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Crowdfunding: We need to talk about the elephant in the room

posted Dec 1, 2014, 12:21 AM by J Shaw   [ updated Dec 1, 2014, 12:22 AM ]

The crowdfunding industry has come of age but it still carries several risks that could sting potential investors

Next week, the London Co-Investment Fund backed by Boris Johnson will announce that it has selected six partners to manage £25m worth of taxpayers’ money, which is to be funnelled into new and exciting technology businesses based in the capital.

The Telegraph has received a tip off revealing that one of these partners is the crowdfunding platform Crowdcube.

The sector has officially come of age.

Deputy Prime Minister Nick Clegg has praised the crowdfunding industry for financing early-stage technology businesses, the Financial Conduct Authority has built a regulatory vehicle for the industry, and the crowdfunding space is further legitimised by placing the fate of millions of pounds worth of growth capital in the hands of one of its platforms.

Crowdfunding allows the public to invest in start-ups and potentially make a big return if a company is successful. The risks are high – up to 75pc of these firms will fail, but the system has been lauded for democratising business investment.


This year, the equity-based crowdfunding market will be worth around £84m, according to recent figures from Nesta, up 201pc year-on-year. It dominates finance headlines as the innovative model through which new and established entrepreneurs can raise capital.

http://www.crowdfundmadeeasy.com

But there is an elephant in the room. Investors have yet to make any money from their crowdfunding investments. The only notable success to date is a German crowdfunding platform, Companisto, which raised money for its own business. Investors were recently offered twice what they invested but many are refusing the deal, insisting they could get more bang for their buck later.

Investor expectations are high, yet there is almost no tangible proof that the model works. Jeff Lynn, co-founder of Seedrs, one of the most established platforms in the UK, explains: “Building really successful businesses takes time and while we’d love to say, 'Look at all these fantastic exits’ the reality is that they are likely to take five to seven years.”

When these exits do materialise, Lynn warns there could be a rude awakening for many investors. “Not all crowdfunding platforms are the same,” he says. “There are cowboys out there that do not protect investor rights and we still have a long way to go, in term of regulatory reform, to bring them into line.”

Crowdfunding platforms typically offer two types of investment shares: Class A and Class B. Class B shares offer fewer benefits to the shareholders, can be diluted, and can be non-voting. “Some deals have been structured in a way that investors will never be able to see returns,” claims Lynn. “Even if the company succeeds, they will be worth absolutely nothing.”

This issue can be avoided by asking the right questions. For example, is this the same class of share owned by the founder? Or, does this deal come with rights and protections? But there are other dangers lurking for investors.

Better Capital founder Jon Moulton recently told delegates at a London Loves Business event that start-up companies were fiendishly hard to value and “deals are sold on hype rather than on any reality”.

But the news is not all bad. Crowdcube co-founder Luke Lang says his platform has raised finance for 165 businesses. Just six have gone bust over that time.

Eleven have raised follow-on rounds. Crowdcube itself raised two crowd rounds before securing £3.8m from Balderton Capital. “Having hundreds of shareholders does not mean you can’t raise further finance,” says Lang.

The arrival of regulation has also steadied industry nerves. As of April this year, prospective investors have been told they can only stake 10pc of their net “investible assets” into crowdfunding campaigns – for instance not their house, pension or life insurance. You can only invest if you are classed as a high-net worth or a reasonably sophisticated investor.

The FCA is still not sure that it has gone far enough. “We want to make sure the risks are properly disclosed,” says a spokesman. “Over half of these companies fail within their first few years. That means any investor is more likely to lose all of their capital than to get it back. Since these shares are not listed or otherwise traded on an exchange, you can’t readily sell them, so your money is locked up.”

The new regulations are not enforced by the FCA; investors are responsible for obeying the rules. But more hand-holding would be inadvisable, says Moulton. “You can blow £500 down at Ladbrokes and no one gives a rat’s,” he says. “People ought to be allowed to lose £5,000 to £10,000 a year if they want to on anything they fancy doing.”

There are still many unresolved questions in this nascent industry. Lynn admits it’s too early to tell whether crowdfunding will stand the test of time. “My greatest fear is that a crowdfunded company becomes hugely successful and exits for millions but investors that should have made money end up with nothing,” he says. “It will be a huge scandal and all the crowdfunders will be tarred with the same brush.

Posted from : http://www.telegraph.co.uk/finance/newsbysector/banksandfinance/11261830/Crowdfunding-We-need-to-talk-about-the-elephant-in-the-room.html