Crowd-funding is the democratisation
19/09/2014
You hear dark mutterings about the rise of crowd-funding. Some regard investors as naive and fear there will inevitably be an almighty train crash involving a crowd-funded business that will lead to greater scrutiny of the whole process. Certainly, you come across businesses looking for investment with unrealistic valuations of the existing enterprise, which in some cases is no more than a business plan. One sector entrepreneur told me he thought the Chilango mini-bond was an “unethical” way to raise money, given how little most of its investors can really know about the Mexican food market. Certainly, the self-certifying process to join as an investor is little more than a tick-box exercise.
But for me, the rise of crowd-funding amounts to the democratisation of the investment process. Given paltry interest rate returns from major financial institutions, here is a chance for ordinary citizens to side-step the legions of sluggish and expensive institutional funds and put their money to work. There is fun to be had along the way as well, with many crowd-funding businesses offering decent perks, not to mention the generous tax breaks that come with investing in start-up businesses. The crowd-funding market is exploding. The market leader, Crowdcube, with its 89,398 registered investors, saw as much investment in the first half of 2014 as in the preceding 12 months.
The market is developing, too. This year has seen the launch of the first mini-bonds, allowing investors to lend money to more established brands, as well as buy an equity stake in start-ups and early-stage businesses. River Cottage Canteen recently raised £1m by borrowing from “the crowd” and will be paying them back 7% interest per annum over a four-year term. These bonds are not without risk, however, which is why they offer higher interest rates than many other investment opportunities. By contrast, the Mexican restaurant brand Chilango offered 8% interest on its bond, reflecting, one assumes, a higher degree of risk investing in the business compared to River Cottage (ironically, the higher rate of interest itself becomes part of the larger risk profile).
There is an element of the wisdom of crowds at work here in a very direct way. The speed and weight of money drawn into particular investments reflect the collective judgement of many thousands on the investment appeal of particular businesses. There is always the danger of a lemming-like rush towards a particular investment, under-researched investors drawn by other investors. But in terms of track record, it is not as if the decision-makers at the professional lenders, the big banks, have covered themselves in glory in the past decade or so. And it is clear that crowd-funders can spot an investment they like. Crowdcube itself reached its own recent investment target of £1.2m in just 16 minutes last month, with individual investors parking their money alongside a private equity firm. Crowd-fund investors preferred River Cottage Canteen to Chilango as an investment, judging by the speed of take-up. River Cottage hit its £1m target in 36 hours. Chilango took a number of weeks to raise £2,160,000. Investors liked the cut of Chilango’s jib – it was the largest amount raised by Crowdcube so far. It’s just that they liked River Cottage Canteen even more as an investment prospect, judged by the speed of the cash flowing into its bond.
An analysis of the Chilango investment community shows the way crowd-funding largely draws those with a bit of money to punt: Chilango’s investors do not look to be staking their life savings. Its 748 investors made an average investment of £2,900, while 22% of the investment group were women.
An estimated 20% of the businesses looking for investment on crowd-finding websites hail from the world of food and drink. Businesses from our sector are particularly suited to fund-raising of this sort because prospective investors can make judgments on the quality of what those businesses do based on the investors’ perspective as consumers. There is less publicity attached to the companies that fail to attract funding through crowd-funding. Watching the major crowd-funding websites, I would estimate that three in four businesses fail to reach their investment target – and quietly fade away. The crowd has spoken, and may well have done founders a favour with their lack of enthusiasm.
It is worth remembering that the grand total of businesses to have been funded so far through Crowdcube is just 143. Like your average series of Dragon’s Den, invested businesses are heavily out-numbered by those that are judged to lack investment appeal.
Paul Charity is managing director of Propel Info