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Would you make a date with the crowdfunders?

Crowdfunding is changing the way that start-up businesses raise money but Amanda Newman Smith says this new investment model poses problems for advisers.

The first day of November is well known as All Saints Day but this year it will also mark a less familiar event this year – the first UK Crowdfunding Day.

Crowdfunding has grown quickly in the UK over the last couple of years and is even represented in Parliament by the Westminster Crowdfunding Forum. Getting accurate figures on the amount of money invested in businesses through crowdfunding websites is difficult but it is estimated that globally $1.5bn was raised this way in 2011 and this was expected to double in 2012. By the end of 2012 there were 44 different crowdfunding platforms in the UK featuring businesses ranging from start-ups trying to raise a few hundred pounds to established businesses raised millions of pounds to finance their growth plans.

But despite this rapid growth not everyone knows about it or understands it, which is why entrepreneur and crowdfunding commentator Barry James came up with the idea for an annual UK Crowdfunding Day.

James says: “It’s about people – the crowd – having access at a new level and type of choice right at the formative stage of many, many new businesses, products and projects, where previously this would be the sole prerogative of a wealthy corporation or individual. Ordinary people, ‘citizen investors’, can also own a part of a growing company.”

The basic idea of crowdfunding works in a very similar way to charity fund raising websites such as Just Giving or peer to peer lending websites such as Zopa and the idea is to raise money by asking a lot of people to invest relatively small amounts into a business, project or venture.

Businesses looking for finance will set up an online profile for the investment opportunity and use social media to widen the circle of potential investors. Since banks have pulled up the lending drawbridge for many small businesses and projects, alternative ways of raising money have obvious appeal for anyone trying to start or grow small businesses.

Similarly, savers who are getting practically nothing from low interest rates could be tempted by the potential returns from crowdfunding and that is a concern for some, including the Financial Conduct Authority.

Crowdfunding is currently unregulated but some of the platforms are FCA-compliant and adhere to the UK Crowdfunding Assocation code of conduct. The FCA has stated that crowdfunding should be targeted only at sophisticated investors who understand the risks.
There is a risk of business failure with any type of investment but the nature of the businesses looking to attract investment make it much more difficult to assess the risk of failure and this makes it a tricky area for advisers.

Informed Choice managing director Martin Bamford says: “I’m  a big fan of the crowdfunding model but don’t think it is suitable for IFAs to recommend it to most retail investors. It tends to work well in cases where the investor has a personal interest in the project and can stand to lose all of their investment. Where crowdfunding becomes less a hobby and more about potential investment returns, the risks are significant.”

Bamford has invested in crowdfunding through the Kickstarter platform. “I’ve based investment decisions on the track record of the people behind the project, committing only very small amounts to individuals without proven experience in the field or a detailed plan to execute the project. I also base my crowdfunding investment decisions on the popularity of the project, in the belief that the most popular projects stand the best chance of success.”

The lower end of the market, where it is possible to take a £10 punt on a company that could go either way, is not an obvious place for advisers to invest client money. But FCA-regulated platforms with higher minimum investment amounts are reporting interest from advisers with high-net-worth clients. This seems to be the point where crowdfunding and advice are most likely to meet.

An example is SyndicateRoom, an equity crowdfunding platform that aims to make business angel-type investments more accessible.

“If you have a lot of people each putting in £10 you don’t have much due diligence and it’s not worth your time,” says SyndicateRoom founder Gonçalo de Vasconcelos. “We have a minimum investment of £500. We don’t want £10 money – we are looking for serious investors who are serious about the potential financial returns, but who don’t want to be business angels.”

All SyndicateRoom’s deals are vetted and valued by business angels, who act as lead investors and fund at least 25 per cent of each deal. de Vasconcelos believes this reduces risk compared to equity crowdfunding opportunities that leave investors to fend for themselves in terms of due diligence and valuing businesses.

“We are targeting sophisticated investors and lowering the barriers to entry because only the very wealthy can make angel investments of £100,000, £200,000 or £300,000 a time. People who don’t want to get actively involved as business angels can be reassured that experienced investors are putting more money in than they are while doing their own due diligence.” He adds that crowdfunding differs from venture capital funds, where management fees can create conflicts of interest.

Plutus Wealth independent financial planner James Robson says the amount of due diligence required for crowdfunding is going to put most advisers off. He says platforms that lower risks are nice to have, but he is concerned about passing responsibility to a third party.

“When it comes to the crunch, it’s on your head because the client has followed your recommendation. You can’t tell them someone else told us it was going to be all right,” says Robson.

Bamford thinks that improvements to due diligence are helpful in reducing the risks of crowdfunding but he feels that regulation is needed. He says: “Crowdfunding risks becoming the new UCIS scandal, unless the FCA acts swiftly to regulate its promotion and clearly define which investors might be considered suitable.”

Platform Black, a crowdfunder for invoice trading, is seeing interest from IFAs and wealth managers but co-founder Lousie Beaumont says the nature of the business and the size of the investment needed to invest through it means they are very much at the higher end of the market. Platform Black allows businesses to raise short term capital by auctioning their invoices which they then buy back up to 90 days later.

Beaumont says: “Our investors are self-certified high-net-worth individuals or sophisticated and professional investors that invest at least £50,000. We don’t see ourselves at the retail end of the market as people need the knowledge to assess invoices.”

