Save, make, understand money


How to invest in an online Dragons’ Den

Annabelle Williams
Written By:
Annabelle Williams

We examine ‘crowdfunding’, or alternative investments in early stage companies.

Five years after the financial crisis began unfolding, investors are still digesting the challenges thrown up by this disruptive set of events.

Chief among the challenges is how money lending can return to pre-crisis levels, as small businesses rank among many that continue to struggle securing adequate finance. But where there is challenge there is also opportunity, and a number of alternative lenders have stepped in to fill the void left by big banks.

George King, head of portfolio strategy, British Isles at RBC Wealth Management, said business funding in the UK could have reached a turning point, where company management relies on investors rather than banks for finance.

“Is this a turning point where the UK market will become more like the US, with corporates funding themselves more through the market than through banks? That is not how it has been in the UK [historically] but it is interesting to ask if this is a turning point,” he said.

Pooling funds

One of the most innovative solutions is ‘crowdfunding’ – the pooling of a multitude of investors in loans to small businesses through an online platform.

The concept of pooled loans to smaller companies is not a new one, but crowdfunding differs from enterprise investment schemes (EIS), venture capital trusts (VCTs) and business angel networks in several ways.

Businesses on crowdfunding platforms usually seek far smaller sums – typically up to £1m – and platforms will often have thousands of registered investors, allowing the businesses to be scrutinised by a larger pool of investors.

While still a very small sector, the concept is growing and has been given formal recognition in the US through an upcoming piece of legislation – the JOBS Act.

In the UK, the Financial Conduct Authority (FCA) is working on plans to properly regulate the sector, and several crowdfunding platforms have received FCA approval.

Luke Lang, co-founder and director of funding group Crowdcube, describes the format as “like Dragons’ Den but online”.

“A business or entrepreneur can pitch itself online to a nation of dragons,” he said.

Crowdcube was founded two years ago and has since gone on to fund 50 companies with a total of £8.7m.

Businesses seeking capital range from a Somerset-based fruit crumble manufacturer to a south London climbing centre and an HR software provider. The platform offers an equal mix of start-up, early stage and growth companies.

Fledgling businesses looking for funding submit their plans to the platform, where it is up to investors themselves – rather than Crowdcube – to scrutinise the viability of the venture. 

Lang said this aspect of Crowdcube is especially important since traditional sources of finance, such as business angels, too often act as gatekeepers controlling the fortunes of smaller businesses.

“For a business that is trying to raise money, it is challenging with one or two individuals looking to invest a large sum of money, because the balance of power is all with them.

“They have the money and can dictate the terms. Crowdfunding shifts the balance of power back to the business,” he said.

Best ideas

While businesses will benefit from feedback from a large pool of investors, Lang argued investors too will gain from the ‘wisdom of the crowd’, where an aggregation of investors’ opinions will single out the best ideas from the pack.

The typical investor on the platform hands over £33,000, and 20% of investors choose to invest smaller sums.

“That is an interesting statistic because if you look at business angel networks the number of smaller angels would be much lower, less than 5%.

“One of the founding principles of Crowdcube has been to reduce the barriers to people investing and allow more people to get involved,” he explained.

“There are a lot of wealthy people working in the City who would not be active in an angel network.”

Investors on the platform tend to be drawn to technology companies, hopeful that one will turn out to be a disruptive force, and food and drink companies, which Lang said is probably because “Britain is a real lover of food”.

VCTs and EIS schemes have been the subject of regulatory scrutiny in recent years, as the FSA raised concerns over whether investors fully understood the risks involved in smaller businesses – many of which go bust before the investor has made a return.

Crowdfunding attracts similar criticism. However, Lang said investors on his platform must self-certify as a sophisticated investor and complete a questionnaire demonstrating they understand the risks and need to diversify their investments.

He admits only 20% of investors on the platform have invested in multiple projects – although they may have investments outside of Crowdcube – but there is one investor who has diversified across 29 businesses.

“He is a kind of portfolio builder and we love to see that he has spread the risk and has a better chance of one, two, three or five businesses doing well and making a return,” he added.

Investors on Crowdcube are yet to turn a profit, since the earliest investments were made just two years ago. Lang expects these young businesses will only start to return money after three to four years – so investors will have to wait and see.

 Crowdcube’s early successes

Kamm & Sons
Kamm & Sons makes a ginseng-based spirit similar to gin. It completed two rounds of funding on Crowdcube, raising over £500,000 from 154 investors. The drink is now sold in Selfridges and Harvey Nichols, and distributed in Europe. 

Escape the City
This company raised £600,000 through 394 investors to finance a website which helps professionals find a way out of dull corporate jobs.