The biggest turn off for investors in equity crowdfunding is the length of time the money is tied up. Most crowdfunding campaigns estimate a ‘return’ or ‘exit point’ for investors at four or five years, but in reality, the lock-in will be much longer. Some platforms project the exit point for most investments will be seven years or more.
Here we are five years into a fledgling industry and out of the hundreds of equity crowdfunded businesses we have so far only seen a handful of exits.
Exits so far …
There are many reasons why investors want to exit investments, we might need the cash for an emergency, we might be holding shares that have increased in value (assuming the venture has been successful) and want to realise the investment, de-risk (which means selling enough shares to ensure the original investment amount is returned and is no longer at risk of being lost) or just realign an overweight portfolio. Investors may also simply see higher returns in alternative opportunities.
The problem with equity crowdfunding platforms is that they don’t yet feature a fully accessible secondary market. Sitting on unrealised profits that you can’t access is possibly more frustrating than if the company has failed, because in that scenario at least you have a clear and known outcome – i.e. you lost all your money.
While you are waiting to realise an investment, even one with accrued gains, there is always the risk the company can ultimately fail and the shares suddenly become worthless.
Unlike shares listed on an easily accessible stock market, private company equity is illiquid and owners have limited options for an exit: a share buy-back by the issuing entity, a sale to another private investor, or a trade sale or take over. A trade sale is the purchase of the entire company and is the most common exit strategy for investments in unquoted companies.
Until there is a fully functioning and efficient secondary market for equity crowdfunding this form of investment will not make it into the mainstream.
An exit strategy should be included in the investor’s prospectus and presentation. It’s the section I turn to first. If the entrepreneur is not focused on returning my money in a timely and profitable way then I’m not interested in giving it to them. Almost all pitches include the now almost passé sentence that says something like ‘we think a potential exit could come from a trade sale to a competitor’, but check if it has laid out the route map to this exit and an estimated time frame.
If the company is focused on giving a timely return to shareholders it will have put the same amount of effort into researching, planning and communicating the exit strategy to potential shareholders as it has done for marketing, competitors, finance, and overall management of the business.
Just because a company says it expects to make a trade sale, doesn’t mean that it’s going to happen. That’s just the entrepreneur’s ambition.
Look for research about:
1. Similar companies which have achieved a trade sale.
2. Have the directors identified companies which might eventually be interested in buying them?
3. Does the strategic plan focus on developing the company for a trade sale with set targets and timescales?
The answer to these questions will help you decide if the entrepreneur has really set out to create a commercial enterprise or if the venture is just a vanity project and you are just funding someone’s dream job. The likelihood of a trade sale is remote, so what other options for exit are available for investors?
Of course, private equity owners can sell their shares, if they can find a buyer and agree on a mutual price or if an independent valuation can be attributed to the company. Other mechanisms are starting to emerge which can give investors more optimism for an early exit:
Entrepreneurs enticing investors with early exit opportunities will not only get more novice investors to try equity crowdfunding but it will make their campaign stand out from the rest in an increasingly competitive landscape.
AltFi is returning to Amsterdam for its second annual Summit in the city. The inaugural event last year was a roaring success, with key figures from across Continental Europe's alternative finance and digital banking sectors highlighted. These included Jeroen Broekema, managing director of Funding Circle Netherlands, and Mieke van Engelen, head of innovative partnerships at ABN AMRO's standalone lending platform, New10.