Equity Crowdfunding – where next?

By Charles Owen on Monday 30 January 2017

OpinionSavings and Investment

Equity crowdfunding launched in the UK between 2011 and 2013 and over the last two years the platforms have been running around like all toddlers do; generally making a lot of noise and ensuring that everyone knows how important they are. Towards the end of 2016 they turned up at primary school and have become noticeably quieter as they started to get a sense of where they fit into the wider financial services world.

Crowdfunding originated as a concept to support social, community and arts projects that would otherwise have been unlikely to raise capital. Contributors were generally rewarded with some form of public acknowledgement or benefit, rarely financially. Equity crowdfunding platforms adapted the concept into an investment process and in doing so substantially altered expectations. Contributors became investors and reasonably believed they should get a return on their money. For their part the platforms believed that they were heralding a new dawn for financial services and all the talk was about democratising investment.

Now, a few years in, we can start to see more clearly the role of equity crowdfunding platforms. Where a contributor to a community project might be happy to see this as a gift, investors are providing capital in return for an expectation of future gain. Logically therefore the emphasis of who benefits from using the platform should change. Social crowdfunding platforms clearly benefit the recipient whereas equity investment platforms should be designed to benefit the investor. Herein lies the difficulty. By their very nature equity crowdfunding platforms provide services to companies seeking to raise capital. Generally, these continue to be very early-stage businesses who very rarely have institutional funding. Sometimes they are not much more than an idea. In investment terms these companies are at the very sharp end of high risk. Statistics gathered over many years indicate a consistently high failure rate for early-stage businesses regardless of their source of capital. The fact that a company has raised money from ‘the crowd’ is irrelevant and the statistics are unlikely to change.

It is arguable that equity crowdfunding platforms have not yet recognised this and remain designed to benefit the company raising funds, and the platform itself, rather than the investor. To date the latter seem to have been given a raw deal. Ask any city professional and they will tell you that there are times when markets are ‘hot’ and deals can get away that in more normal times may have struggled. The first few years of equity crowdfunding have felt a bit similar with investors seduced into making investment decisions on limited data and the belief that they might just be backing the next big thing. This was partly emotional and partly driven by technology, with the latter opening up access, but as a result there are now many hundreds of new investors with a portfolio of early-stage investments and statistically the majority will see little, if any, return on their money.

This is not to say that equity crowdfunding platforms do not have a role to play within the investment sector. It is widely recognised that smaller companies are the lifeblood of the UK economy and drive growth, employment and taxes and it is important that we continue to foster an entrepreneurial culture and encourage risk taking. These new companies need investment capital and crowdfunding platforms remain a potentially strong source of this. They are finding their niche as a provider of high risk early-stage investment opportunities to investors who fully understand and are happy to take on this risk.

If however they are going to be able to mature successfully and continue to attract, and more importantly retain, new investors in the way that the lending platforms have done then they need to change their emphasis to more clearly recognise the risks to the investor. Issues such as a lack of due diligence and questionable company valuations are regularly raised as concerns and unless the platforms pivot to more closely align their interests with the investor, then these concerns will persist.

The recent FCA review of the sector has undoubtedly helped in highlighting these issues but ultimately the strength of the equity crowdfunding business model will be determined by the investors themselves. There is a considerable weight of money which could be introduced to the early-stage investment sector, primarily sitting behind the doors of financial advisers. Sophisticated and High Net Worth retail investors have an appetite to expand their investment portfolios to include direct investments, particularly where these come with tax benefits such as EIS. However, they rightly remain very risk aware and wherever possible seek to invest on the back of advice, or at minimum professional guidance. The winning platforms will be the ones that recognise this and offer investors risk mitigated solutions into this asset class.

Charles Owen is Founder and Director of CoInvestor.

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