Tempted by crowd­fund­ing? Nine key rules

The Daily Telegraph - Your Money - - MONEY -

It of­fers ac­cess to the firms of the fu­ture but it’s very easy to lose your cash. Jane Wal­lace ex­plains what to con­sider be­fore you in­vest

As well-es­tab­lished com­pa­nies suf­fer stock mar­ket wob­bles amid the cur­rent un­cer­tainty, some in­vestors may be look­ing for al­ter­na­tive places to put their money. One (risky) op­tion is to bet on the em­bry­onic firms of the fu­ture be­fore they list.

An easy way to in­vest in these com­pa­nies is through crowd­fund­ing, where small amounts of money are raised from a large num­ber of pub­lic in­vestors. It is of­ten used by en­trepreneurs seek­ing fund­ing for projects in their early stages.

This kind of fundrais­ing has gained a higher pro­file thanks to some suc­cess­ful cam­paigns. Revo­lut, which is­sues pre­paid cur­rency cards, raised £4m last year on See­drs, a crowd­fund­ing web­site, while beer maker Brew­Dog clinched £10m through a mini-bond sold on Crowd­cube, a sim­i­lar site.

Robin Vau­drey, who works for the Euro­pean In­vest­ment Fund, a ven­ture cap­i­tal firm, has in­vested via crowd­fund­ing since 2014. His hold­ings in­clude Oppo, which makes ice cream with 60pc less su­gar than reg­u­lar brands. Not all of his hold­ings have been suc­cess­ful. For ex­am­ple, the founder of one, Giftgam­ing, fell ill and the firm col­lapsed.

Mr Vau­drey’s ad­vice to be­gin­ners is to ask ques­tions of the web­site, other in­vestors and es­pe­cially the en­trepreneurs, to in­vest only what you can af­ford to lose, to diver­sify, and to be pa­tient about re­turns.

There are dozens of plat­forms that host thou­sands of hope­ful com­pa­nies. The re­al­ity is that lucky win­ners will be vastly out­num­bered by losers, such as restau­rant group Square Pie, which col­lapsed this year after ris­ing rents and fall­ing trade killed its busi­ness.

It won’t be the last. Only 6pc of the com­pa­nies funded via Crowd­cube have gen­er­ated any re­turn.

Alex Davies, founder of Wealth Club, an in­vest­ment bro­ker, said: “These com­pa­nies aren’t re­ally vet­ted, so you’re tak­ing a lot of risk. You need to think of it as a punt, not an in­vest­ment.” The City watch­dog, the Fi­nan­cial Con­duct Au­thor­ity (FCA), said in April that it was look­ing at how to bet­ter reg­u­late crowd­fund­ing.

The odds aren’t good, but there are com­pa­nies that do well. How can you pick out the good from the bad? There is no se­cret for­mula, but the fol­low­ing nine points could help you avoid ba­sic mis­takes.

The idea

A com­pany will ul­ti­mately suc­ceed only if the prod­uct or ser­vice it is sell­ing is worth­while. Test­ing (or tast­ing) the goods your­self is use­ful re­search. If you rate the com­pany’s propo­si­tion, oth­ers prob­a­bly will too.

Qual­ity of man­age­ment

The cal­i­bre of the peo­ple in charge and their ex­pe­ri­ence are cru­cial. “Lots of peo­ple can have ideas, but far fewer can ex­e­cute them,” said Mr Davies. “You’ll want to know if they’ve done this or sim­i­lar be­fore. You don’t re­ally want peo­ple ex­per­i­ment­ing with your money.” Check the in­for­ma­tion given about the di­rec­tors and their back­ground.

Ben Years­ley of ad­vice firm Shore Fi­nan­cial Plan­ning said he wanted to see man­agers’ own money on the line. He gave an ex­am­ple where the founders had con­trib­uted noth­ing yet al­lot­ted them­selves a 75pc stake in the firm. “That, to me, is a big ‘no’,” he said. “I’m al­ways look­ing for man­age­ment to be on the hook for a se­ri­ous amount. It might be work­ing for noth­ing for two years, or com­mit­ting £100,000.”

Com­pet­i­tive ad­van­tage

A start-up must be able to stand out from the crowd. If many oth­ers of­fer the same thing, the firm will strug­gle. Ex­clu­sive deals with re­tail­ers or distrib­u­tors can help.

