Equity crowdfunding: be an angel and back the next Facebook
Ed Bowsher has been using equity-crowdfunding platforms to invest in small businesses and start-ups since 2012. Here’s what he’s learned so far.
There's a lot to be said for equity crowdfunding. It enables private investors to buy shares in firms that aren't listed on the stockmarket, often start-ups or early-stage businesses allowing you to dream that you're investing in the next Facebook, right at the beginning. What's more, many of the investments on the equity-crowdfunding platforms are eligible for tax relief under the Seed Enterprise Investment Scheme (SEIS) or Enterprise Investment Scheme (EIS).
I've been following the sector since 2012 and I've also made modest investments in various businesses. It's been fun, and I don't regret doing it, but I'll admit I'm a bit disappointed that I haven't had a big winner yet. You could argue that this is true for the sector as a whole. But the big winners will probably come.
What is it and how do I get involved?
The best-known equity-crowdfunding businesses are Crowdcube, Seedrs and SyndicateRoom, which are all platforms where businesses can go to raise cash from individual investors. Here's how it works. If an entrepreneur wants to raise funds for their company, they can approach a platform and ask to pitch their business to investors. Assuming a platform is willing to host the fund-raising which is far from certain the campaign is launched.
Each campaign has a target for fund raising. So let's say a business called XYZ Ltd is running a campaign. The target might be £500,000 at a £2m valuation for the business. Typically the campaign would then last for 60 days. If the campaign doesn't reach the £500,000 target within the timeframe, then the campaign has failed and all money is returned to the people who had pledged it. But if the campaign does hit its target, then it can carry on and go into an "overfunding" phase, where more money is raised. Investors then get shares in the business once the campaign has finished, and the paperwork has been done.
The first thing to note is that investing in this type of company and this particular market is extremely high risk. It's almost inevitable that you'll invest in some companies that will go bust. You've just got to hope that your "hits" will make you enough money to make up for your "misses". You also need to factor in the lack of liquidity. While some platforms have set up secondary markets on which you may be able to sell your stake in unlisted companies, there's no guarantee of being able to do so. So even if your companies perform reasonably well, you may have to hold them for some time before you can realise that value.
These risks are one reason why there are often tax advantages for investing in these companies. If you invest in a company that's eligible for the SEIS, you get 50% tax relief, and for the EIS it's 30%. There are other reliefs on top as well.
A brief history of equity crowdfunding
The first equity-crowdfunding campaigns in the UK ran on Crowdcube in 2011. Seedrs followed suit in 2012 and SyndicateRoom in 2013. The different platforms have all evolved in slightly different directions, and I'll look at each of them in more detail in a moment. But overall, looking at how things have gone, while there have been a few success stories, I'm disappointed that we haven't seen more successful "clean exits", where a business has been sold at a very substantial profit for investors. The growth for the sector as a whole has also been a little disappointing. Yes, the sector has grown, and Crowdcube, for example, has raised £335m for businesses since it launched. But I certainly expected the sector to be bigger by now, and I'm not alone in that.
Crowdcubehas attracted support from a wide range of private investors, and it now has more than 500,000 registered investors on the site. And there have been some real successes. E-Car Club was an electric-car-hire business that was sold to Europcar in 2015. Investors made a 300% return. The Camden Town Brewery has also done well investors made a profit of around 70% in a very short time.
But the most impressive success on Crowdcube has probably been Revolut. This digital-banking business first raised cash on Crowdcube in 2016. Last month, it raised money from venture-capital investors who valued the overall company at $1.7bn. Crowdcube investors were able to sell out at that point if they wished, with a return of something like 20 times their original investment. That's the kind of success story I want to see more of. Monzo has been another digital-banking success story on Crowdcube.
