Wednesday, 16 September 2015

Will investors via Crowdcube ever see a return?

We thought we would publish this article we wrote as guest blogger for Finance as they seem to be unable to publish anything without changing the meaning of most of it - this is the real version. Needless to say we would not recommend anyone either reading anything on their site or writing anything for it.

Will Investors ever see a return from UK Equity Crowdfunding?
Equity crowdfunding started in the UK in 2011. So what have we to show for it?

Equity Crowdfunding (ECF) was launched in the UK in 2011. The first platform and now by far the largest, is Crowdcube; established by two PR entrepreneurs. It has to date supplied funds to almost 300 companies, raised a total of over £100m and this year alone has exceeded £50m in funding. The question now is when will investors start to see returns ?

In order to see these returns, investors need to off load the shares they have bought. There is no secondary market, so exchanging them for cash requires either the business to be sold or floated via an IPO. These decisions, should they be available, will be made with no reference to the Crowd who invested.

One company, E-Car Club has sold out and investors apparently took a return of 3 times their investment – the details were kept secret. This is a slightly odd case as the company agreed to sell a major stake to Europe's largest car rental firm, Europcar, thereby giving this tiny loss making electric car club an instant pan European platform – something it had failed to deliver flying solo. Investors were forced to sell their shares as a drag along clause in the Crowdcube deal was activated. Clearly with these new backers, this company is likely to be worth a lot more than 3 times in a few years. Unlike most ECF pitches, this one was not eligible for the UK Government's generous income tax rebate scheme - a scheme that has proved the main driver for ECF's growth.

It is to date, the only return.

It pales into insignificance when measured against the mounting losses. E-Car Club raised £100k and therefore returned £300,000. To date investors in all the UK ECF platforms have lost in excess of £5m. Without fail, pitches on a platform like Crowdcube promise returns in 3 or 4 years, so we really should be seeing some by now. There is absolutely no evidence that that we will. Our research, based on Crowdcube and a few pitches from other sites since 2011, shows that 99.9% of the companies that have raised money this way, have missed their projections for all years since. Some have missed them by over 1000% .

These are the projections promoted by the platforms and used by punters to decide to invest. Under the current regulations this is all totally legal. Given the illiquid nature of these shares and the poor performance of these businesses, the chances of realising any return look very remote – they are locked in for eternity or until closure. Throw into this mix the dilution suffered by B share holders, when the inevitable unscheduled second and third raises occur and you have a gloomy picture. Caveat Emptor only works if you have information symmetry and that does not exist here. The reporting systems we operate for businesses with a turnover of less than £6m (most of the companies raising ECF) only require them to file a very sparse balance sheet for their annual accounts. These are quite often wrong and can be adjusted at any stage in the future. These filings are being used by investors to make decisions; so is it any wonder they get it wrong.

One recent development highlights the problem of ECF as practised in the UK. Mara Seaweed raised over £500,000 on Crowdcube and valued itself at £3.5m, pre money. When asked how they had come to this value, they replied they had used the Discounted Cash Flow method. As most people know this method is favoured by VC firms but cannot be reliably used for start ups, as the historic data just isn't available. Mara is a start up. Despite this the company was successful in its pitch. The punters are just that – punters. Ask a car parking attendant to position a military strike drone and you can expect collateral damage; blind fold him and anything could happen.

Does it matter? Well yes because despite the attempts of the platforms to cripple ECF in its infancy, this could be a very valuable source of funding for SMEs. Sooner rather than later, investors will wake up to the fact that throwing money at Crowdcube and the others for zero return is actually pretty foolish and the well will dry up just as suddenly as it appeared. Reaching a £100m investment milestone is rather pointless if all that money achieves is failed businesses and angry creditors. It seems very likely that finding such an easy source of cash, many companies that partake are over trading – with the usual dire consequences. A more responsible approach to promotions and to due diligence with the financials would help alleviate these problems. A model more along the lines of Australia's ASSOB would be better than the one we have now.

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