As a starting point, companies crowdfunding do make available to the crowd the legal documents to be entered into – investors should take the time to review these (particularly the proposed articles of association) as they will contain details of the shares investors will be receiving. However, these documents are not always user friendly, and are often written in legal jargon. Therefore, we thought it would be helpful to list some of the key factors eager investors should consider before agreeing to invest in the latest crowdfunding trendsetter:
Check whether the shares are capable of being diluted on a downround? This occurs when, following completion of the crowdfunding, the company subsequently raises additional funds at a lower valuation than the valuation offered in the crowdfunding round. The net result of this is that the existing shareholders (including those coming in on the crowdfunding round) will have their shareholding in the company heavily diluted. By way of contrast, typically a VC or angel investor would expect to receive contractual protections, ensuring that if there were a downround, they would receive such number of additional shares to offset the dilutive effect of the issue of cheaper shares.
Has the proposed valuation been properly scrutinised, or is it simply based on an over zealous estimation of the company’s revenue and potential growth? It is becoming increasingly clear that one motivation for companies choosing to crowdfund is that platforms are willing to market the company with a higher valuation than that which would be considered acceptable to a VC or an angel investor. The recent example of Camden Town Brewery serves as a cautionary tale – the company gave itself a valuation of £75m when it crowdfunded, but within a couple of months it sold part of its business to a Belgian firm, and Camden Town Brewery’s valuation based on that transaction was £50m.
Do the shares have the benefit of pre-emption rights? This means that if the company raises money in future, will all investors be entitled to participate in the fundraise in order to maintain their proportionate shareholding in the company? If not, then they will be diluted. Again, this is a protection that a VC or an angel investor would insist on.
What are the rights of the shares upon the sale or liquidation of the company? Will the shares issued to the crowd only receive a payment if the holders of other classes of shares (often with some form of preference right) receive a specified amount first? If that is the case, the crowd may not receive any of the proceeds if the company is sold or is liquidated. This is the position adopted by Adzuna in their constitutional documents, a company that earlier this year raised just over £2m on Crowdcube.
Do the shares have voting rights? If they do not, you will have minimal ability to have any influence or to exert even the most basic rights enjoyed by most shareholders. For instance, the usual position is that shareholders in a private company are entitled to attend, speak and vote at a general meeting.
Investors should be aware that it is unlikely that any secondary market exists for their shares, and therefore the shares may not be easily transferred. Therefore, the shareholder will not be able to ‘
cash in
’ their shares until either the company is sold or lists its shares on a stock exchange.
In our view, non-professional investors need to be better informed about the risks they are taking, and their expectations about the future performance of crowdfunded companies needs to be somewhat recalibrated. Otherwise such investors may soon start to become disillusioned with the crowdfunding model. There is therefore a risk that as opposed to being the moment in which crowdfunding entered the zeitgeist, 2015 may instead be remembered as the year in which Joe Public started to become more inquisitive about the propositions presented to them on crowdfunding platforms.
Fox Williams LLP are experts at advising fintech businesses. and have experience in setting up crowdfunding platforms. For more information as to how Fox Williams can help you (including arranging a free consultation) or for further information on the issues discussed in this blog, please contact me at ecowan@foxwilliams.com