The minimum investment size on Crowdcube is £10, so it's easy for private investors to take a small punt. As for my own portfolio, I've only ever made one investment via Crowdcube £250 in Chilango, a restaurant chain. I was never happy about the fact that Crowdcube started raising cash for businesses back in 2011 before the platform had regulatory approval (although it has had that regulatory approval for a long time now). I'm also concerned that too many fundraising pitches on the platform include forecasts and targets that are far too ambitious. Rob Murray Brown from ECF Solutions, a small-business finance consultancy and equity-crowdfunding specialist, told me he has records of more than 400 companies that have raised money on Crowdcube and the vast majority have missed the projections they made when they first raised cash.
Seedrsis similar to Crowdcube in many ways. The minimum investment is £10 and there's a wide range of companies on offer. The Seedrs' list of success stories includes Revolut (again) the company raised money on Seedrs in 2017 after its Crowdcube campaign and Wealthify, a "robo investment" business that was sold to insurance giant Aviva.
Seedrs has always operated a nominee model where your investment in a company is held by Seedrs on your behalf. That means Seedrs makes decisions on voting and so on. The advantage to this is that it puts the platform in a stronger position to look after the interests of all the crowdfunding investors in the years following a campaign (this can help to minimise the risks of dilution or other governance issues, when and if further fund-raising campaigns are launched). I much prefer the nominee model to holding shares on a direct basis. Crowdcube offers a nominee model as well as a "direct" model where each shareholder can make his own voting decisions.
Seedrs has been a pioneer in launching a secondary market on its platform, which the nominee system has made easier. The secondary market is a bulletin board for sales and purchases that operates during the first week of the month. Transactions have to be done at the prevailing valuation for the company concerned (this is normally the last price at which the company has raised cash).
I've had a lot of fun investing via Seedrs I've invested in 58 different companies so far. Some of these investments have been minuscule less than £100 but others have been more significant. They include a £1,000 investment in the Seedrs business itself (which could bias me in its favour, I guess). I've often invested following evenings where companies raising money pitch to potential investors in person.
SyndicateRoomis a little different from Seedrs and Crowdcube its minimum investment is £1,000. Under its model, there has to be a "lead investor", sometimes an individual angel investor, sometimes the representative of a syndicate or firm. Crucially, all investors on SyndicateRoom invest on the same terms as the lead investor.
SyndicateRoom tends to attract firms in the technology and healthcare sectors. I've invested a modest amount in the SyndicateRoom business itself, along with two other investments. Syndicate Room also operates some investment funds that enable you to invest in all businesses that raise money on the platform, giving an element of diversification.
How have they done?
Other platforms out there include GrowthDeck, VentureFounders and Envestors. I don't have space here to discuss them, but they're all relatively small. As far as overall performance goes, it's very hard to get conclusive data on the industry. That's mainly because there haven't been that many exits. If a company is sold, you know its valuation; if it goes bust, you know it's worth nothing. But otherwise it's tough a company may raise money in a later fundraising round with a high valuation, but you don't know if that will be sustained, and the lack of liquidity makes pricing particularly tough. Seedrs provides an estimated valuation for investors' portfolios, and for what it's worth, it says that my portfolio has grown by 30% in value with an internal rate of return (IRR) of 12%. With tax relief, that rises to 25%. But I've had no exits and there's an element of "finger in the air" here. Using the same methodology, Seedrs reckons its whole portfolio generated a 14% IRR up to September 2016.
A site called CrowdRating provides analysis and ratings on nearly all Crowdcube campaigns and some campaigns on Seedrs and SyndicateRoom. There is some evidence to suggest that CrowdRating is good at spotting businesses that are likely to go bust, so it may be worth subscribing if you are interested in the sector. I also like the Fantasy Equity Crowdfunding Blog, written by Rob Murray Brown (mentioned earlier in this piece). It may well evolve into a subscription site in time, but for now it's free. As I said, I'm a little disappointed with how my investments have done and with the returns so far for the industry as a whole. But I'm not going to give up investors just need to be clear that this is high-risk stuff and a lot can go wrong.