The idea of platforms raising equity direct from the general public like a charity is relatively new around the world. Equity-based crowdfunding is surging in the UK and just starting in New Zealand and Canada. In the US it has been stymied – the Securities and Exchange Commission has held up legislation for the past two years. The signs are that once the US gets over the hump of legitimising “mass market” equity stakes, it will become a viable alternative to raising capital and a new form of investment with huge mass appeal.
In the past there has been some serious snob value around investing in start-ups in just about every market. In most countries only sophisticated types may partake – in Australia, for instance, those who earn around AUD 250,000 for two consecutive years (or have a net worth of AUD 2.5 million) – are eligible.
The popularity of equity crowdfunding in the UK shows that the need to “get” to brilliant ideas early before the rest of the world is a lure many can't resist. Equity markets as a whole do not fulfil this need – once the company has been seeded and later funded by venture capital, it’s ready to be listed – and so much of the equity has already been sucked out of it. You only have to look at half the new IPOs that come on-stream. The smart money has already been invested long ago. The price has been set on their terms only – the fix is well in.
Lucky strike? People have been warned there’s a 90% chance of losing their money in an equity crowdfunding syndicate.
Too many people have been excluded from venture capital investments because they didn’t know the right people or they were not part of an angel group. As one equity-based crowdfunding group said: “It’s an exclusive club, and before this there was no way of being included. Equity-based crowdfunding democratises high-tech funding.”
Stian Westlake, executive director of UK innovation charity Nesta, says there's a long history of collusion between investment banks and venture capital funds to limit and police access to IPOs and hot tech companies. "In the past you had to be privileged to make investments,” he says. And yet Nesta has estimated that GBP 84 million was invested in the UK via equity crowdfunding in 2014 — three times the previous year.
Ask the tech start-up in-crowd about it and they’ll tell you this is where all the “dumb money” will flow. Your everyday punter, often beguiled by the idea of investing in the latest tech wizardry touted as Twitter Mark II, will lap it up and then some.
The consensus seems to be that equity-based crowdfunding will be a good additional way of raising funds, but not the full answer to capital hungry start-ups. They desperately need sophisticated investors – those more likely to have practical business acumen (read more $$$) – to avoid becoming one of the many start-ups that never make it. In other words, the industry doesn’t need an overload of dumb money investors – which is what equity crowdfunding will bring.
“These are all high risk by nature. Who vets these companies and how do they qualify for equity investment? Only 1 in 20 start-ups get up from seed level. In venture capital it’s about one in six. So people have to have their eyes open going in,” says John Tanner a partner at specialist tech recruitment firm the MitchelLake Group.
One of the big questions has been around platforms administering a high number of investors but this can be solved by forming the investment portfolio into a unit trust or into syndicates, which the platform administers on behalf of everyone. It makes life a whole lot easier having one investor rather than 50. There are other things at stake. Companies can use the idea to bring in the concept of “customer ownership”. A loyal customer base with a stake gives better feedback to a company.
The US-based company AngelList, which recently entered the UK works by letting experienced angel investors create syndicates that outsiders can join to acquire small slices of a company. The syndicate leader and AngelList take 20% of any gains on an exit – 15% goes to the syndicate lead and 5% goes to AngelList. The rest is distributed among the other individual investors.
One of the criticisms is that these small and innovative tech stocks need to have effective controls and this is what is holding up the US market for this type of venture. “At least with listed companies the exchanges make companies jump through a few hoops. Authorities will need to know if directors are legitimate and how liquid these start-ups are as a business,” says Tanner.
Early last year the UK’s financial watchdog, the Financial Conduct Authority, gave its assessment. “It is very likely that you will lose all your money,” the FCA said. And yet far from putting people off, the sector in the UK is among the fastest of all alternative investment platforms. Nesta says it grew by 410% between 2012 and 2014.
In the end, with many of the websites in the UK warning that there’s a 90% chance of loss in these syndicates, one wonders why this sector is thriving at all. It may be a bit like finding gold in the midst of rubble – you might just be the one to hit the jackpot.