When Fairtrade beauty product company Bubble & Balm successfully raised £75,000 in equity finance in July 2011, it was a landmark moment in the evolution of the UK’s then barely established crowdfunding market. Bubble & Balm was the first UK company to make it to the finishing post. Using the newly established Crowdcube platform, the company pitched itself to a community of equity investors and came up trumps with the capital it required. The deal demonstrated that crowdfunding could be used as a viable means of raising growth finance.
Equity has grown rapidly since then, both in the UK and internationally. We’ve also seen the parallel rise of peer-to-peer lending under which businesses can obtain debt finance. The result is that businesses are no longer pitching themselves to a single bank, investor or institution but to a broad community of potential backers, some of which are investing relatively small sums.
According to Kieran Garvey, Associates Coordinator at the UK Crowdfunding Association, equity crowdfunding and peer-to-peer lending sites have so far provided funding for around 5,000 small and medium-sized companies in the UK. It is currently estimated that the crowdfunding market supplies more than £1 billion per year, a figure that is growing annually.
However, it is important to put the figures in perspective. Bank lending to SMEs stood at £7 billion in the third quarter of 2013 alone. VCTs invest considerably less – the Association of Investment Trusts estimated around £1.2 billion in 2012 – with the bulk of that money focused on businesses requiring £1 million or more.
In terms of the bigger picture, crowdfunding has evolved to fill a relatively small but significant space in the corporate finance ecosystem. Bank lending is still the primary source of finance for SMEs but crowdfunding is providing start-up, early stage and growth finance for businesses with a good story to tell. Equally important, funding is available for businesses that would be under the radar of VCTs.
Crowdcube has now facilitated funding for around 80 companies. The average amount raised per pitch to date is approximately £187,000 but there is considerable variation between pitches – one business pitched for (and secured) £12,000, while the largest amount raised was £1.9 million. The average amount invested by individual members of the site is £2,500.
“It wouldn’t be crowdfunding if small investors didn’t continue to take part. But it is right that they should understand the risks.”
Crowdcube certainly isn’t the only option for businesses. Focusing mainly on start-ups in the UK, Ireland and across Europe, Seedrs also has a strong track record of putting businesses in touch with equity investors. Most of the funding deals secured through the site have been in the sub-£100,000 bracket – with a few less than £10,000 – but the sums raised have been as high as £200,000.
As the market has evolved, crowdfunding houses have established their own niches: while Seedrs is primarily aimed at start-ups, Crowdcube’s investment remit runs from start-up, through early stage to growth capital.
“We are seeing more specialisation,” says Keiran. “For instance, you have Abundance Generation focusing on investment in renewable energy projects and Mission Crowdfund specialising in social and environmental projects.” Other platforms include Buzzing, which focuses on social enterprise, while Angels Den and Syndicate have created platforms combining elements of crowdfunding with professional angel investment. Across the Atlantic, Moolahoop is a funding platform for female entrepreneurs.
One of the advantages of equity-based crowdfunding is that you can raise finance at well below the VCT threshold of £1 million plus, without surrendering the kind of stake that venture capitalists require. Nor will you dilute control of the company – in most cases small investors will not expect or receive voting rights.
However, when considering your funding options, it’s worth remembering that in parallel with equity investment crowdfunding, a healthy debt market has also developed – often referred to as peer-to-peer lending.
Building a reputation
From small beginnings the leading players have established themselves as significant finance providers. For instance, Funding Circle draws on a community of around 60,000 people who will collectively lend up to £1 million to businesses in the form of term loans. To date, the business has lent more than £187 million.
While businesses are drawn by the ability to pitch directly to lenders, and to secure relatively low interest rates, investors enjoy an average return of 5.7 per cent and can spread the risk across a number of businesses. In addition to individuals, investors include bodies such as local councils and universities, keen to maximise the return on their cash.
There is still a question mark about the ability of crowdfunding sites to attract investors over the longer term.
Web-based crowdfunding was born early this century, mainly as a tool for creatives to raise money for small projects such as making CDs or films. Donors pledged a small amount of money and were offered certain rewards – such as their names on the credits and access to the artist – but there was little or no expectation of financial return.
Things are different today. While there are still some low-risk armchair dragons who offer £10 or £20, others will potentially be exposed to large losses should the investee businesses fail. So, when businesses begin to fail will the appetite of investors be dulled. Kieran doesn’t think so. “I think people understand that investing in a start-up business does involve risk.”
Change of play
As crowdfunding increases, the ground rules are set to change. The Financial Conduct Authority (FCA) has signalled that in the case of equity investment crowdfunding, sites should only promote their services to ‘sophisticated investors’ and high net worth individuals, or to those who agree not to invest more than 10 per cent of their total assets. The FCA will also impose measures to ensure all investors are aware of the risks across the equity and debt market as a whole.
Kieran believes the proposals are sensible and that small investors won’t be deterred. “It wouldn’t be crowdfunding if small investors didn’t continue to take part,” he says. “But it is right that they should understand the risks.”
The FCA rules will come into force in the spring of 2014, introducing new protections for lenders and investors. This should help cement crowdfunding and peer-to-peer lending into the crowdfunding landscape.
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