Securing investment, when three isn’t always a crowd

Posted 03/04/2014

Crowdfunding is fast becoming a popular source of alternative finance for entrepreneurs and business start-ups who are unable or unwilling to approach a bank or other ‘conventional’ source of investment.

The idea is simple – business owners and entrepreneurs ‘pitch’ their ideas to a large number of individual investors, usually via a crowdfunding website. Those seeking finance can publish details of their project, including how much cash they need, how they will use it and how investors stand to profit. The ‘crowd’ can then choose whether or not to invest.

Whilst there are a variety of different models, many investors consider equity crowdfunding to be the purest form of crowd investment. The idea is compelling: individuals pool small funds together to become equity stakeholders in early stage companies, when the opportunities – and risks – are the greatest. Many insiders anticipate the growth in equity crowdfunding will transform startup finance.

The growth in the US is already considerable – angels have invested $393 million on the 10 largest equity crowdfunding platforms to date, with $90 million of that being invested in the first quarter of 2014 alone. So what is behind this growth? The payback from equity crowdfunding can be enormous.

‘Facebook’ and ‘Dropbox’, two headline businesses that have benefitted from crowdfunded investment, achieved returns on investment of 62,000% and 39,000% respectively. Whilst not all investments could achieve that sort of stellar performance, a long-term investment of five to eight years in the right startup could produce higher returns than any other asset. Indeed, such is the growth in crowdfunding websites, London based UP Investments is seeking to raise £100,000 on Crowdcube to establish a ‘crowdfunding supermarket’ where investors can view pitches from dozens of crowdfunding websites across the UK.

Local businesses are already benefitting. Yippydada, a Buckinghamshire based business which has developed a stylish baby bag range, hopes to secure £100,000 through Crowdcube, in return for a 10 per cent stake. ‘Ready Steady Mums’, a Cambridgeshire based fitness enterprise for mums, has recently secured £57,190 for a 6.68 per cent stake in its business on crowdfunding platform Seedrs.

Against a backdrop of low interest rates for savers and a general perception (however accurate) that banks are reluctant to lend to small entrepreneurial businesses, it is perhaps no surprise that crowdfunding is becoming more mainstream. It cuts out the middle man, allowing small businesses to get the funding they need without banks taking a slice of their profits. For savers, these ventures offer the potential for much greater returns and to potentially qualify for special tax reliefs under the Enterprise Investment Scheme (EIS) or Seed Enterprise Investment Scheme (SEIS) rules.

But what about risk? The Financial Conduct Authority is taking a close interest in crowdfunding and wants to ensure private investors fully understand the risks they are taking. Under new rules which came into force on 1 April, equity based crowdfunding is now subject to the ‘10 per cent rule’. This means that investors must certify that they are not committing more than 10 per cent of their net investible assets (excluding their home, pensions and life insurance). The new rules are only waived for those deemed sophisticated investors and do not apply to peer-to-peer loans.

Some platform providers have claimed the increased regulation may prove detrimental to both investors and businesses alike, unfairly disbarring small investors and ultimately leading to a “thinning of the crowd”.  Peer-to-peer lenders on the other hand, fear that the rules are not tough enough to protect individuals from bad debts.

Whoever is right, the phenomenal growth in crowdfunding looks set to continue. Recent figures suggest that over £1,700 per hour is currently being raised through crowdfunding in the UK, with more than 45 new equity and rewards projects having being launched each day in the first three months of 2014. Although this represents only a fraction of the total value of investment being raised, crowdfunding is clearly becoming an attractive means of raising finance for businesses who need that vital injection of cash.

For advice on all types of business ventures and equity investments, please contact Ashtons Legal’s corporate team.