22 February 2017 Issue 15 Feb/Mar

Calling for crowd control

The two dominant equity crowdfunding platforms, Seedrs and Crowdcube, are under pressure to iron out their wrinkles and generate more wins for investors.

Allowing startups to raise money over the internet in exchange for shares in their company was always likely to bring thrills and spills.

Hailed as a way of breaking open investment in companies from the narrow and cliquey world of wealthy backers and well-connected founders, equity crowdfunding has allowed any company to hoist up an ‘open for investment’ sign and let absolutely anyone take a stake. The two leaders in the space, Crowdcube and Seedrs (launched in 2011 and 2012 respectively), have made gaining and providing funding much more accessible.  

The platforms have talked up the sector’s impact: hundreds of thousands of pounds have been raised through equity crowdfunding to date. And this has been the platforms’ focus so far: getting as many companies as they can to raise as much money as possible.

But with the six year anniversary of the first crowd raises this year, Crowdcube and Seedrs are facing mounting calls to prove their credibility as serious and enduring vehicles for investors as well as companies.

Inherent asymmetry

Six years is the typical timeframe for a seed, angel, VC or private equity investor to bank a return on a company they have backed. The scorecard for both Seedrs and Crowdcube on this front has been modest. Of the £210m raised on Crowdcube, investors have seen a total of just £5m in returns through the exits of E-Car Club (bought by Europcar), Camden Town Brewery (bought by AB InBev) and Wool and the Gang (bought by BlueGem Capital Partners). Meanwhile, Seedrs has helped companies raise an approximate £190m across more than 450 fundings and has had one exit to date, accounting software firm Free Agent, which floated at the end of 2016.  

Both platforms justifiably say it’s still too early for a proper appraisal. There were only a small number of companies crowdfunding in those early days, so the majority that have raised are still only two or three years on from their campaigns. 

Many observers, however, say the platforms haven’t done enough, arguing there is an inherent asymmetry in their model which favours companies rather than investors. At the crux of the issue is the transparency of company information and the vetting process on Seedrs and Crowdcube. 

‘Due diligence is left entirely up to the public and it’s in the interest of the platforms to provide optimistic financials to help completions,’ says analyst Robert Murray Brown.

Regulator concerns

While there have been relatively few stories of notable investor returns, the crowdfunding narrative has suffered a number of blunders: notably around companies raising with ‘impossible valuations’ and individuals with a history of insolvencies seeking capital without their earlier business failures being declared on the platforms. 

The financial regulator has been playing catch up with this relatively novel form of investment. As recently as December last year, the FCA went public about concerns it had about poor quality disclosures, weak background checks and a lack of clarity over where invested money was coming from.

Perception issue

Both Crowdcube and Seedrs are, of course, startups themselves, and their own race to become the leading platform in the sector has led to questions over whether aggressive commercial growth on their part has come at the cost of building sober, buttoned-down financial platforms.

Crowdcube, reckoned to be the more ‘commercial’ of the two, has recently produced a due diligence charter in a bid to change that image. Its founder, Luke Lang, told Courier: ‘We’ve become a lot more transparent on what we check and what we don’t check. That’s free for people to see.’

He argues it’s a perception and communication issue for the platform rather than something more structural. ‘We spend a lot of time and money asking questions to make sure businesses are in a fit state. If investors are surprised, we should do a better job communicating.’

Seedrs, meanwhile, has created a dashboard feature, which allows investors to track their portfolio’s performance. This, it claims, is a way to build transparency into the process and give investors something to look at during the long gestation period. Shameel Khan, an investment associate at Seedrs, said: ‘We want to encourage people to diversify their portfolio; to invest more, and invest more safely, across a variety of companies.’

Investors’ responsibility

Neither platform has plans to demand more searching questions of companies pre-launch, arguing that, like any financial risk, analysis is the responsibility of investors.

Companies such as fintech firm Rebus went bust not long after raising, but Lang argues: ‘Those pitches were fair, clear and not misleading. Every pitch has a link to Companies House and you can see the history.’ He adds: ‘I don’t think there was a breach of trust.’

Both platforms have started encouraging professional investors to back companies on their platforms to lend them credibility and confidence. It’s meant VCs, larger companies and even institutional investors have begun participating in crowdfunded raises. 

Defenders of crowdfunding say anything this complex, ambitious and pioneering inevitably has hiccups in its early days. 

Despite that, 2017 is a critical year for crowdfunding; raises are likely to be more frequent, larger in size, and will see big firms participating in rounds. But just as important will be the platforms’ ability to produce more successful exits and fewer controversies.


Cracks, gaps and loopholes that need fixing

1. Checks on companies

Better vetting of companies is a recurring demand. The issue comes down to the extent that platforms should do background checks on founders, extract existing financial information and check the viability of a company that lists for a raise. What exactly those checks should be is debatable, and arguably could give the platforms too much power in deciding which companies are ‘good enough’ to campaign.

2. Clarity between investors and backers 

Money raised by founders privately can be bundled into a crowd raise and presented as part of the same round (as long as all investors sign up on the same terms). Investors can feel misled about the momentum of interest in a company in such scenarios. On Crowdcube, the amount raised is ‘pledged’. The company is then responsible for chasing up the cash from investors itself.

3. Plausible valuations

Valuations are both subjective and controversial in any asset class. But there’s a belief that without proper corporate governance, startups raising on the platforms are more likely to set unrealistic valuations.  As a result, they carry a greater risk of exiting at a value lower than their raise, or of the funders’ stakes being diluted to minuscule levels. Increasingly, professional investors and VCs are investing in crowdfunding rounds, which is hoped to moderate valuations.

4. Conflict of interest 

The platforms are set up in such a way that they are paid a slice of whatever investment is raised. This invites criticism that the platforms are motivated to ensure as many raises are completed as possible, regardless of the calibre of the company. Seedrs, however, does take a 7.5% cut of any returns gained by investors in the event of a successful exit down the line. Neither platform suffers a direct financial penalty in the event that a company ceases trading.

5. Lack of secondary market for shares

Many crowd investors have been hankering for a development in the crowdfunding structure which would allow them to sell their stakes on secondary markets. Seedrs says this is not something it is actively pursuing, while Crowdcube is understood to be exploring trialling secondary trading on a select number of companies later this year. Although this would give crowdfunding dynamism and offer liquidity for investors, it appears fraught with challenges.

6. Enforcement of regulation

One of the UK’s main strengths as the home of new concepts like crowdfunding is that it has a strong legal system with an experienced and trusted regulator overseeing financial activity. But the FCA has been criticised for not stepping in on occasions when investors have been misled. If applied stringently, the FCA’s rule that financial firms must be ‘fair, clear and not misleading’ could provide a framework to solve many of the industry’s gravest problems, without adding complexity and further rules.