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Anyone for a Crowd VCT?




By David Stevenson on 3rd November 2017


Maybe it’s the route I travel on public transport which is the giveaway but my London City – Waterloo journey seems to be increasingly turning into the AltFinance Line. Currently the excellent Wise Alpha is plastered all over the Waterloo and City line. And in recent months Crowdcube has also been blasting out adverts at the Waterloo train station. Not to be outdone, Seedrs is making a regular appearance on the London tube as are a whole number of digital banking apps. Even Abundance in recent years has been making an appearance on billboards at railway stations as far away as Winchester. Now we're seeing Funding Circle blasting out its message nationwide as part of its multi-million-pound advertising campaign.

 

This is all very welcome, but I think it poses some broader questions about what the alternative finance space needs to make itself seem more mainstream. I see no reason why a big player such as Funding Circle shouldn’t use big national brand advertising, but I doubt its overall effectiveness.  My sense is that much smaller, baby steps are needed to mainstream the sector and originate new customers – and, crucially, build brand acceptance amongst investors.

 

I used to think that this process would all be about tax wrappers and platforms. If one looks at the UK, vast amounts of retail investment capital are tied up in investment accounts involving some form of wrapper – usually an ISA but also a SIPP. Thus, I believed that the advent of the Innovative Finance ISA, or IFISA, would be an absolute game changer. I was wrong. My perception – soon to be tested by an AltFi Special report – is that hardly anyone knows what the IFISA is, and even fewer people have bothered to invest any money. Crucially they’ve not invested to date because of simple platform dynamics.

 

Like me, they already have an existing ISA with some other big brand name, and they can’t be bothered to move around to a new provider – or open an additional IFISA. Everything comes back to consumers fundamental disinterest in anything that involves filling out large amounts of questions online or via paper forms. These fact finds are I know a horrible necessity that most investors will go to great lengths to avoid – favouring incumbent platform providers such as Hargreaves Lansdown.

 

What most investors want is to be able to deal in an investment on their existing platform in a structure that they understand and can efficiently price. For the vast majority of investors that means either a FSCS savings product, a fund (UCITs and onshore) or a share/bond. Anything else is frankly too much bother. If said platform offers a tax efficient tax wrapper they can use – fab! Any other structure will fail to get mass market traction. On this reading, a Hargreaves Lansdown IFISA would be a major deal – anyone else’s is a no show.

 

Unit trusts are probably the default mechanism by which investments are allocated in the UK, if only because most independent financial advisers tend to prefer them. But shares and bonds are a decent second best. And these shares and bonds also offer another crucial plus: public markets cachet.

 

Sure, listing a bond, fund or share is a horrible drag, requires layer upon layer of compliance, and is costly. But it provides a warm afterglow to the issuer – these are respectable businesses offering a liquid market in their shares and bonds. This matters. It makes investors think that the businesses are real and will stay around. Crucially it also allows investors to channel money via established platforms – easily, at the click of a mouse, with low dealing costs.

 

Cryptocurrencies are currently struggling with this dilemma. The challenge of packaging up these digital currencies into a user friendly structure is immense but we’re already seeing the emergence of a slew of exchange traded notes (ETNs) which track these digital currencies. I’d expect to see even more baby steps in this market over the next few months – before the inevitable crypto currencies rout. The recent decision by the CME to offer futures contracts on bitcoin is just the start!

 

Back in alternative finance we’ve also seen some very concrete examples of success with public markets. LendInvest’s retail bond has been a real winner - you can find out more about it here. It was over-subscribed, closed early and is now trading at 2.5% premium to net asset value, yielding just over 5%. Over in listed funds land, Funding Circle’s SME Income fund has arguably been an even bigger success. The £300m plus fund is trading at a 3% premium on a yield of just over 6%. Talk to many in the City and they’ll say that they regard the fund as the ‘best in class’ with a premium reputation for delivering on its promise.

 

All of which brings me nicely to crowdfunding. The big platforms in this fast-growing space have been making the right noises of late. Seedrs only this week put out a note saying that more and more IFAs and wealth advisers are making use of its platform. Great! SyndicateRoom has also been making solid progress and I think its Twenty8 fund is a great innovation – pooling investments on its platform in one fund.

 

But I think these are all baby steps – along with the inevitable advertising. Crowdfunding as a business model needs more public market validation. It needs people in the City to go: “ I really rate this model of finding early stage companies because of the success of Vehicle X”. And what might that Vehicle X be?

 

Venture capital trusts or VCTs. These listed investment funds were initially set up many decades ago by Treasury to provide the public markets with a route to investing in early stage businesses. Over time I think it’s fair to say they slightly lost their way and ended up being dominated by asset backed business models. Precisely because so many investors were very wealthy and frequently a tiny bit ancient, they focused on the tax benefits of the wrapper. The game thus became to minimise the possibility of losses by using asset backing. Unfortunately, the Treasury didn’t really like this form of tax avoidance and has rightly forced a change in the model – back towards early stage risky venture capital option.

 

We now need to see the next evolution of the model – a Crowdfunded VCT.

 

This would obviously require a brave asset manager to run the fund and a portfolio of more mature businesses, but I think we are now at that point. There are already fund structures lurking around and we’re told via advertising that there are more and more partial and full exits from underlying portfolio outfits. Crucially we’re seeing a profusion of businesses on the crowd platforms that are now about 2 to 4 years into their evolution – perfect test cases for a CrowdVCT. Investors will still reap all the benefits of a Venture Capital Structure (30% tax reliefs) and the industry would also instantly acquire the right kind of public markets cachet. Who’s going to go first?

 

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