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How does equity investment work?

What is equity crowdfunding?

To any average member of Joe public, the word ‘crowdfunding’ might conjure up images of small indie companies accruing funding for product development, or emerging artists pleading for money to fund a CD or a tour, all carried out through donation-based sites such as Kickstarter. This public face of crowdfunding is, however, markedly far removed from the variety of crowdfunding carried out by equity crowdfunding platforms. Whereas in the donation model you might receive a token t-shirt to say thank you for your contribution, in equity crowdfunding – also known as crowd-investing – investors receive shares in a company, and hence the opportunity to see cash return from a company’s success.

Gonçalo de Vasconcelos, CEO of Cambridge-based UK crowdfunding platform SyndicateRoom, explains the two main models of equity crowdfunding:

There are two models of equity crowdfunding: a company-led model, where companies will set their own investment terms and valuation after listing on a platform, offering their own class of shares to investors; and an investor-led model – which SyndicateRoom uses – where its members invest alongside professional investors, who have negotiated investment terms to whatever price per share they are happy to invest their money at.”

Crowdfunding is here to stay!

Whilst equity crowdfunding is still relatively new, it has taken a remarkably short amount of time for a wide array of different platforms to assert themselves as a credible alternative to other more traditional routes to early stage funding. As Christian Girard – expert in orphan drugs, competitive intelligence and alternative financing – explains, equity crowdfunding has asserted itself in a prime position in the UK:

“Crowd investing is definitely not a fad. Even if this industry is still in its infancy, the number of equity crowdfunding platforms is increasing everywhere in the world. It’s now one dilutive-funding option among others, such as friends & family, seed funding and venture capital. In the UK, startups may raise yearly as much as £5M through crowdfunding platforms.” 

Gonçalo de Vasconcelos firmly believes that crowdfunding is a game-changer to early stage finance. Its long term success, he claims, lies in the fact that its model does not rely solely on funding companies, but also makes money for the investors:

“VCs have been criticised, particularly in the last five to ten years, for trying to minimise their risk as much as possible, to the point where it’s no longer venture capital. This is why crowdfunding will do so well; people are more willing to take risk if it’s for something they really believe in, or a very disruptive technology.

I have no doubt that equity crowdfunding is a game changer. You can see how much market share crowdfunding as an industry is taking from early stage investment. The important thing is you have to be sustainable and make money for investors; you can’t just be about funding companies, because then you’ll never get anywhere – you’ll just be a flash in the pan and gone in a few years.

However, because crowdfunding is sustainable and investors make money out of it, it is a completely legitimate investment opportunity or asset class. Hence I see crowdfunding becoming huge in early stage investment scene for life sciences, and for pretty much any sector. It wouldn’t surprise me if in three to five years’ time crowdfunding had 50% or more of early stage life science investment scene”.

The role of social media

Equity crowd investing was born from social media: the ability to pitch your ideas to people you have never met before and keep your backers regularly informed are central to the crowdfunding paradigm. Just as the use of social media has ballooned throughout the last decade, so too has the use of crowdfunding platforms, and this may well be more than simply coincidental correlation.

“Early stage investing is no longer just exclusive to very well connected offline investors, instead it’s open to a much wider audience. Social media and press coverage is extremely important for crowdfunding because that’s how people learn that there’s an alternative to the more usual, mundane investment opportunities.” - Gonçalo de Vasconcelos, SyndicateRoom CEO.

Crowfunding – the new Venture capitalism?

Since the financial crisis of 2008, venture capitalists have been less willing to take on riskier ventures. This is bad news for startup companies, especially those who work in inherently riskier sectors like life sciences. As a result, there has been a push to find new sources of funding for this early stage period – particularly for smaller sums of up to $500k, as many professional investors and VCs will not be drawn to sums as small as these.

This is where the crowdfunding model proves its worth. Instead of trying to attract one big fish, why not attract several smaller fish? The continent is teeming with small scale private investors, willing to invest their money, and the government recognises the dire need for a new source of startup capital. The result? Loosening of investment regulations to allow small scale private investors (‘the crowd’) the opportunity to invest in startup businesses. The aptly named JOBS (Jumpstart Our Business Startups) act in the USA is mirrored in the UK by tax breaks that aim to lower the inherently high risk of startup investment. Whether the UK government offers tax breaks on profit made or promises to subsidise any losses, the effect is the same: suddenly the idea of using your money to allow new businesses to get off the ground seems like a desirable alternative to just leaving it in a bank.

