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.