BLOG: What impact will rising interest rates have on crowdfunding?
Crowdfunding has exploded in both the US and UK in the wake of the credit crisis and the near collapse (and subsequent rescue) of the banking sector.
Having leveraged itself to the hilt and beyond during the boom years of the early noughties, banks suffered untold losses in 2008 at the height of the crunch, causing them to effectively shut up shop and stop lending.
Only unprecedented government intervention and moves by central banks to cut interest rates to effectively zero saved both economies, and the wider world, from an even deeper downturn.
Such was the impact of the credit crisis that it is only now that central banks can even consider beginning the slow process of normalisation. The US Federal Reserve was the first to take action at the close of last year by raising its base rate to between 0.25% and 0.5%.
More rate rises are likely in the US this year, and we may even see one in the UK at the tail-end of 2016 if growth and inflation expectations do not disappoint.
How crowdfunding – which was born and evolved in an era when rates have been at record lows – is going to be able to cope as they rise is up for debate. There is definitely a case to suggest that as the risk-free rate you earn on cash goes up, investors currently turning to crowdfunding may have less need to do so.
After all, it is one thing to come to market with a mini-bond paying 6% when the best an investor can earn from a fixed-term savings account is around half that (not to mention all the hassles that come with most savings accounts these days, such as switching direct debits). It is quite another to pay 6% when the base rate is, for example, at 3%.
However, there are a few important points to consider which should prevent rate rises acting as some kind of death-knell for crowdfunding, both here and in the US.
Firstly, the point when rates get back to 3% is a long way off. Barring a sharp spike in inflation (and there are no signs of such an event at present given record low commodity prices and sliding global growth), there is simply no need for central banks to hike aggressively.
Secondly, when we eventually reach a point in the cycle where economies can handle rates back at 2% or 3% it will mean growth and inflation are much more stable and entrenched.
As such, the rates of return that businesses can earn on capital they employ might be elevated, potentially prompting more companies to consider borrowing from whatever route – including crowdfunding – to enable them to grow.
The more businesses competing for funding via crowdfunding, the more they may have to offer would-be investors, and therefore rates on mini-bonds and other social investment products may rise.
Lending conditions for banks are also not likely to improve dramatically even as rates climb. Banks are under more regulatory scrutiny now than ever before, meaning even if they wanted to lend more to companies as the recovery continued, they may not be allowed to do so. Crowdfunding has no such regulatory pressure bearing down upon it.
So while a rising rate environment is a new dynamic for the developing crowdfunding sector to deal with, there are plenty of reasons to remain optimistic. It will not be a smooth ride, and due diligence around every fundraise – be it a mini-bond or otherwise – will therefore remain crucial. But there should be no doubt that businesses and investors alike will keep turning to crowdfunding, even as rates slowly creep higher.
Richard Wheat is the founder of the communications consultancy MRM