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Crowdfunding – the new normal?

Alternative finance is continuing to fuel the UK’s smaller businesses. For start-ups, equity crowdfunding is coming of age

Crowdfunding – the new normal?

The alternative finance industry in the UK is booming. According to the Cambridge Centre for Alternative Finance (CCAF), it grew by 35% in 2017 to over £6bn*.

Much of this growth is because the UK’s smaller businesses have embraced alternative finance. Peer-to-peer (P2P) business lending – where individuals and financial institutions lend to businesses through matchmaking platforms like Funding Circle – is the largest source of funding, with over £2bn lent in 2017, 66% up on 2016. The CCAF estimates that in 2017, up to 29% of all the new loans issued to businesses with less than £2million turnover were P2P loans.

But P2P lending isn’t aimed at start-ups. Bryan Zhang, executive director and co-founder of the CCAF says that P2P lending is really for the post-start-up stages of an entrepreneur’s journey. For start-ups, equity crowdfunding is the most viable form of alternative finance – where investors purchase shares in companies, through online platforms such as Crowdcube or Seedrs.

He says: “A start-up with no trading history will automatically be disqualified from obtaining a P2P loan. Most of the platforms would require at least three, preferably five years of trading history. However, equity crowdfunding can be used by entrepreneurs for their very early pre-seed funding rounds, all the way through to later-stage venture capital type rounds.”

CCAF research shows that equity crowdfunding grew by 22% in 2017 to provide early stage businesses with £333 million of capital, and now makes up around 13% of all UK seed and venture-stage equity investment.

Bryan sees the growth continuing for now. “The trend towards crowdfunding is entrenched. We are in the process of finalising the 2018 data, and it’s looking like it will be another year of crowdfunding growth.”

Not an ‘either-or’ choice

Kirsty Ranger, CEO of IdeaSquares, an agency that has assisted nearly 150 businesses to raise crowdfunding (and raised crowdfunding capital itself), says that it shouldn’t only be viewed as an alternative to more traditional forms of funding, such as business angels and venture capital (VC). She says: “Whereas it used to be a very separate method of fundraising, we’re actually seeing that angels and VCs are moving to become part of the crowd, particularly the larger campaigns.” CCAF data shows that in 2017, institutions provided 49% of the capital invested through platforms, up from just 8% in 2015.

She also says it’s becoming more important for companies to secure a ‘lead investor’, usually a business angel or a VC fund, before they go live with their crowdfunding campaign. The crowd is then used to complete the investment round. “It’s far easier to attract unknown crowd investors when there is already significant investment on the table. It also helps if some of that money is coming from a source that could also support the business as it grows. If there is an angel that has experience in the sector and the crowd can see that person has put money in, that definitely helps.”

Marketing meets finance

Kirsty also advises businesses to think of crowdfunding as part-marketing, part-fundraising. She points to Monzo, the bank, as an example of a company that combined the two well. It raised the bulk of its £22 million 2017 funding round from VC funds, but kept £2.5 million reserved for customers and the crowd. Incentives such as exclusive debit and credit card deals were offered to these investors, in a clear strategy of using crowdfunding to grow the number of banking customers.   

The point Kirsty stresses most is that crowdfunding doesn’t start when you push the button to go live on the platform. That’s just the tip of the iceberg. She says: “It starts months before this with a really strong and careful communication campaign to your audience. And you have to think about how you warm up each segment of that audience so that you have a successful campaign when you do push the button.

“You might have closed meetings with professional investors first, to try and secure part of the funding round. And then you might have a communication campaign for existing customers, to try and convert them into investors, creating ‘brand advocates’. Only once you have created significant ‘buzz’ in advance, do you want to go live with your crowdfunding campaign.”

She also says that the marketing advantages of crowdfunding can continue after fundraising. “You now have relationships with many investors who may be clients as well. Ask for help. Ask for introductions. Use the crowd as appropriate.”

While the momentum shift towards crowdfunding is still strong, it’s not yet the ‘new normal’. Bryan points out that the real test of investors’ continued interest is still to come. He says: “Over the last five or six years, there have been very few exits (where shareholders have sold their stakes). Many of the companies that have been through the crowdfunding process are still a few years away from that. So it’s too early to judge if this model has longevity.

“When we have data over a longer period, so we can track the number of exits compared to the number of deals going through the platforms, and how profitable these exits are, then we can track the upside for investors with more certainty and make that judgement.”

* Source: The Cambridge Centre for Alternative Finance, The 5th UK Alternative Finance Report, Noeverber 2018.

The opinions expressed by third parties are their own are not necessarily shared by St. James’s Place Wealth Management.