By Matthew Cushen
A report about private investment deals released this week shows that over 2017, Crowdfunding platforms raised £218million. After a dip in 2016, they are back to growth for a record ever year. At £69 million raised, the last quarter of the year was also the strongest and crowdfunding is showing real momentum going into 2018. (The report is The Deal: Equity Investment in the UK 2017 published by Beauhurst.)
As an experienced angel investor the question I get asked most often – from budding investors and from entrepreneurs – is should we consider crowdfunding?
In answering this I always have to declare a bias, Worth Capital has an investment fund – the Start-Up Series Fund – that has been very deliberately designed to exploit the investment philosophy that my business partner and I have developed over a dozen years of angel investing. Nominally it is a competing product to crowdfunding, and has been designed to overcome some of the shortcomings of crowdfunding. But as for any investment class, a discretionary fund (where the investment choices are made on behalf of the investor) is designed for a different risk appetite and for different objectives than for when an investor wants to pick their own investments.
Spreading the word and creating a market
Crowdfunding – particularly Seedrs and Crowdcube – have done more than anyone to engage a mass consumer, create an interest in seed investing, and spread the word about the generous Seed Enterprise Investment Scheme (SEIS) & Enterprise Investment Scheme (EIS) tax reliefs available. Along with Scottish Enterprise, Crowdcube, Seedrs and Syndicate Room are the top funders for the number of private investments in 2017.
Engaging and breeding excitement
The crowdfunding platforms are super engaging & stimulating, what’s not to love about seeing loads of interesting innovation? It’s easy to get lost for hours of browsing.
Then making an investment, however small, creates the opportunity to tell others about ‘buying equity’ and being a part of a company’s growth. Sharing in the excitement, e.g. when a product hits a super market shelf or an app takes the app store by storm.
But a great idea is not the same as a viable business. And it does feel as though the platforms very effectively use consumer marketing techniques to engage and entice, sometimes at the expense of the cold-blooded analysis and due diligence that should go into deciding whether a business is worthy of an investment.
This is where a fund is more efficient and effective. In our case we are a couple of real world commercial entrepreneurs with stacks of brand, marketing, retail and innovation expertise – deployed on finding the best businesses. Then we are further held to account by an FCA authorised Fund Manager who ultimately choose whether or not to invest in our picks. Our process takes about 6 weeks and includes plenty of face time checking out the entrepreneurs.
The biggest criticism of crowdfunding recently has been the company valuations. These seem to have drifted very much in favour of the entrepreneur. It’s almost as though the incentive given by the government in tax reliefs to mitigate the risks of seed investing have ended up being absorbed by increased valuations. We struggle to see the circumstances where an idea, with no proof points and an inexperienced team is valued at anything over £500,000. Maybe in the frenzy of tech in the US, but not for rational investors. Sharing a stage at an event last week I heard a senior crowdfunder mention that they were now actively encouraging more circumspection amongst their entrepreneurs when setting valuation.
An investor receiving professional advice or investing in a fund will be guided, or mandated, to diversify risk across several investments. This is even more important for seed investors, where the nature of the investment means that a proportion of investments made will fail completely, others may not return and the profit will come from a high return from a relatively small proportion of the investments. So it is particularly concerning that the crowdfunding platforms themselves are concerned about the low (1.3 investments on average) number of holdings per investor. These the equivalent of betting on a number at a roulette table and being disappoint that it didn’t come up.
A significant challenge for the whole seed investment market is the likely wait to see a return on investment. Whilst others promise less, we believe 5 to 7 years is a realistic timescale for SEIS and 3 to 5 years for EIS investments. Where Seedrs have made a great leap forward is by creating a secondary market so that – if there is demand – it may be possible to sell a holding before the point of an exit or other liquidity event. It’s a difficult nut to crack but we are starting to gain confidence that several platforms (and not just for crowdfunding) will successfully facilitate an open market in seed investing over the next couple of years.
So, we see some huge positives around crowdfunding. But there are significant watch-outs. If an investor gains lots of value from the act of choosing and investing, can put effort and care into selecting a balanced portfolio and is circumspect and digs into valuations offered then there is no reason they cannot create a good return. There are, however, other lower effort ways to invest in seed businesses, gain the tax advantages and end up with well-considered, expertly assessed, diversified portfolio.