By Sam Griffiths on Friday 3 July 2015
Investing in the equity of young companies is risky - we all know that. Just read the risk warnings on equity crowdfunding websites and they will tell you as much. According to research by the British commercial insurer RSA 50% of UK companies fail in their first 5 years. But how many companies that raise money through equity crowdfunding fall into this bracket?
Equity Crowdfunding has been around in the UK since mid 2011 when Crowdcube launched. Aside from one case (a crowdfund just prior to a planned IPO), AltFi is not aware of any ‘exits’ (ie where investors have got their money back and more) by companies that have crowdfunded on a UK platform. That’s not to say that exits won’t come. But these things take time and the industry is not yet even four years old.
There is in fact a dearth of information about how crowdfunded companies fare after a successful campaign. Even to those who have invested in the companies it is sometimes not entirely clear how their investment is doing. Here at AltFi Data we have been doing a bit of digging into what has happened to the companies that have crowdfunded in the UK over the past 4 years.
We looked at all successful crowdfunding campaigns from the top UK platforms (Crowdcube, Seedrs, Syndicate Room and Crowdbnk) and divided the companies according to the year they were funded. We then used Companies House records to ascertain whether the company was still active, was late with its annual accounts or annual return, or if the company had gone into administration or been dissolved. Companies incorporated and dissolved in the UK are required by law to make this information publicly available through Companies House, a government agency sponsored by the Department for Business, Innovation and Skills.
If a company has gone into administration or been dissolved it is not a good thing for an equity investor. It almost certainly means that they will lose all of their investment (although each case is different). Companies are penalized when they fail to file appropriate accounts and annual return documentation with Companies House. Late filings may be an indication that all is not well at the company and the company is about to go into administration or be dissolved. It may also simply be an administrative oversight but it is on balance a good indicator that all is not going to plan.
The results of our analysis are shown in the chart above. As expected, the proportion of successfully funded firms that are still active is higher for more recent fundraising years, there having been less time for things to go wrong.
Given the RSA statistic that ‘50%’ of companies fail in their first 5 years equity crowdfunded companies appear to be doing rather well. Indeed only 12.5% of companies funded in 2011 have dissolved.
As always this analysis, is not perfect:
Whilst this analysis is a start at trying to quantify the risks and returns associated with equity crowdfunding, it is by no means a finished piece of work. But what good are risk warnings if an investor cannot start to quantify that risk? We understand that past performance is not an indication of future returns, but it’s a starting point.
Lets start by looking at the figures from 2012 – campaigns that happened long enough ago for the businesses to have executed a lot of their business plan and therefore for us to identify some indication of success or failure. Additionally the 2011 sample is too small for us to draw many firm conclusions. So looking at 2012 we can see that three years on from the crowdfund nearly one in ten companies have failed. This alone seems to be a pretty sobering statistic for crowdfunding investors. How many crowd funding investors recognize that one in ten of their investments are likely to go to zero?
This statistic looks even worse when you consider some other factors. Firstly this doesn’t take into account businesses that might have diluted their original investors. These statistics cannot pick up situations where a company has survived, but only because the original investors have had to commit more funds, or been diluted by new investment. On top of this is the lag built in by the 12 month historic nature of companies house data – the true failure rate is very likely to be higher.
Equally alarming is the late filing rate – especially when considered alongside the failure rate. We can forgive some late filings in year 1. This can be attributed to companies learning the ropes. But if we look at 2012 nearly 23% of companies are showing signs that all is not going well with over 9% failed and nearly 14% still struggling to file. You would hope that a company that is progressing to plan has by now a full time finance director or appropriate relationship with an accounting firm. That means nearly 1 in 4 companies are having problems.
To provide some balance we must acknowledge that crowdfunded companies do seem to be doing much better than the rule of “50%”. Arguably this should be expected as not all UK start up companies enjoy the benefit of equity funding at the outset. Equally we have to acknowledge that not enough time has passed for us to show the success stories as it is understandable that realisations are likely to take longer than the 4 years of history we have at our disposal. Finally we should also note that these statistics come against an extremely benign economic backdrop – things will likely look far worse if a down-turn were to hit.
But perhaps the most alarming fact is that we have to dig into the vaults at Companies House to find this data. Equity crowdfunding platforms do not report this kind of information themselves - in stark contrast to the default information that all established lending platforms provide. We would argue that if crowdfunding platforms are serious about representing risk accurately they should allow investors to track the success of previous campaigns. We accept that an accurate measure of capitalization is of course impossible. But some sort of record of the on going position of past campaigns would give investors a far better chance of understanding the risks involved.