Everything you need to know about: Equity crowdfunding
Crowdfunding has become an increasingly popular funding route for UK businesses and today there are two principle platforms in play. Equity crowdfunding (not to be confused with rewards, loans or donation crowdfunding, or peer-to-peer lending) allows fans of your brand or potential customers to take a small slice of equity, putting in as little as £10, creating a crowd of advocates that are invested in your success.
In the first half of 2020, UK companies raised a total of £103m through crowdfunding, according to Beauhurst data. The industry has exploded over the past decade; in 2011 there were just eight deals. In 2019, there were 422, making crowdfunding the second-biggest investment category, after venture capital/private equity.
The types of companies using crowdfunding have changed over the years. In 2013, 82% of the companies raising capital this way were seed stage, but now the split between start-up and established company is 50/50.
The UK industry is regulated by the FCA, as are all equities. The average investment size from an individual investor on the UK’s biggest platform, Crowdcube, is £1,428, and the largest ever crowdfunding campaign was created by the Scottish brewery Brewdog, which has raised £73m from devotees. As a benchmark, fees are around 5 to 7.5% of a successful raise, but members warn to look out for other fees.
There are two main equity crowdfunding platforms in the UK: Crowdcube and Seedrs. However, these two giants announced plans to merge in late 2020 so – depending when you read this article – there may now be only one.
Equity crowdfunding platforms require:
- A lead investor: You need a lead investor to kick off your campaign. This may be a VC or a private investor. Before you campaign goes live to the public, you will be given a private link to circulate amongst your lead investors so that they can commit funds.
- Between 20% and 30% preloaded investment. Research shows that campaigns that fail to get to 30% of their total funding early on rarely complete. This is why platforms now insist on businesses securing this level of capital up front.
- Campaign creation: You must create the video and pitch deck. The video is usually around three minutes long and sells your concept and vision to the armchair investors and VCs on the platform. Members say this can cost from £5,000 upwards. If you take on a specialist consultant to help with the process, then this cost will be much higher.
Equity crowdfunding platforms offer:
- Access to an expert panel, which offers analysis and guidance to both investors and investees
- There may be an option for “tailored” crowds: fewer investors but higher investment amounts
- Larger crowds with lower minimum investment levels
- Business set valuation: the investee defines or sets the valuation
- Crowd set valuation: the valuation is based on crowd interest and investment
- Equity stake: the platform takes an equity stake and arrangement fee for hosting a pitch
- Direct ownership: shareholders hold / administer their own shares so talk directly to investees
- Nominee ownership: the platform holds / administers shares and can advocate for shareholders
Members also observe that some platforms have begun to take a cut of investor profits, charge retention fees, and take a cut upon exit.
Campaigns tend to last between 30 and 60 days but it can take many months to prepare the pitch, video, and secure the pre-loaded investment from lead investors. Platforms have been known to be flexible on timings – if your campaign is very near its funding target, they may grant an extension to allow you to complete.
Crowdfunding has boomed because of how easy it is to allow fans, customers and investors to back the business, and the relative simplicity and cost-effectiveness of the listing process. Those seeking investment also gain profile from a highly-marketed platform.
For those looking to invest, all of the research and due diligence is done upfront so people can either opt in or out. Investors can also tap into two kinds of tax relief if they crowdfund start-ups that are less than seven years old. These are: the Seed Enterprise Investment Scheme (SEIS), whereby investors, including directors, can receive initial tax relief of 50% on investments up to £100,000 and Capital Gains Tax (CGT) exemption for any gains on the SEIS shares, and the Enterprise Investment Scheme (EIS), which gives investors 30% tax relief on sums up to £1,000,000 in any tax year.
The downside is that between a third and half of companies do not reach their target and that failure is just as public. Research also shows that crowdfunded companies are twice as likely to fail as VC-backed ones, and four times less likely to exit successfully (Beauhurst – Following The Crowd). Just 3% of crowdfunded companies reach IPO or acquisition, compared to 12% of venture-backed companies.
