Should you invest in Equity Crowdfunding?
Equity crowdfunding offers investors a stake in a company in exchange for funding. Although there are exceptions, these businesses are normally private and not listed on an exchange. In the past, these businesses would have sold shares only to angel investors or venture capital firms. This is still an option, but by using equity crowdfunding, that business can instead choose to sell the same set of shares and raise the same funding by selling to multiple investors.
For investors, this gives them the opportunity to invest early in companies for a lower minimum investment, and at an earlier point in the business’s lifecycle.
How Does Equity Crowdfunding Work?
Businesses partner with an equity crowdfunding platform to issue shares to investors. These platforms work with the businesses to develop their business plan, establish a valuation, and start their crowdfunding campaign.
Equity Crowdfunding in 5 Bullet Points:
The equity crowdfunding process is relatively simple, and looks like this:
- You start by browsing potential investments.
- Businesses provide their business plan, forecasts, and other information to help you make your decision.
- You decide whether the equity on offer is worth the valuation and whether to make an investment.
- Before you can make an investment, the platform will carry out a series of checks to confirm your identity, prevent money laundering, and verify that you understand the risk of your investment.
- Checks complete! Your equity crowdfunding investment is processed.
Depending on the platform, the investment will follow one of two structures:
Direct Investment Structure
In a direct investment structure, the platform facilitates your investment but then takes no further part.
For example, you decide to buy £1000 in shares of Alpha Ltd. The platform fulfills your purchase, taking their cut in the process (typically 5–7%, but can vary). Alpha Ltd then issues you with a share certificate detailing your investment of £1000 (minus fees) and how many shares you own.
In this structure, your name will be on the company’s shareholder register.
In a nominee structure, the platform continues to be involved after your investment, acting as a shareholder on behalf of a crowd of investors.
For example, you decide to buy £1000 in shares of Omega Ltd. The crowdfunding platform gathers all the offers they receive from the crowd and invests it in Omega Ltd as a single unit. The platform is the shareholder and is responsible for representing the views of the investors that invested through them.
The platform will be on the company’s shareholder register, and, because of its large shareholding, may also hold a position on the company’s board.
Direct vs. Nominee
Platforms that favour a nominee structure are critical of direct because they believe it makes it harder for the business; there’s a long list of shareholders that need to be kept up-to-date, and the number of shareholders could put off or make it harder for a VC firm to invest. 
A nominee structure is much closer to a traditional way of investing, but for some investors, this structure reduces the feeling of being involved in the business — which can potentially be a key motivation to invest.
A & B Shares, And Why They Matter
A nominee structure is theoretically safer because the one large investor, the platform, is typically given A shares (and often a place on the company’s board). A shares are more powerful; providing voting rights and the option to invest at a fair level in future funding rounds. This provides crowd investors with more influence (with the platform acting on their behalf).
On the other hand, if you invest directly in a business you may receive B shares. You still own a part of the business, but you cannot vote. This exposes you to a small risk that a large VC firm could agree on a deal for shares with the company’s board at a price that is not favourable to you. This is unlikely but not impossible.
Should You Invest in Equity Crowdfunding?
Like almost any form of investment, your money is at risk when you invest using equity crowdfunding. To help you decide whether this form of investment is for you, we’ve listed the advantages and disadvantages, along with a list of questions to ask yourself before investing, below:
Advantage — High Returns on Successful Investments
Your early, risky investment pays off when successful. platform Seedrs released data showing that their investors have generated an annualised rate of return of 14.44% between 2012 and 2016. Of course, future results may vary (and other platforms may vary), but in its short history so far, equity crowdfunding has delivered some excellent returns. For example, when Camden Town Brewery was sold to AB InBev in December 2015, investors received a return of almost 70% on their investment.
Advantage — Invest in Exciting Startups
The businesses seeking to crowdfund tend to be relatively small, often pre-profit (although some are more established), with exciting potential to disrupt their niche. Short of becoming an angel investor — which is out of reach for many — equity crowdfunding is your best opportunity to invest in these exciting young businesses. If they are a success, you get the satisfaction of having invested in them first.
