I like to think of Equity Crowdfunding as form of small scale private equity for DIY investors. It presents a really interesting opportunity for almost anyone to get involved with a start-up business, and the involvement is not always restricted to just a financial perspective.
It is well accepted that start-ups are risky, but still most investments are done on the back of a strong hope that one day the business in question will have a successful exit allowing a multiple of the principle to be realised.
As an investor I found myself asking; how do you actually get your money back?...If you get anything back that is!
This is a question which I have been asking since I very first heard of crowdfunded equity, however it does not appear to be that active an area of discussion. First of all, its very important to note that there is by no means any form of guarantee that you will get all your money back; by investing in the equity of the business as opposed to lending to it there are some differences. On a positive note, the UK Government has put in place generous Seed Enterprise Investment Scheme (SEIS) and (Enterprise Investment Scheme) EIS schemes to considerably reduce these risks; on initial investment and in case of default, allowing oneself to offset losses against income tax.
Turning to the data to paint a picture of these risk I ran into issues. With so few actual equity crowdfunding exits, it's impossible to draw any meaningful conclusions statistically. Instead I turned to proxy information to help colour in the picture of what could be expected. One such piece of information was the Nesta Siding with the Angels report where some great statistics can be found on small business activity from the perspective of investment:
44 per cent
of businesses generate positive exits
The overall return to business angel investing in the UK is
2.2x invested capital
On average it takes
3 years for an investment to fail, but 6 years to win
Winning is big, but most are failures;
9 per cent of investments generate 80 per cent of positive cash flows
Given the above information and average holding period of 4 years gross Internal Rate of Return (IRR) is approximately
22 per cent.
Just to give context to the above; the data in this study is drawn from a survey of 158 UK-based angel investors in late 2008 who had invested £134m into 1,080 angel investments between them, and have exited 406 of those investments.
Once I had a better idea of the statistics at play with this calibre of asset class I then turned to the actual investment platforms which would allow me to invest in such start-ups. I found the process roughly following the lines of:
Initial fund raising on investment platform; investors pledge and wait for target to be reached
Raising completes, money leaves your bank account, due diligence is completed, the crowdfunding platform ‘hands over’ the investors to the start-up, so they now manage them
SEIS / EIS certificate received by investor, risk reductions are applied for by investor
Start-up business does what it needs to with your cash, keeping you informed by letter, website and any other means
Months / Years pass…
An opportunity for investor exit occurs, investors are made aware by the start-up and offered an exit valuation and strategy for their share sale
If accepted the company sends a check in the mail, if not accepted you continue being an investor under potentially different terms
Company defaults, shares are now effectively worthless…
SEIS / EIS scheme tax relief is effective further reducing investor exposure
The key thing to note here is that the crowdfunding platform is simply a funnel for funds, an advertising medium and a screening service for investors. As soon as the raise is complete you are a shareholder of the business and will be treated that way going forward, it’s not Crowdcube or Seedrs issue what happens after the raise!
Turning now from stats and theory to some actual examples:
Crowdcube is one, if the only, major platform in the UK to have successful exits, their e-car club exit was apparently the world's first. Following this a couple of years later Camden Town Brewery successfully exited.
Average Annualised Return: 280 per cent, Percentage of investment at risk: 61.5 per cent
(I cannot disclose exact figures in the calculations for these companies, unfortunately, as the acquirers were both public companies not wishing to disclose purchase valuations)
To say the above differently; if I had invested 50 per cent of my cash in each company at the same start date and they had both exited after 12 months* I would have had £2.8 profit for every £1 that went in with the risk of losing 60p on the £1.
* Assuming Camden town had continued to add value at the same rate over the 8 months for a further 4 - this is not a good assumption to make but allows us to compare the returns.
Just to quickly explain risk figure; both companies were EIS eligible so 30 per cent of the investment was instantly deductible from income tax, the remaining portion was deductible @ 45 per cent rate in case of bankruptcy.
If both start-ups had failed, you would have lost 61.5 per cent of your money after all the enterprise scheme relief’s.
All in all, I think the returns in the crowdfunded equity space are very attractive even considering the risks, the SEIS and EIS schemes are icing on the cake. The true task here is acknowledging the stats and so diversifying your investments to tilt the odds more in your favour.
Make sure you do your own due diligence before investing in any start-up, no matter how enticing the offering!
Marcus Williamson is a private investor in P2P and marketplace lending as well as crowdfunded property and runs a small private fund of alternative assets.