A guide to equity crowdfunding
We go back to basics and look at the risks and rewards of the fast-growing equity crowdfunding space.
Equity crowdfunding offers investors the chance to own shares in private, start-up businesses through online platforms.
The first platform launched in 2010 and since then, the market has grown exponentially with the arrival of big name entrants such as Seedrs – which attracts an average monthly net investment of £1.6m from around 1,000 investors – and Crowdcube – which raised £39.5m last year, a 133 per cent increase on 2013.
However, the report was not without caveats. It identified several potential benefits of equity crowdfunding, believing it a useful way for organisations or individuals to access finance that banks or other lenders are not prepared to offer (or, only at high rates), and that consumers may be able achieve higher returns than those available from other financial products if an investment was successful.
Backing the next Apple
The main advantage of the sector is the chance to back businesses that could be the next Apple or Google, at an early stage.
There have been a number of sector success stories.
In 2012, 207 crowd investors raised €300,000 for biotech start-up Antabio. They subsequently sold their stake to an angel investor, securing return of over four times their collective investment in the process. In 2014, Rewalk Robotics floated on the NASDAQ, producing a return of over five and a half times the original crowdfunded investment of $3.3m. In July this year, E-Car Club became the latest exit, securing investors on average four times their initial investment when it floated.
“Get it right with equity crowdfunding, and the returns can be significant,” says Goncalo de Vasconcelos, chief executive of SyndicateRoom.
“While not the 10 times return on investment some angel investors aim for, it’s still great news for the sector and investors alike. As equity crowdfunding matures, there will be more and more successes.”
James Codling, co-founder of equity crowdfunding platform Venture Founders, highlights the “very generous” tax relief offered to equity crowdfunding investors.
Depending on the campaign, equity crowdfunding investments are covered by the Enterprise Investment Scheme (EIS) or Seed Enterprise Investment Scheme (SEIS), provisions intended to assist small companies raise finance. Platforms typically denote which scheme an investment qualifies for.
EIS investments attract income tax relief of 30 per cent of the cost of shares, on investments up to £1m annually; SEIS 50 per cent, on a maximum investment of £100,000. Shares must be held for a period of three years from the date of purchase for relief to be retained.
An illiquid, high-risk investment
Although there are plenty of success stories, for every triumph there are countless flops. As many as nine in ten start-ups fail within the first five years.
Among other warnings, the FCA’s report said of equity crowdfunding: “It is very likely that you will lose all your money”. While Codling thought the report was severe, he agrees the main risk of equity crowdfunding is the prospect of an investment failing.
“An awful lot of businesses that get listed [on platforms] don’t make it,” he says.
The quality of an equity crowdfunding platform is also of crucial importance. de Vasconcelos believes a worthy platform can be identified on the basis of its existing investor profile.
“Do you want to be one of a large number of small investors, or part of a select group of sophisticated investors? I know where I’d rather be,” he says.
Codling believes investors should stick to platforms with strict and selective screening processes.
“Ensure the platform only admits opportunities that meet certain criteria, and demonstrates how the company can achieve profitability,” he says.
“A platform should actually meet with the prospects they list, too – and offer up their diligence freely. If they don’t, or this isn’t available, treat the prospect with scepticism.”
Where your money is held when you make an investment is important. Crowdfunding platforms regulated by the FCA are covered by the Financial Services Compensation Scheme. The investee company, however, is not covered. This means that is a regulated crowdfunding platform fails, your money is protected if they hold it. If the platform passes it directly to the listed firms, it is not. If a business you invest in fails, this money isn’t protected either way.
Investors should also be conscious that equity crowdfunding investment is a long-term prospect. As such, it is not for investors who need to cash out in four or five years time.
“Remember, equity crowdfunding investment is fundamentally illiquid – once you’ve made your investment, you can’t exit easily. You should assume your shares can’t be sold until the company lists on a stock exchange, or is bought out by another company, if at all,” de Vasconcelos says.
He also warns that some platforms can deprive investors of profits by offering different share classes.
“Some platforms treat their crowd as second class citizens, by offering them inferior classes of shares (B class) to those available to larger investors,” he says.
“This is unacceptable. Look for a platform that only offers one class of shares, or lets investors choose.”
Codling believes equity crowdfunding should only form a small part of a diverse portfolio.
“Not only should you invest in a number of different start-ups at once, you should limit your equity crowdfunding investments to 10 per cent of your portfolio – as per the FCA’s recommendation,” he concludes.