Need to Know . . . equity crowdfunding

Buying shares in a company through equity funding ranks among the riskier ways of investing. The businesses tend to be new and the regulatory protections very limited.

But given that you can invest as little as £10, it’s a low-cost way of betting on start-ups, as long as you don’t get carried away.

Equity crowdfunding platforms are hoping for a rally this year as the turmoil in financial markets has limited many new companies’ access to loans and private capital, their main funding sources.

With higher interest rates driving private equity and venture capital firms to pull back on riskier investments, crowdfunding may become a more tempting option, at least for a slice of the capital needed.

If fundraisers are keen for cash, investors might get better deals. But bear in mind there are tough economic times ahead — and those private equity experts have withdrawn for a reason.

What is equity crowdfunding?
Retail investors have long sought to access private markets, due to the prospect of above average returns. But the main entry routes into individual companies require large investments, often £100,000 or more. Vehicles such as venture capital trusts are aimed at wealthy investors — and involve investing in a portfolio of private companies.

Equity crowdfunding investors typically put £1,500 to £4,000 into a single business, and sometimes much less.

The market has swelled since the early 2010s, after the 2008 global financial crisis hit mainstream sources of capital, and encouraged equity crowdfunding platforms to fill the gap.

Hundreds of millions are invested by UK investors each year, with Crowdcube and Seedrs raising £324mn in 2021, in popular sectors such as fintech and consumer goods.

Challenger bank Monzo and craft beer company BrewDog have raised multiple times on crowdfunding platforms, as well as tapping larger mainstream financing.

Where can I invest?
While equity crowdfunding began in the US, it has grown in the UK with the emergence of two market-leading platforms, Crowdcube and Seedrs, which together have 90 per cent of the market. Crowdcube’s co-chief executive Matt Cooper says the platforms were born out of the financial crisis and remain a “solution for companies raising capital in a downturn”.

Investors are charged upfront between 1 and 2.49 per cent, while platforms take anywhere up to 7.5 per cent of any profits after a successful exit.

Fundraising companies pay between 6 and 8 per cent of the money raised by the platform, including administrative charges.

Am I a typical investor?
The bulk of investors in their late thirties and early forties, but older people too are active.

Alayne Perrott, a retired climate scientist, who has invested in 60 crowdfunding companies, has supported the likes of Salisbury-based Small Robot Co and Scotland’s Orbital Marine Power.

She says investors must have a strong risk appetite, but can benefit from backing small companies pursuing innovation.

Many crowdfunding investors are enthusiastic about climate tech. Perrott says: “I’m determined to translate my deep anxiety about the current trajectory of the global climate into action . . . but I’m not into superglue or climbing gantries.”

Product incentives can also be attractive. Brian Byrnes, head of personal finance at investment app Moneybox, says he invested in a London distillery which put a third of the investors’ money behind the bar as a tab — an attractive offer.

Can I lose my money? 
Start-ups are speculative. Nearly a fifth of companies which raised money on a crowdfunding platform since 2011 have folded, according to Beauhurst, a research group, which traced 2,394 companies.

Moreover, only 5.3 per cent of these businesses have staged a successful exit where investors were paid out.

Success stories include investment app Nutmeg, which was acquired by JPMorgan for double its value in 2021 only two years after it had raised funds on Crowdcube.

But bear in mind that a successful company doesn’t necessarily mean a happy crowdfunding shareholder. Crowdfunding investors usually provide only a slice of the initial capital, alongside the founders themselves and wealthy backers, such as angel investors.

If a company does well, it will need more finance — which is normally provided by those bigger investors, plus venture capital and PE firms. So the interests of the original crowdfunders can get forgotten.

For example, some shareholders in BrewDog, who number 180,000, have in the past raised concerns over aggressive dilution when institutional investors entered the picture.

How much risk is right for me?
Don’t even think about crowdfunding if you have other more important financial bases to cover. “There’s a lot of boxes you need to tick off before [equity crowdfunding] comes into the picture,” says Byrnes, such as paying down debt.

The Financial Conduct Authority advises investors to stake no more than 10 per cent of their net investable assets in unlisted companies.

Crowdfunding platforms say they verify claims made by companies raising funds against the FCA’s “fair, clear and not misleading” guidelines. But disgruntled investors have claimed companies can be overvalued.

Property site Emoov’s collapse in 2018 only months after it raised £1.84mn in funding on Crowdcube left backers in uproar, while investors in app Money Dashboard were dismayed when it was acquired by ClearScore for a quarter of its valuation last year.

At the time, Crowdcube told This is Money that it warned investors of the “real risk when investing in start-ups and growth companies”. Money Dashboard did not respond to a request for comment.

Disaffected consumers can raise complaints with the Financial Ombudsman — but only where they think there were shortcomings in how an investment was explained. Last year, when 48 complaints were received, only eight were upheld.

Crowdcube says it fact checks every pitch against the FCA’s guidelines, significantly discounts sales projections and undertakes credit and bankruptcy checks on company directors. But it does not approve or review pitch decks, updates or company forum discussions.

Seedrs’ chief executive Jeff Kelisky says the company has a team of 30 focused on due diligence, though it cautions it does not require evidence for “aspirational statements” and does not take a view on whether ambitions will be realised.

So, dear investor, you are largely on your own in assessing the offer before you.

Are there tax benefits?
UK residents can benefit from 30 per cent tax relief on crowdfunding investments eligible under the government’s Enterprise Investment Scheme. Investments. Up to £1mn each year must be held for at least three years. Individuals can “carry back” their investments, treating all or part of an investment as if it were purchased in the previous tax year.

Investors can also claim loss relief if a company enters administration or is sold for less than its initial valuation.


Business Asia
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