The obvious advantage of crowdfunding is that it enables entrepreneurs and startups to access capital from a wide range of investors. Small companies, like Vulpine, that would otherwise struggle to access traditional forms of financing are therefore able to access capital and get the venture off the ground.
Crowdfunding also serves as a way to spread risk. Startups and young businesses often incur significant and unexpected costs in the early days – which can be fatal to success.
Vulpine, which was set up in 2012 by Nick Hussey, was recently declared insolvent – with the late arrival of summer stock putting it in a “difficult cash position”, according to Hussey. The business had twice turned to crowdfunding as a way of raising money, once successfully, so what went wrong?
Raising money through crowdfunding presents a way to spread such risks amongst more people. For investors, the alleged promised return on investment through crowdfunding could be significantly higher than that generated by other traditional financial products. It also offers investors opportunities to invest concepts in which they have a personal interest.
Crowdcube alone states on its website that it has invested £309,802,924 in pitches, and has 400,439 members. It is still early days to judge the success of crowdfunded companies, given that not many have sold or floated on the stock exchange. However, the platform boasts some impressive success stories, for example, Camden Town Brewery, Ready Steady Mums and E-Car Club, which have rewarded investors with generous returns.
What about the risks?
Equity-based crowdfunding typically carries risk because investors can potentially commit large sums of money in return for an equity slice of the business itself. The FCA (Financial Conduct Authority) has published guidance addressing the risks associated with crowdfunding and, in respect of equity crowdfunding, even goes as far as to say that investors are very likely to lose all their money.
Equity-based shareholders should also anticipate that the value of their investment will be diluted as it is common for startups to require several rounds of funding – and consequently issue more shares in the business.
In fact, if an investor invests an insignificant amount, it may receive a different class of share which is non-voting and does not benefit from pre-emption rights. In a similar vein, successful crowdfunded ventures can be acquired by private equity firms at a low premium, if the crowdfunding investors have no voting rights. This was the case in respect of Wool and the Gang, and they may be forced to accept very modest returns.
Some of the most high-profile failures, such as Rebus which raised just over £800,000 via an equity crowdfunding platform, have caused critics to take issue with the standard of due diligence provided to the investor and the perceived lack of transparency. One of the main concerns with crowdfunding is that the investors involved often lack the skills required to make their own analysis of a company’s financial health. The FCA has not yet issued prescriptive guidelines for due diligence so each platform adopts its own approach.
The collapse of companies like Vulpine, two years after raising £1m, demonstrates the need to ensure that investors are aware of the level of risk they are taking. The industry has now been around for long enough so as to not be seen as being in its infancy and, as it matures, the trend may shift towards greater protection for investors.
However, a balance will need to be struck in creating a transparent system that shifts some of the due diligence burden back to the crowdfunding platforms but does not stifle the industry completely.
Amelia Villiers-Stuart is a paralegal at Wedlake Bell and Janice Wall a partner and head of the Corporate Team at the same firm.