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With interest rates at historic lows, consumers are turning to new avenues to make returns on savings. The alternative finance industry in the UK has grown from £267m in 2012, to £666m in 2013, and £1.74bn in 20141, and is on track to double again in 2015. Around 95% of those figures relate to debt finance and invoice factoring1, but the fastest growing segment has been equity raises.

Equity crowdfunding is growing at a remarkable pace, estimated to be at around 400% year on year1. The first platform set up in 2011, Crowdcube, has raised £101.3m at the time of writing2, and is estimated to hold a 50% market share.

Equity crowdfunding is at a far earlier stage than its crowdlending older brother, and the returns can be expected over a much longer scale. Furthermore the investments are highly illiquid, with the only path to a return on the investment being at IPO or, more likely, at merger or acquisition several years down the line. To hammer the point home to consumers, the FCA has come out to say that “it is very likely you will lose all your money”3.

Q. So despite the high risks, why is equity crowdfunding growing so strongly?
A. People want to own a piece of the next big thing.

For the first time, ordinary people are able to invest in the latest technologies and ideas. People can make a real difference to small companies with their money, and there is the potential of huge returns if the new product becomes a global success. Crowdfunding sites enable people to sit on the sofa at home, browse through dozens of new companies and pick and choose these bets.

Crowdfunding’s place in the world – Companies

From a startup company’s perspective, equity crowdfunding makes a lot of sense. Crowdsourced debt is a good for companies that have a project that will pay off by the end of the loan period, at which point the principle needs to be repaid, but for companies that are still growing and developing there is more value to be gained by reinvesting that money back into the company.

Crowdfunding brings with it other benefits alongside the cold, hard cash. Bringing in thousands of investors also brings on board thousands of advocates and customers. Once someone has a financial interest in the success of a company they are going to talk about it amongst friends, colleagues and business partners. They are also going to invest time in using the product themselves, and provide valuable feedback to the company.

A couple of months on a well-trafficked crowdfunding website is also going to be an excellent marketing opportunity for a young company. As we have seen numerous times with donation-site Kickstarter, there is serious potential for pitch videos to go viral across social media.

On the flip-side is the additional administrative burden, and publicising of un-patented ideas. A company is required to keep a register of all its shareholders, and send them important information such as business updates, annual reports, and details of upcoming votes in which they are eligible to participate. Naturally with thousands of investors this escalates hugely. Some crowdfunders, such as Seedrs, have chosen to act via a nominee structure, whereby they hold the shares on the investors’ behalf. This makes life easier for the fundraising company as it puts the extra administration on the platform instead. Some of the feeling of ownership is lost, however, as the platform will also vote on the investors’ behalf.

Crowdfunding’s place in the world – Investors

Time will tell if equity crowdfunding is right for the masses. No one has made serious money yet due to the long road from initial fundraise to IPO.

One company looking to solve this liquidity issue is InvestDen. They have created a secondary market where members can buy and sell their private crowdfunded assets to other members at a mutually agreed price.

The opportunity for high returns as part of a balanced portfolio, alongside traditional investments and P2P debt, makes early stage equity investments an attractive and sustainable opportunity. Crowdfunding sites need to educate investors on effective portfolio management, and how much of that should be small, high risk investments. Within the amount invested in crowdfunding, the portfolio should be diversified as much as possible as well, with the total amount split across 10 or more companies. If the importance of diversification is adhered to then the chances of success for the sector and its investors will be greatly increased.

Crowdfunding offers investors the chance to make a difference to small businesses, and get ideas off the ground that they believe in. The desire to make worthwhile investments is equally as important in defining crowdfunding’s place in the world.

Regulation may curb the hand of investors. The FCA has so far introduced a reasonably generous limit on the portion of liquid assets that retail investors (excluding sophisticated and high net worth) can invest via equity crowdfunding; this limit is 10% of investable assets, excluding house, pension and life insurance. If it develops that more people lose money than make money from crowdfunding then the FCA will likely reduce this allowable portion considerably.

Syndicate Room has taken a different approach to protecting investors. All funding rounds on the platform are led by experienced angel investors. Though by no means a guarantee of success, this does have the benefit that companies and their ideas are put through a more developed vetting process.

In short, is crowdfunding here to stay?

Yes, for the foreseeable future. Over the next 5-10 years we will start to see the clearer emergence of winners and losers. If the numbers stack up, and the returns for the winners are in line with the risk that was taken on, then crowdfunding will have marked out its territory in the capital markets for good.

Crowdfunding will never replace the smart money that is brought to the table by experienced angel investors and early stage VCs, but it is a way to dramatically widen the investor pool and create a host of ambassadors out of the crowd.

The high growth in crowdfunding investment seen over the last 3 years has been in part due to the growing economy and low interest rates. This market makes equities attractive, the FTSE 100 and Dow Jones have seen all-time highs in 2015. As wider economic influences change we could see a change in appetite for investments in early-stage companies.

Importantly, investors need to ensure that investments made on crowdfunding platforms are only a part of their total investment strategy.

Investment in early-stage companies has the ability to capture the excitement and the passion of the crowd and social media. Annual investments on platforms will continue to at least double year on year until impacted by a change in the wider economy. If more successful exits are realised in the meantime then equity crowdfunding will hold its share of the capital markets going forward.

  1. https://www.nesta.org.uk/sites/default/files/understanding-alternative-finance-2014.pdf
  2. https://www.crowdcube.com/, 8 September 2015
  3. http://www.fca.org.uk/consumers/financial-services-products/investments/types-of-investment/crowdfunding