Advantage — Invest in Brands You Believe In
For many investors, equity crowdfunding isn’t just about investing to make a profit; it’s also about getting involved with a brand you’re passionate about. For example, many of the investors in BrewDog were regulars at their bars and drinkers of their beer; investment for them was about more than just making a profit, it was about owning a part of a business they believed in.
Advantage — Tax Incentives
A lot of the businesses seeking equity crowdfunding are eligible for either the Enterprise Investment Scheme (EIS) or the Seed Enterprise Investment Scheme (SEIS). These schemes offer investors tax relief on their investment, helping private investors reduce their risk when investing in unlisted companies.
EIS income tax relief can potentially reduce your income tax liability by 30%, and SEIS income tax relief can potentially reduce your liability by 50%. These incentives make investing in equity crowdfunding a potentially much lower risk for individuals with a relatively high net worth because losses may be written off from their tax bill.
Advantage — Low Barrier to Entry
Some equity crowdfunding investments can be accessed for as little as £10, making this form of investing one of the easiest to get into with a low budget. This could be an advantage for new investors who want the excitement and experience of investing while limiting their losses.
Disadvantage — High Risk
As with any investment with potentially high returns, you also have to accept a high risk. If you were to invest in ten different crowdfunding investments, it would not be unusual for eight of them to fail — and it’s not outside the realms of possibility that nine or even all ten will fail.
For example, claims management group Rebus raised over £800,000 from more than 100 investors via crowdfunding platform Crowdcube in 2015. By early 2016 the company had entered administration, and investors lost their money. A report by law firm Nabarro in conjunction with AltFi Data found that one in five businesses that used equity crowdfunding between 2011 and 2013 are now bankrupt.
Investors are often happy to take this risk because a few successes will often outweigh the losses.
Disadvantage — Low Liquidity
Crowdfunding investments have very low liquidity, which means that once you’ve bought them, it’s hard to sell them until one of a few scenarios occurs. If you do buy shares you must accept that you will likely hold them until either a) the business goes bust, b) a larger investor (such as a VC fund) buys the business, or c) the business is listed on an exchange, allowing you to trade your shares.
Need to Know — The Importance of Diversification for Lowering Your Risk
Because of the high risk of each individual investment, diversifying your portfolio is key to lowering your overall risk. So, for example, buying less equity in ten companies is safer than spending all your money on shares from one company.
Most investors go further, with a portfolio made up of several different types of investments of varying risk level, some of which could be crowdfunded businesses. The more diverse the portfolio, the potentially lower risk of losing everything if a particular business, investment, or industry suffers a shock setback or loss.
Questions to Ask Yourself Before Investing in Equity Crowdfunding
Any investment is a risk, and equity crowdfunding is particularly risky. Before you consider investing, you might want to ask yourself the following questions:
- Can I afford to lose my investment (always ask this before making any investment)?
- Do I understand the high-risk nature of equity crowdfunding?
- Have I diversified my investments (or accepted the higher risk for not doing so)?
- Am I happy to invest my money for the long-term in a low-liquidity investment?
- Is the investment a direct or nominee structure?
- Will I (or the platform acting on my behalf) receive A or B shares?
Getting Started With Your First Equity Crowdfunding Investment
Choosing your first investments can be hard; take your time, remember to diversify, and read all the information made available to you. You might want to research:
- The track record of the team running the business.
- Who the non-executive directors and board are.
- The product they produce, and its place in the market.
- The company’s revenues and forecast.
- How the business has calculated their valuation.
- How the business plans to use the funds you provide.
Please head over to the OFF3R equity crowdfunding channel to compare the latest opportunities.
Risk Warning: Investing in early stage businesses involves a high level of risk, including illiquidity (inability to sell assets quickly or without substantial loss in value), lack of dividends, loss of capital and dilution risks and it should be done only as part of a diversified portfolio. Tax treatment depends on the individual circumstances of each investor and may be subject to change in the future. Your capital is at risk.
Originally published at learn.off3r.com on March 16, 2017.