Access to funding isn’t getting any easier for the UK’s small and medium sized enterprises, aka SMEs. With most businesses unwilling or unsuited to raising traditional venture or growth capital, and with a scarcity of bank loans and overdrafts, there’s an increasing focus on the alternatives. To an extent, asset-based lenders (banks or others who provide invoice or asset-based finance) have stepped into the fray and tax-incentivised business angel activity appears to be increasing, but there’s a never-ending demand.
Enter crowdfunding, the process by which people pool their resources to support a cause, often associated with disaster relief or sparked by an individual tragedy, but now increasingly adopted by businesses seeking working capital finance, loans or even equity.
The business crowdfunding bandwagon is only just starting to roll. Much of the activity has been driven by the internet, which enables campaigns to be spread far and wide or within defined or captive communities. An early example (1997) was the British rock group, Marillion, whose fans conceived and managed a fundraising of $60,000, underwriting the band’s US tour. Since then Marillion have used the technique to fund the recording and marketing of several albums.
Another example of crowdfunding is the issue of retail bonds. In 2010, using a largely captive model (its customers), Hotel Chocolat famously offered a three year, FSA-approved ‘chocolate bond’ to the 100,000 members of its tasting club. Customers were invited to invest £2,000 for a gross annual return of 6.72%, or £4,000 for a return of 7.29% – all paid in regular deliveries of chocolate. This had the advantage of raising the company’s profile, winning it new customers and raising £3.7m in the process.
Caxtonfx, the foreign exchange company, used a similar approach with its customers in 2011 to raise a £4m bond. Mr & Mrs Smith, the award winning travel website and hotel booking service, followed suit in 2012, raising twice their hoped for minimum. In Mr & Mrs Smith’s case, nearly half opted for ‘Smith loyalty money’ at 9.5%, rather than the offer of 7.5% in cash, giving a further boost to their business.
Using a captive crowd is only half the story, however. The big crowdfunding sensation of 2012 is Pebble Technology, a Palo Alto based smart watch company, who used US-based crowdfunding platform Kickstarter.com to raise a minimum of $100,000 against forward sales of its Pebble watch. The offer closed on 18th May 2012, by which time the company had raised over $10 million from more than 68,000 backers.
Reward or debt
For businesses, there are essentially three categories of crowdfunding: reward-based, loan-based or equity-based.
Pebble is the most successful example of the reward-based model so far, where the crowd agrees to donate to a business or project in exchange for tangible, non-monetary rewards such as watches. Simon Dixon, a UK-based entrepreneur who has recently launched his own crowdfunding site, Banktothefuture.com, says that there’s already an established route to success. “To be successful in crowdfunding, there’s a simple formula, £££=R+SC+E, where the amount of money you will raise depends on the strength of the rewards you offer (R), how much social capital you have (SC) and the emotion attached to your story (E),” says Dixon.
So far, so good, but what happens when there is debt or equity involved, rather than a promise to deliver products or other non-cash rewards?
There are a number of debt and equity based crowdfunding models emerging in the UK. Some target sophisticated investors and some the wider public. Some simply provide access to a crowd, with funding delivered by single subscribers, whilst the majority encourage multiple participation. All serve a purpose and a number have come together to form the Next Generation Finance Consortium (www.ngfc.org.uk ), a privately led initiative to create a platform for entrepreneurs seeking alternative sources of funding for their high growth businesses.
At the more sophisticated end, MarketInvoice has developed a new and innovative funding platform where businesses can selectively auction individual invoices to a network of high net worth individuals and institutional buyers to raise flexible working capital. According to its website, over £13.5 million has been advanced to over 90 businesses. Rather than waiting 30, 60 or 90 days for large customers to pay, businesses can get access to cash immediately.
Funding Circle, another debt-based model, operates along more traditional crowdfunding lines. Describing itself as “Better for business, better for investors, better all round”, businesses borrow from multiple lenders (aka investors) and lenders can lend to multiple businesses, thereby spreading their risk. The site claims average gross yields of 9.1% for investors (compare that to rates on offer from the banks!) and easy access to their money, while businesses can benefit from quick and convenient one, three or five year loans of between £5,000 and £250,000.
As reward and debt-based crowdfunding become better established and understood, equity-based crowdfunding models are emerging. These offer investors equity participation in start-ups or early-stage businesses, carrying high risk and the potential for high reward. The recent Facebook flotation is a good example of the potential rewards available from early-stage investing, but it’s not for the fainthearted. Investors looking for the ‘next big thing’ need to understand that the vast majority of early stage investments either fail, or fail to deliver positive returns to investors.
The best known equity-based crowdfunding platform in the UK is Crowdcube, which imposes strict barriers to entry, insisting that businesses seeking funding must pass rigorous checks. Founded in 2010, it describes itself as a new way to fund start-ups and business expansion by giving entrepreneurs a platform to connect with ordinary people and raise venture capital. It handled the £1 million funding of The Rushmore Group in November 2011, the biggest equity crowdfunding success to date, with 143 participating investors. Another emerging platform is Seedrs, which is regulated by the Financial Services Authority (FSA), which facilitates investments up to £150,000 from single or multiple investors.
So where to next for crowdfunding? Whilst there are regulatory challenges and there will almost certainly be some accidents along the way, it’s new, it’s here and it’s a welcome alternative for the nation’s entrepreneurs.
For further information on crowdfunding, please contact Guy Rigby on 020 7131 8213 or email[email protected].
This article was originally published in Accountancy, August 2012, and has been updated for this newsletter.
By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of writing.
Smith & Williamson LLP
Regulated by the Institute of Chartered Accountants in England and Wales for a range of investment business activities. A member of Nexia International
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Registered to carry on audit work and regulated by the Institute of Chartered Accountants in England and Wales for a range of Investment business activities. A member of Nexia International