Crowdfunding – is it taking over?

Crowdfunding has hit the headlines in recent days with some major fintech companies raising serious money in no time at all – Monzo Bank raised £20 million in a few days which will help them further challenge the high street banks. Previous successes have also included Revolut (another fintech fast becoming a household name) which has since become the first crowdfunding billion dollar (or so-called unicorn) valuation. LinkedIn feeds are full of companies announcing a raise. So, is crowdfunding the future for equity financing?

In short, my view is that, as per usual when it comes to financing, it’s a case of “horses for courses”. But let’s dig a little deeper.

First of all, what is it? Crowdfunding does what it says on the tin – it enables companies to raise funds from a crowd of people. Typically a few hundred people or more investing on average in the order of £1,000 each, often through a nominee structure. Technology and FCA regulation have helped this become mainstream in the UK, allowing the “normal” person to act like a business angel investor. There are many sites out there now but the current dominant players in UK equity crowdfunding are Seedrs, Crowdcube and SyndicateRoom. (There are a host of other players of course and if you widen the net outside of equity there are many other sites offering, for example, Peer to Peer lending platforms such as Funding Circle, which recently listed, or specialist sector platforms such as CapitalRise in property lending).

Where does it work well then?  For the company which is raising finance, crowdfunding seems to work particularly well in certain circumstances (and by “work well” I mean the company funds, or over-funds, at a good (high) valuation:

• Anchor investors in place: Normally it is sensible (in fact most sites actually insist on this now) to have an anchor investor or group of investors who have already committed a minimum of 25%-30% of the fund raise which then encourages the crowd to follow on. In this respect one tactic can be to use crowdfunding to “top up” other forms of more traditional equity funding.
• Existing large and engaged customer or member base: the company can then seek funding from their own customer base using the crowd platform to facilitate the investment. This has the added benefit of a virtuous circle when your customers will then naturally be very loyal to you and also become advocates of your business – a double whammy effect.
• The sector or business has good PR and marketing possibility: Not only will this mean you have a good story to reach out to the wider public but the crowdfunding sites may also use you as their poster boys to promote their business too, meaning greater awareness of your business and your fundraise.

It is well known that a major advantage of crowdfunding is the high valuations companies can achieve via this route. You only have to look at some of the pitches (including those that have been funded) on the sites to see the incredible valuations with little or no revenue generated.  This is really down to the fact that the valuation is set by the company and then it is non-negotiable from that point on (Syndicate Room is slightly different in that their investments are all led by a lead investor who sets the valuation). The hype and “crowd” effect then generates the further interest from investors who are often probably less price sensitive especially given the small-ish sums typically involved per investor.

Speaking of the investor, what is it that has attracted people to invest via this route? Well, having invested myself relatively early on the in the crowdfunding days in 2015 in the salad chain Tossed I can speak a bit from experience. I think people invest via crowdfunding for a few key reasons:

• Tax breaks:SEIS/EIS give investors generous income tax and CGT reliefs and this is almost a pre-requisite for successful early-stage fund raising in the UK now.  Companies must be eligible or seek advanced assurance from HMRC that they should qualify.
• An interest in the business (perhaps they are already a customer) and a desire to be part of the journey:in my case I knew Tossed was over-valued when I invested but I found it an interesting business (quite innovative back in 2015!) and I was already a customer.  As it happens, I had met the founder of Tossed, Vincent Mckevitt, when he opened his first store in Paddington near my office at the time and was impressed by him. They have since gone on to do a deal with Welcome Break service stations, acquire a lot of the Vital Ingredient shops out of administration and have recently done a deal with Coop, so I feel they could be a good long-term success story.  But it is still illiquid and the secondary market is stuck on the original valuation. This is of course one obvious aspect all investors should be aware of and which potentially gets forgotten in the hype – the illiquidity of the investment. Most companies will pitch that they will do a trade-sale or IPO in 5 years time as an exit route but in reality a small percentage actually achieve this.
• Ease of investing: I think the technology and process is now so easy that this is also a driving factor. Similar to Amazon’s strategy of frictionless 1-click buy usability, by making the process easy and relatively transparent transactions via these sites are increasing. For both the companies and the investors, the standardisation of legal documents and the provision of the data room and handing of the deal process, makes this an attractive option.

In conclusion I think there are many reasons crowdfunding is attractive to both investors and companies alike. However, it really comes into its own well in specific circumstances (Monzo is a great example of these criteria coming together) and crowdfunding is certainly not the only answer to funding high growth early-stage businesses. The key to crowdfunding’s long-term survival though will be having enough lucrative exits for investors to keep up their appetite. Perhaps Monzo will provide this too.