Mr Davies said high-mar­gin busi­nesses, such as a ve­teri­nary hos­pi­tal, usu­ally had bet­ter chances of suc­cess be­cause the spe­cial­ist knowl­edge and larger com­mit­ments of cap­i­tal re­quired were harder to match.

Val­u­a­tion

Iden­ti­fy­ing the real worth of a start-up is com­pli­cated be­cause there is no “one rule fits all”. Those fa­mil­iar with price-to-earn­ings ra­tios or prof­itabil­ity mea­sures like “Ebitda” could use them to make com­par­isons with sim­i­lar busi­nesses; bear in mind that tech­nol­ogy firms tend to have higher val­u­a­tions.

Com­mon sense is key. There may be data on past rev­enue, prof­its and pro­jected earn­ings. Mr Years­ley said: “You need to look at the his­tory of the busi­ness. If turnover has gone from £100,000 to £250,000 to £500,000 in the past three years and man­age­ment pre­dicts £1m this year, maybe a high val­u­a­tion is jus­ti­fied. But if turnover is fall­ing you should ques­tion a high mul­ti­ple.”

Busi­ness plan

Com­pa­nies seek cap­i­tal to help them grow. It is up to the in­vestor to de­cide whether the stated tar­gets are re­al­is­tic. Check how quickly the firm’s prof­its are grow­ing and con­sider whether it’s op­er­at­ing in a growth mar­ket. “For a small com­pany with an in­ter­est­ing prod­uct, 10pc growth a year is eas­ily achiev­able, but 100pc is more of a stretch,” said Mr Years­ley.

Di­ver­si­fi­ca­tion

With fail­ures so com­mon, it makes sense to spread the risk be­tween lots of com­pa­nies.

Kirsty Grant, in­vest­ment di­rec­tor at See­drs, said: “This is why we have the £10 min­i­mum in­vest­ment. Even if you have only £100 to in­vest, it still means you can di­vide it be­tween 10 com­pa­nies, not just one or two.”

Mr Years­ley’s ad­vice is to de­cide the to­tal amount you want to in­vest in crowd­fund­ing and then spread it among at least 20 to 30 com­pa­nies.

Exit strat­egy

Get­ting your money back can be prob­lem­atic: div­i­dends are rare and al­though there are nascent “sec­ondary” mar­kets, sell­ing your shares can still be dif­fi­cult. A float or a takeover, if it does hap­pen, could take five or 10 years to emerge. Whether the com­pany will be at­trac­tive to fu­ture buy­ers should be a cen­tral pil­lar of your se­lec­tion process.

Stay up­dated

Pop­u­lar deals can sell out quickly. Monzo, a “chal­lenger” bank, raised its first tar­get amount in just 96 sec­onds, leav­ing many dis­ap­pointed. Luke Lang, co-founder of Crowd­cube, said: “Most com­pa­nies don’t fund at that rate and you do get a chance to pon­der the doc­u­ments in ad­vance.” His ad­vice for stay­ing ahead of the pack is to sign up to the web­sites’ email news­let­ters.

Charges and taxes

Most crowd­funded com­pa­nies are struc­tured via the En­ter­prise In­vest­ment Scheme (EIS) or Seed En­ter­prise In­vest­ment Scheme (SEIS), both of which carry healthy tax perks. An in­vestor in the EIS can knock 30pc of the value of their in­vest­ment off their in­come tax bill. For the SEIS it’s 50pc.

There are still fees to pay. See­drs charges in­vestors 7.5pc on any re­turn and takes 6pc of the amount each firm raises. Crowd­cube takes 7.5pc of funds but there is no charge to in­vestors.

Both web­sites un­der­take some due dili­gence, but they do not ac­cept li­a­bil­ity for it and there are gaps, es­pe­cially in ver­i­fy­ing own­er­ship of as­sets and his­tor­i­cal fi­nances. The short­cut is to pay a man­ager such as Wealth Club, which has ac­cess to port­fo­lios of vet­ted EIS schemes for a 3pc-5pc ini­tial fee and 2pc an­nu­ally. Ku­ber Ven­tures has a sim­i­lar of­fer­ing.

Justin Mo­dray of Can­did Fi­nan­cial Ad­vice said: “Crowd­fund­ing re­mains a niche in­vest­ment and I wouldn’t risk more than a small part of an over­all port­fo­lio on it.”

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