Crowdfunding is often sold as a great source of finance for young companies eager to get big ideas off the ground. It made perfect sense, then, for the maker of an esoteric hybrid of an airship and plane to turn to this fast-emerging form of funding.
Bedfordshire-based Hybrid Air Vehicles (HAV) is the maker of the world’s largest aircraft, the Airlander 101. The length of a football pitch, the height of six double-decker buses and irreverently nicknamed the ‘flying bum’, the low-emission craft can stay airborne for five days, and can land almost anywhere that’s flat.
Such an ambitious venture doesn’t come cheap but, thanks to Airlander’s origins as a taxpayer funded project for the US military, which invested about $300 million in the craft, it has required a relatively modest £20 million2 in equity backing to get to the stage of test flights3.
Pioneered by Crowdcube and Seedrs in 2011, equity crowdfunding, which allows investors to acquire shares in private companies, has provided almost £376 million of investment for UK companies, according to the Liberum AltFi Volume Index4.As a result, the online platforms that enable small businesses to sell stakes to the public have won their fair share of praise.
‘Democratisation’ is the buzzword often bandied about to promote crowdfunding; what was once an asset class reserved for the very wealthy is now open to everyday investors.
Companies, meanwhile, have both a fresh route to raising money and a way to increase loyalty and advocacy from customers. What better way to keep a customer interested than to make them a shareholder, even if they did only pay £10 for their stake?
The importance of crowdfunding as a source of capital is underscored by the fact that of the 1,203 equity investment deals completed for private companies last year, a quarter (301) came via crowdfunding, according to industry analyst Beauhurst5.
Stephen McGlennan, Chief Executive HAV, says that crowdfunding was a ‘natural route’ for his company, given the level of public interest in the unusual business.
However, not everyone is convinced that the industry is always providing a good, or even fair, deal to investors. While it is still relatively early days for crowdfunding, the biggest question hanging over it is the shortage of financial returns it has provided to date. Beauhurst says that since 2011 there have been only 13 ‘exits’6 – moments when shareholders who have subscribed through crowdfunding have been able to sell their holdings – and these have been at best solid rather than spectacular7. While things could yet turn around, the fact that only 1% of companies have produced a return is clearly disappointing.
What of the failures? Beauhurst reckons that 11% of funded businesses are dead or ‘zombies’, a modest figure in the context of the high-risk world of start-up investing. Yet, there have been some spectacular blow-ups, which may point to broader problems over the quality of due diligence and investor disclosure.
Pronto, for example, a food delivery start-up, collapsed just three months after raising hundreds of thousands of pounds on Seedrs8. The Solar Cloth Company, meanwhile, raised almost £1 million via Crowdcube. Only after it collapsed 18 months later did it emerge that the entrepreneur who had led the campaign had been declared bankrupt twice and had a string of failed businesses behind him. The company’s demise is being investigated by the government’s Insolvency Service.9
Entrepreneurs report that crowdfunding platforms have improved the standard of due diligence since the industry’s early days. It took HAV five weeks to go from making the decision to raise funds to listing its offer on Crowdcube. ‘It was reasonably straightforward in that respect. However, there was a lot to cover off in that time, particularly regarding extensive due diligence to ensure every statement we made was fully justified,’ says McGlennan.
Assuming that disclosure standards are indeed improving, there are plenty of other issues with crowdfunding for investors to be wary of. One is the fact that it is not uncommon for businesses to fail to provide any investor communications.
Refreshingly, HAV takes its responsibilities in this area seriously, McGlennan says. It holds an annual shareholder meeting and sends out a monthly newsletter with both business and technical updates as well as more general stories about Airlander’s progress.
Crowdfunding is a good route,’ he says, ‘but only for companies willing to be very open and public about their business and fundraising, and transparent about their plans.’
Sadly, not every business that has crowdfunded is as enlightened as the HAV boss when it comes to understanding that selling shares to the public should involve signing up to a certain standard of transparency.
Some entrepreneurs come to see having hundreds of small shareholders at an early stage as a burden. Communications, if there had been any to start with, dry up. Others complain that the process whereby prospective investors quiz entrepreneurs during the fundraising stage provides a chance for rivals to steal their business plans.
There is a fundamental question, too, about the appropriateness of crowdfunding platforms’ business model. A study by the Financial Conduct Authority last year noted an inherent conflict of interest at the heart of these online registries where most of the business is done10.
Since they make their money from successfully completing a company’s funding offer, platforms’ allegiances lie more closely with companies than investors. They are financially motivated to raise as much money as possible rather than to find the right price for the right companies. This issue relates to arguably the thorniest crowdfunding issue of all: valuations.
The biggest risk to crowdfunding may not be the failures, or even a lack of exits, but a wildly successful exit that fails to produce decent returns for investors. If investors pay too much for a company at an early stage, then the chances of realising a decent profit years later when, say, the company floats, are drastically reduced. Chances are the business will have a series of fundraising events, all of which risk ‘diluting’ the size of each earlier investor’s stake.
To tackle this, platforms need to crack down on the sometimes ludicrous valuations they are accepting from companies. Crowdfunding investors might stomach a relatively high failure rate among the companies they back, as most understand the high-risk nature of backing a start-up. But the industry will quickly find itself unpalatable if it is repeatedly giving backers a raw deal, especially in the unlikely event that the business they back does become a world-beater.
Please note that crowdfundiing is unlikely to be the first option for raising finance and will not be suitable in many instances.
1bbc.co.uk, May 2017; 2Forbesmiddleeast.com January 2017; 3invess.com, March 2015; 4altfi.com, May 2017; 5The Deal: Equity Investment in the UK, 2016; 6crowdfundinsider.com, September 2016; 7about.beauhurst.com, March 2017; 8 fantasyequitycrowdfunding.blogspot.com, September 2016; 9companieshouse.gov.uk, May 2017; 10fca.org.uk, December 2016