Thursday, 17 September 2015

Predicted growth rates for ECF pitches are on the edge of the ridiculous

So what is the expected rate of growth for UK start up?

If you look at nearly all the companies that use ECF, you see that over their 3 year projections,the growth rate is a minimum of 500% and a maximum of over 3000% - yes thats three, zero zero zero percent or 30 times.

Recent work by Deloitte's Fast 50, a collection of the UKs highest growth tech start ups, gives us some clue as to what might be expected. Of these 50, the average 5 year growth rate was a real 1300% or if you take an annual average about 250% pa. Of course there are many other factors that make this simple growth percentage almost irrelevant but you have to start somewhere.  If a company has a turnover in year 1 of 1p and by year five has reached £5, its 5 year rate would be 5000%. It wouldnt make it a success however.

When presented with projections showing growth from a standing start of 1000% over 3 years, what are we make of it? The sector the business is in is highly relevant, as are its market conditions and the expertise behind the company to drive this growth. Even if all of these are in a good place, to beat the average of 250% or a 2 and half times increase pa, would need something very special.

Most companies that raise ECF predict growth rates in excess of this norm (3 or five year) even if they are not in the high growth tech sector. This clearly is a mistake. So what are the consequences?

Encouraging companies that pitch in this way to sell their equity, using fantastic projections, will have negative consequences. For starters most of the Fast 50 are well financed and part of the entry criteria is that the business has to have  been trading for 4 years. Unrealistic expectations can lead to over trading - a situation which might mean overselling a service or product without sufficient funds to deliver, resulting in often fatal order cancellations and customer loss. So setting yourself up for a 3 times revenue growth pa without sufficient capital to deliver this is just as stupid and dangerous as holding stock with too few customers to buy it.  In fact over trading is a main reason for the collapse of SMEs.

All new businesses will make mistakes - read books on Branson or Roddick or any other successful entrepreneur. The difference between them and us is that they made mistakes at times when they were not critical - be it by design or luck. If you are going to force your business revenues from £100,000 to £400,000 to £1.6m and then £4.2m in three years then you had better have stress tested your systems beforehand. Losing an engine when cruising at 30,000 ft is not fatal, losing one when on the final descent to land will be.

Another important factor is the resource available for this growth. You see time and time again on platforms like Crowdcube, expectant companies project growth of 400% pa with sales and marketing budgets only increasing by 50% pa or less. Quite a few even show this resource diminishing. Likewise personnel and administration costs tend to rise in years one and two and then plateau  - never taking into account the different strains a £3.5m turnover will place on the workings of a small company compared to a starting £100k. 

All of the above helps to explain the dominant feature of nearly all of Crowdcube's 'successes' - their failure to get anywhere close to the revenue projections they promoted on the platform when they were selling their equity. The forums have been filled to bursting with entrepreneurs saying that their sales growth is on the conservative side. Then later, when they run out of cash and return for more, they never mention these projections.

Of course Crowdcube would say that no one is being forced to invest. That is so. If you ever needed proof that the sorts of people who are investing know very little about how business is run, then the success of the platform is just such evidence. They dress the whole charade up as some sort of Dragons Den game show and this is allowed by the FCA. But we have people talking to us who have invested and lost money and clearly do not understand the first thing about what the risks are. So somewhere the message is being missed and we believe it is the platform's responsibility to engage more honestly with investors. Of course that would mean sensible projections and fewer investors so the chances are really very small.


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