Equity Crowdfunding: a VC perspective
We are often asked if we see equity crowd funding as a competitive threat to early stage venture capital. MMC is an investor in Series A, which is usually defined as the first institutional money raise. In the current UK market that is typically round sizes between £1.5m and £4.0m and the company will have already taken one or more rounds of seed and “seed+” capital. To date we have not competed with a crowd funding platform to “win” a deal and we have not yet invested in a company that has previously taken crowd sourced capital.
We invest in both b2c and b2b companies and I see little interest in crowd funding from the SaaS based software companies we back. Even among the broader b2c sector there is concern about the level of public disclosure (including to competitors) that crowd funding requires. Entrepreneurs remain sensitive to a market perception that taking equity from the crowd can be a mark of funding desperation, though we expect that to diminish.
With those caveats, however, we view crowd funding as a complementary finance channel that can source additional and strategic capital for appropriate portfolio companies. Our perception is that appropriate companies are largely b2c with easily understood models and a supportive customer base. For entrepreneurs in that sector crowd funding is now another feature of their tool kit, like venture debt. It is particularly valuable as a means of attracting customers of the company to invest and we see this as the best reason to access equity crowd funding.
The following practical observations have been fed back to us from entrepreneurs who have used equity crowdfunding.
1. Time Commitment. First, the commitment of time and effort is much greater than expected. The amount of time required from a CEO can be 2x-3x what an institutional due diligence process would require. The factual information provided needs to be verified as you would a prospectus. Then the flow of individual questions from prospective investors (all on a public forum) can be massive: potentially taking several hours per day over two to three weeks. It is imperative to anticipate the time commitment to be sure the business has sufficient cash to see it through!
A video interview is necessary and it is well worth the cost (c. £2000) as it can reduce the flow of questions and stimulate interest. It adds to the time taken, however.
2. Valuation. Companies typically achieve a valuation premium over what a VC would pay but of the order of 20%-25%. It is not true that valuations are ridiculous (with obvious exceptions) and because crowd investors are often fans of Dragons’ Den they are searching for indications of risk reduction, including a valuation that can be justified.
The best demonstration of justifiable value is institutional investment at the same price. It does appear that a later stage (i.e. Series A or beyond) crowd raise needs to have institutional backing to ensure success. A good percentage (40% or 50%) of the target amount should already be secured and it is helpful to announce that in stages in the course of the raise and so build momentum.
3. Investors. US investors are excluded from UK crowd funding platforms so if US investors are a target they will need to be accessed through a US platform.
EIS is not a requirement. I understand that Just Park — the largest Crowd Cube raise at £3.9m — was not EIS qualifying.
The number of sophisticated investors who write cheques of £25k and above is small and so larger target amounts will require hundreds of small investors (£100+ tickets). However, you can impose a minimum investment amount. If it is EIS qualifying the CFO may have to sign hundreds, possibly thousands, of EIS certificates!
4. Nominee Services. Several crowd funding platforms have responded to the widespread concerns about the headache of managing a shareholder list of hundreds or thousands of small investors by introducing nominee services. These need to be fully understood, including whether the nominee takes authority to execute the shareholder agreement and exercise all the voting and other shareholder rights.
A growing b2c business with an engaged customer base that wants to deepen customer loyalty and promote a viral marketing message should be considering crowd funding alongside other sources of capital. A carefully planned, well executed crowd financing can achieve several objectives simultaneously.
(A version of this story was first published in CityAM on 14th July 2016)
