capital Im worried about its return of capital.

      These unregulated schemes always end in tears. You just have to tick the box to say you are a sophisticated investor which means that you have seen Grand Designs according to Money week or a couple of episodes of Dragons Den.

      • 17/09/2013, steveH wrote

        Why plug thincats?
        Because I’m a believer.
        Because I think it’s much higher quality than Funding Circle.
        It’s not for startups, it’s at the level below AIM.
        Because it seems to me that the management of thincats are not on some hit-and-run swindle, they don’t appear to make huge amounts, in fact the cludginess of the website says just the opposite to me, too busy doing business to gloss up the premises.

  6. 16/09/2013, charlesdb wrote

    In fairness, anyone who reads this article will be intelligent enough to know the risks involved. We all know its just a punt. Like betting on the horses. So I have no complaints.about the article on that score. The problem is one of trust and integrity. Having attended a number of presentations by would be entrepreneurs, I can tell you, these characteristics are often in short supply. So on that basis “I’m out.”

  7. 17/09/2013, nickm wrote

    I also feel I need to defend lending to businesses a bit here. The number of defaults in the industry is currently c.1%. This is forecast to rise to as much as 5%, nothing like the 50% default rates quoted on this thread. That is also the percentage of loans classed as bad debt, which is important because if a loan is repaid monthly (as the majority are) and towards the end of the term it goes bad, the amount of money lost will be significantly less, but the loan is still classed as bad. There is also the functionality on many sites, Funding Circle, rebuildingsociety, Funding Knight etc to trade loans, so investors can de-risk their portfolios by concentrating on loans that will carry less risk – like those secured on assets.

  8. 26/11/2013, Sage of Aldershot wrote

    I found Ed Bowsher’s article and these comments very interesting. Just because some investments are more risky than others does not mean that we should be protected from hearing about them. A company has to start somewhere, so what is wrong with a pitch on a web site? Some standardisation of the controls on propositions and proposers, as Ed mentions, would be helpful, but then it is up to us to decide. Nice to have that freedom.

Commenting on this article closed

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