Members that have successfully raised investment through crowdfunding advise founders to participate as an investor first to understand the process from both sides. They also recommend getting as many investors on board before the crowdfunding project goes live, ensuring that a more than that aforementioned lucky 30% of the total is invested within a day or two of launch, to create momentum and encourage other investors to come on board. They also advise creating your own PR and marketing collateral for your company, product or concept and to use this as part of your application as this will help to instil investor confidence. As with any form of investment, you need to be able to answer any question about why you need the capital and how you will deploy it. Do your homework on the financials as people will ask probing questions.
It’s common for companies to come back for extra rounds of funding via the crowd. Some platforms offer full pre-emption rights to investors for follow-on rounds. For multiple rounds, the main platforms are generally good at making their "drag and tag" quite clear and not giving investors nasty surprises.
It’s advisable not to give away too much equity early on if you will be seeking further funding down the line. If it looks like you’re going to raise more than the amount you are seeking you can stop and you’re not obliged to accept further funding. However, members say that it is often worth getting more than you need: this is great PR and can give you more runway initially so that you can focus on growth rather than cashflow. Once you have secured your optimal investment, send out a weekly or monthly update on the company to all of your investors to keep lines of communication open and maintain confidence.
While the founder essentially leads valuations, some platforms have an in-house investment team who will mediate valuations and others can choose not to list you if they feel it’s over-valued. Platforms usually let the market decide if valuations are fair but everything should be supported by evidence.
Crowdfunding is subject to the same regulation as other investment opportunities. There are numerous rules and regulations to protect investors. All statements must be fair, clear, and not misleading. Risks must be sign-posted; and investors should know what they are getting into. A basic rules of thumb is that you can’t just tell people they will double their money if they invest in you. Promoting an inducement to invest is deemed as a Financial Promotion, which you can only do if you are an authorised financial services business. Every claim you make must comply with Financial Conduct Authority (FCA) regulations. If marketing your campaign outside the UK, you should check the local rules. Alternatively, authorized businesses can make promotions on behalf of the business – the crowdfunding platforms usually have this authorisation. Most good platforms will also give you guidance on what you can and can’t say.
To protect investors, platforms have a quiz for people to demonstrate their understanding of the risks.
Around half of all crowdfunding campaigns are successful but certain sectors tend to perform better than others. In 2021, the flavour of the month is fintech, followed by AI, with food in third place. The most common reasons that crowdfunding campaigns fail are: overvaluation, failure to secure lead investor/30% pre-loaded investment, a bad pitch video, and a lack of clarity over how the business will scale.
Top three UK platforms highlighted by members
CrowdCube currently facilitates the highest number of deals in this space. The platform is regulated by the FCA. It doesn’t charge for the listing but takes a success fee of 7% of the total funds raised plus a completion fee, which is on average 0.75% -1.25% of all funds raised. Right now, 79% of the businesses that ever raised funds via Crowdcube are still trading – 15% have gone out of business.
Seedrs is the platform where the largest deals are done. In the first six months of 2020, nearly £50m was invested over 97 rounds. It is regulated by the FCA and business can raise from the crowd as well as angels, VCs and other institutional investors. Seedrs takes up to 6% of the total funds raised plus other fees (i.e. payment processing). Its nominee structure means that Seedrs becomes the single legal shareholder for consents and the crowd is then made up of beneficial shareholders. Seedrs also runs a secondary market, allowing companies to realise liquidity without needing an exit or IPO; investors can simply sell on their shares. Of course, Seedrs charges a fee for this service.
SyndicateRoom is an online equity investment platform regulated by the FCA that once offered crowdfunding but moved to a new VC-esque model in 2019. It now invests directly alongside a vetted network of sophisticated investors - or ”super angels”. The site says that most businesses raise between £400,000 and £1m. There is a minimum investment of £5,000, and businesses listing on the site must qualify for EIS tax benefits. There is a 2% fee for listing companies, and SyndicateRoom pledges to get the investment moving 10 days after receiving all the due diligence documents from the company.