Johnston Gray & Wardrop independent financial planning director Alan Wardrop has used crowdfunding to raise money for his business and has also been an investor with Funding Circle. He sees crowdfunding as suitable for semi-professionals, such as retired business people, and expects opportunities for advisers to come from the other side of the fence. “IFAs won’t be promoting it to savers but advisers who work in the commercial lending market could recommend it to their business clients,” he says.

Robson says crowdfunding does not fit the investment model of the financial planner, but if clients mention it, they will at least expect an opinion from their adviser. “Even though crowdfunding is not something we would do, if a client wanted us to do some research we would do it. But we wouldn’t make a recommendation,” he says.

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Comments

There are 5 comments at the moment, we would love to hear your opinion too.

  1. Thank you Amanda

    We’re looking forward to celebrating UK Crowdfunding Day at the next Crowdfunding Deep Impact conference to be held in London 1st November. More information can be found at http://ukcrowdfundingday.org/ and http://crowdfundingdeepimpact.com/ and hope you can join us. Follow us on twitter @UKCrowdfundDay

  2. 1. It’s not properly regulated
    2. It doesn’t fall under the FSCS
    3. The firms themselves don’t provide nearly enough information, so you are never really sure what you are investing in.
    4. It is more of a social enterprise than a robust business model and probably makes more for the promoters than the investors.
    5. You really are putting your regulatory backside on the line dabbling in these.
    6. If you want to do something like this there are plenty of firms around into which you can invest and take an equity stake. What is the point of investing fifty quid into some daft enterprise? Private equity requires real money. On a smaller scale – say £100k to £150k you could for example help to set up a newly qualified dentist and get a decent return.

  3. Forgive me Harry but you do seem to have something of a laser focus – which may be why you are somehow missing the point.

    Most things in life, especially the ones that tend to make it worth living, are not ‘properly regulated’ or “fall under the FSCS”. Strangely the ones that are – the banks spring straight to mind – seem to be the cause of a hugely disproportionate amount of trouble – not to mention fraud and financial misbehaviour of all kinds.

    This is not a problem that crowdfunding has. The expected epidemic has yet to materialise and the current legal framework is doing pretty well while those of us closely concerned with it’s regulation and legal framework work to adapt the regime for equity crowdfunding to the reality rather than paranoia based on the above.

    I don’t think anyone is seriously expecting IFAs like you to start making recommendations but as a citizen you might recognise and applaud the fact that this is a new, exciting, and much needed way for startups and small business getting the funding they need to survive and thrive – now that the banks have abandoned that role.

    So no one is expecting you to put your “regulatory backside on the line” but clients will be asking you about this increasingly and are likely to want to put small amounts of their own money into businesses and social enterprises because they want them to happen – not always solely for the ROI. They may ask for your advice as an expert – and might expect a balanced view. Is this mixing business and pleasure? Possibly. Is it mixing business and humanity. Certainly.

    Meanwhile I think the days of ‘real money’ – or even just £100k plus deals – being the only option and the only thing worth talking about are numbered – thank goodness.

  4. Barry
    Thank you for the compliment. “You do seem to have something of a laser focus”

    “….Most things in life, especially the ones that tend to make it worth living are not ‘properly regulated’…” Well, that’s an opinion. What is a fact that regulation – or more especially the failure to comply with it – can make our lives NOT worth living. This is something you seem to recognise. (“I don’t think anyone is seriously expecting IFAs like you to start making recommendations”).

    As investor myself I have to say I personally don’t find Crowd Funding an attractive proposition. One of my (many) hobby horses is that too many financial advisers think they are social workers. By all means support charitable causes, but don’t confuse that with business or investing. I have to say that so far no client has asked me about this topic and I am inclined to put it in the same basket as SRI or ‘ethical’ investing. Not really to be confused with serious investing.

    I have have run several small businesses (in and out of financial services), so I am not entirely inexperienced. I also see people who come to me with the idea of starting their own business. Some of them a pretty clueless. In general to run a business you need capital. You start with a good wodge of your own and then if you need more you go to a bank or take on partners who will put in money in exchange for equity. If your proposition stands up you get the funds; if not – think of something else.

  5. Goncalo Vasconcelos 8th October 2013 at 9:48 am

    Disclaimer – I’m the founder of SyndicateRoom, interviewed for this article.

    Dear Barry and Harry, I actually believe you are both correct in some parts of the arguments you presented.
    Equity crowdfunding should not be disregarded as long as it is done properly. ‘Wealth is not a skill’ and smaller investors may easily be just as sophisticated as some millionaires and Barry as a good point here.
    Harry on the other hand makes a very good point that not all entrepreneurs are ‘backable’. Some of them are, indeed, pretty clueless. This is what Business Angels are very good at weeding out – clueless entrepreneurs will never raise money from Business Angels but if they are good at selling themselves online, they might get away with it with crowdfunding.

    The big difference is detailed due diligence. A Business Angel investing £100k or maybe even £300k will carry out a level of due diligence (checking the business and the entrepreneur very carefully) that somebody investing £10 or £50 or even £100 will not do because it’s just not worth the time.

    However, having 100 people from different backgrounds asking questions to the entrepreneurs does bring some advantages too. Different backgrounds mean better questions in some areas that Business Angels may not know so much about it.

    And this is why we give the power to the crowd to invest with Business Angels and vice-versa. It is a win-win situation for both small and large investors and the entrepreneurs get the best of both worlds – the marketing boost from crowdfunding and the guidance and contacts from Business Angels.

    Goncalo,
    Founder of http://www.syndicateroom.com

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