Alternative Finance – Equity Crowdfunding

What is equity crowdfunding?

Sale of a stake in a business to a number of investors in return for investment, predominantly used by early–stage firms.

Equity–based crowdfunding grew by 201 per cent in 2014

Equity–based crowdfunding, whereby investors can diversify their portfolio and invest in both early–stage (e.g. pre–seed, seed and start–up) ventures as well as growth–stage companies, continues its rapid expansion with a 201 per cent year–on–year growth rate and facilitated £84 milion in predicted total transaction volume for 2014.

Analysis of a dataset gathered from equity–based crowdfunding platforms, covering £37.43 milion transactions from 2011 to the first quarter of 2014 and including 188 funded deals and 23,414 micro–transactions, shows that the average deal size of an equity–based crowdfunding campaign is £199,095. On average, it takes 125 investors to fund an equity deal with the average micro–transaction value being £1,599.

The average age of fundraisers is 43 and the average age of investors is 40. From the investor side, the average investment portfolio size is £5,414 with an average diversification rate of 2.48 (i.e. on average, one investor has invested in 2.48 equity–crowdfunding deals). Almost 95 per cent of the funded equity–based crowdfunding deals were eligible either for the EIS (Enterprise Investment Scheme) or the SEIS (Seed Enterprise Investment Scheme) schemes.

Sixty–two per cent of investors didn’t have previous investment experience

Equity–based crowdfunding platforms are proving attractive for both retail investors who are new to venture capital investing, as well as for experienced investors. 62 per cent of the 290 investors surveyed described themselves as being retail investors with no previous investment experience. A sample of data from the platforms shows that the average portfolio size for certified high networth individuals and ‘sophisticated investors’ is over £8,000 in contrast to less than £4,000 for ‘retail investors’.

The pitch and the team are what matters to investors not comments by other investors

Three–quarters of investors had invested in businesses run by entrepreneurs whom they had no previous knowledge about or connection to. The most common method of discovering investment opportunities was through browsing the equity–crowdfunding platform, with the least being offline promotion of the investment opportunities.

Investors primarily invest through equity–based crowdfunding platforms in the hope of making a financial return (very important to 61 per cent of investors). Portfolio diversification, the ease of the investment process and the added control over where their money goes was also seen as important or very important to more than 75 per cent of surveyed investors. Few investors came to the model to invest in a family member or a friend or to support a local business. Instead, investors are selecting specific investment opportunities on the crowdfunding platform, with the quality of the team( rated ‘important’ or ‘very important’ by 97 per cent of respondents) and the pitch (96 per cent) named as the most important factors. External endorsements and the views of other investors on forums were deemed less important.

While 66 per cent of surveyed investors identified tax reliefs as an important factor, more than half stated that they would have invested even if the tax incentives were not present, with only a quarter saying they would not have. While investors often read comments by other investors when making investment decisions, they rarely contribute comments or get in touch with other investors to discuss investment opportunities. The money they use to invest is money that would otherwise have (at least partly) been invested elsewhere (68 per cent of respondents) or saved (44 per cent of respondents).

Ventures seeking finance tended to find out about equity–based crowdfunding through online advertising or through the media and press. Over a third had sought funding from friends and family or business angels prior to approaching an equity–based crowdfunding platform.

Forty–seven per cent of successful fundraisers have increased their profit

For those who were successful in their attempt to fundraise, the biggest challenges with the process were developing a marketing strategy and a crowdfunding pitch. They reported that finding and working with an equity–based crowdfunding platform was not difficult.

Fundraisers found that funders added value beyond their financial contributions to the business through assisting with making connections to people in their networks (63 per cent of respondents) and providing market validation for the venture (60 per cent). Fundraisers believed that the most important routes to successfully sourcing funders was through their existing social networks and direct mailing.

Since securing funding, 47 per cent of fundraisers have increased profits, 70 per cent grew turnover and 60 per cent of them have taken on new employees. Three–quarters of the surveyed fundraisers have also launched a new product or service and two–thirds have attracted media coverage.

Those ventures that failed to reach their funding target identified that failure to generate momentum in the early stages of the campaign, insufficient support from the platform and not doing enough marketing as factors that led to their failure. Despite this, 80 per cent of them said they would be willing to try it again and half would recommend equity–based crowdfunding to others with the rest unsure.

Half of investors plan on investing more in 2015

Of the 196 active investors surveyed, 85 per cent had made their first investment since the beginning of 2013, with 36 per cent of investors becoming active in the last three months.

Around half of the investors surveyed plan to invest more in the coming year with around a third planning on investing the same amount. Eighty–one per cent of investors state they would recommend equity–based crowdfunding to someone they know, while 75 per cent say they would recommend a specific business seeking investment.

However, it is important to note that given the nature of investing in early–stage companies and the relative nascent state of equity–based crowdfunding model, that most equity crowdfunding investors are yet to see what returns their investments can bring.

All successful fundraisers would recommend equity–based crowdfunding to someone else seeking funding and 91 per cent of them state they would approach an equity crowdfunding platform first in the future if venture capital is needed.