“Crowdfunding” is one of the real financial buzzwords of 2015 so far.
Craft beer punks BrewDog have done much to publicise the relatively new approach to raising capital; even though its £25mln attempt to break funding records may not strictest sense be crowdfunding at all.
Now listed companies such as Kea Petroleum (LON:KEA) and Ascent Resources (LON:AST) have also sought to raise funds from the crowd.
Here, we look at some of the key issues surrounding this form of alternative financing and examine more closely what it all means for investors.
So, what is crowd-funding?
At its essence crowd funding is as simple as it sounds. It is the raising of funds form a potentially large group of individual people. It allows investors and lenders to put cash directly in the hands of organisations.
Like peer-to-peer lending, offered by companies like Zopa or Wellesley, the ‘distruptive’ new business intends to challenge traditional business channels by effectively cutting out the financial services middle-men.
While p2p lenders replace the bank, crowdfunding seeks to bypass the corporate financing function. Capital raised via crowdfunding does not – in most cases – pass through the hands of City intermediaries such like stockbrokers.
There is no ‘old boys’ network here, a company simply signs up to one of several FCA regulated crowdfunding platforms and places what is essentially an advert for its proposed fund raise.
The idea is that armed with little other than an internet connection and a bank account private individuals can invest directly, without paying fees to intermediaries like fund-managers, IFAs or brokers.
Not dis-similar to the premise of the BBC’s Dragons Den the company’s pitch must set out a minimum funding amount which must be met for the raise to go ahead.
Where can I do 'crowdfunding'?
There are several online crowdfunding platforms and some of the most prominent include: Crowdcube, Seedrs, Funding Tree, Crowd for Angels, TrillionFund and Crowdbnk.
Why is it a big deal?
The alternative finance industry, which includes crowdfunding, is estimated to have raised more than £1.7bn for businesses in 2014 and, according to innovation charity Nesta, the sector will raise over £4bn in 2015.
Experts predict a tipping point will soon be reached and as such it is little wonder that the City is beginning to take notice.
FundingCircle - a crowd driven platform that’s so far raised over £600mln of debt financing for small enterprise – just this week raised US$150mln from blue-chip institutions including Blackrock, Singapore’s Temasek and US firm Sands Capital Ventures.
Valuing FundingCircle at about US$1bn the deal, organised in-part by Goldman Sachs, highlighted that the City establishment is getting behind backing the alternative finance sector.
So can anyone invest?
Yes, basically. So long as you’re a individual there are no exclusions. Conceptually the crowdfunding is supposed to be open to all. In theory everyone has the opportunity to participate regardless of how much money is in the bank, whether they have a broker or how much experience an investor may or may not have.
That said the FCA, Britain’s financial watchdog, last year brought in rules designed to protect novice investors.
Ordinary private investors, those that don’t self-identify as being either ‘sophisticated’ or ‘high net worth’, are limited to investing no more than 10% of their net investible assets across crowdfunding schemes.
Why the protection?
The vast majority of equity raised through crowdfunding is not listed on stock exchanges and as such there is no secondary market to sell shares to easily manage risk or realise returns (or indeed losses).
In the words of the FCA the shares are “non-readily realisable securities” and they are deemed to carry much higher risk for investors.
If the company you’ve invested in is failing there aren’t likely to be opportunities to cut losses and back out of a bad investment. It is therefore most likely that 100% of the invested capital would be lost.
Investors qualifying as ‘sophisticated investors’ or those that are deemed ‘high net worth’ are not capped by the FCA guidelines. Nor are investors who take regulated advice. If investors don’t take professional advice then the FCA also requires firms check whether investors understand the risks of the proposed investment.
How is crowdfunding regulated?
Like any other financial services promotion crowdfunding is covered by a variety of FCA regulations, and the watchdog last year expanded its oversight via new rules specifically for the emerging sector.
Aside from the protections to cap investment from novices, described above, the new rules also required the online crowdfunding platforms to be regulated.
It is the responsibility of these platforms to ensure that investors understand the risks of the investment proposals, and also to ensure that the companies are marketing themselves fairly.
“Our responsibility as a platform is to make sure there aren’t any claims made by companies that can’t be substantiated,” said Julia Groves, who is chairwomen of the UK Crowdfunding Association as well as chief executive of TrillionFund, the specialist renewable energy crowdfunding platform.
Groves explains that every single piece of communication between the company and investors during the funding process is signed off by FCA regulated people.
“The value of regulation is that investors (using the crowdfunding platforms) know that the people involved have their necks on the line, for an unlimited fine and jail sentence if they’re wrong, and there are controls in place.
“If they (the companies) can’t prove something, then they can’t say it.”
As an investor how can I benefit?
Crowdfunding is supposed to be very simple, direct and transparent. Importantly, it is also likely that in most cases any fees will be lower.
For small investors there also the advantage in that minimum investment levels can be low. It means that those at the lower end of the market can actually build varied and interesting investors relatively quickly and cheaply.
Groves says that in the past twelve to eighteen months many investors ‘dipped their toes’ into crowdfunding, with smaller investments of just a few hundred pounds, before returning later with more confidence to invest larger sums.
‘The man’ wants you to crowdfund
For all the anti-establishment bluster of BrewDog, the ‘punk’ brewery which is one of the more vocal proponents of crowdfunding, the government or proverbially ‘the man’ is actually right behind crowdfunding and is incentivising investors.
The vast majority of crowdfunding investment opportunities qualify for the government’s enterprise investment scheme - or EIS – which allows individuals to claim a 30% refund of its investment back against their income tax liability.
Investors get the cash back for the year they invested the money, and relief can be claimed on investments up to £1mln per year, which would in theory mean £300,000 off your income tax bill (if your salary was big enough that is!).
Gains of EIS investments are, subject to certain criteria, can also be free from capital gains tax as well.
The future …
Experts predict alternative finance will continue to go from strength to strength in the coming years, and with the recent emergence of stock market companies pursuing crowdfunding initiatives (through platforms like Darwin’s Primarybid.com) it appears likely it will become more popular and more accessible to investors.
There is also a possibility that in the coming years some form of secondary market may be developed for equity raised via the crowd.