This whole system is highly regulated, but according to Gonçalo the high level of regulation seen in equity crowdfunding brings legitimacy to the model, meaning people trust the setup more than if it were less restricted. He also highly endorses the UK’s approach to alternative finance regulation, claiming that the JOBS Act in the US, despite its high profile, is actually inferior to the UK’s system.

“Equity crowdfunding regulations seem to be working very well. We are heavily regulated, but this has certainly brought a huge amount of legitimacy to the industry, which is obviously very welcome. Investors trust SyndicateRoom because it’s an FCA regulated entity.

With regards to the JOBS Act, the UK actually already has something fairly similar in the shape of the Prospectus Directive. In the US the JOBS Act hasn’t really delivered what people hoped for at the beginning: it still makes it too expensive for companies to raise money through crowdfunding, unless they raise a huge amount of money. The UK is still miles ahead of the US in alternative finance."

How will Brexit affect equity crowdfunding in the UK?

The future of both the UK economy and the economy of Europe as a whole might look relatively uncertain right now, but its effect on early stage venture may not be so bleak. As bank interest rates stoop ever lower, many might be persuaded to invest their money rather than leave it in a bank. As SyndicateRoom CEO Gonçalo de Vasconcelos explains, Brexit should be treated as an opportunity:

It’s still too early to say what effects the recent interest rates announced by the Bank of England might have. But crowdfunding – both equity crowdfunding and peer-to-peer lending – address real issues in the market, like the issue of companies not having access to capital. I would say Brexit is a huge opportunity for alternative finance in general, and equity crowdfunding in particular; with banks tightening their lending criteria further and interest rates lowering to 0.25%, investors are looking for alternatives. It’s called alternative finance because that’s exactly what we provide: an alternative to banks and the usual investment opportunities.”

Equity crowdfunding platforms in Europe

Whether you’re a member of the crowd looking to invest in promising young companies or a promising young company looking for investors in the crowd, you’ll need a platform to give you access to them. Europe has a strong reputation for crowd investing, with several large and successful firms having appeared within the past five years.

France and Germany are particularly strong in the life science crowd investing game. French platform Wiseed stands as one of the most successful platforms for life sciences, with 15 raises under their belts since 2010. Meanwhile, German platforms Seedmatch and Companisto also recently added medtech and biotech to their portfolios.

It is also worth noting that several platforms in Europe specialise in life sciences completely: Wellfundr and MyPharmaCompany in France; Aescuvest in Germany; and Capital Cell in Spain.

In the UK, notable platforms include Seedrs, the first equity crowd investing platform to receive approval from the FSA; CrowdCube, which was launched in 2011 and received FSA approval in 2013, and SyndicateRoom, which was authorised in early 2014, and has since risen to become arguably the most successful crowd investment platform in the country.

Crowdcube has over 290,000 members and allows joe public to back a variety of sectors – including food and drink, health and fitness, retail, IT and telecommunications, and technology – from as small an investment as £10. Members invest alongside angels, VCs and the government, and so far have helped to launch familiar names such as BrewDog and River Cottage. There have been instances of companies raising £1million, even in as quick a time as 96 seconds, and one individual invested £1million in Sugru – a mouldable glue that turns to rubber – through an iphone.

SyndicateRoom, who boast both a miniature aircraft and a Hollywood film in their portfolio, operate a somewhat different model: all companies must undergo a rigorous screening process before being considered for inclusion in the platform’s portfolio, requiring the backing of professional investors, before shares are then offered to the crowd at the same rate as them. It boasts no upfront fees to investors, and it also imposes a £1000 minimum investment on its members.

What’s more, only those who class themselves as ‘sophisticated investors’ are able to take part; a measure designed to ensure that ventures are only backed by those who understand the risks of equity crowdfunding. One result of these measures is that only experienced and dedicated investors tend to get involved. This is useful for companies, as keeping a large base of small-time investors informed can be time-consuming and difficult. As CEO Gonçalo de Vasconcelos explains:

“Our investor-led crowd funding model has made a huge difference; it attracts far more sophisticated companies and investors than other platforms. This means that we typically get significantly later stage deals that require more capital, as well as more sophisticated investors, who tend to be wealthier. This means that the average investment is much higher than in the vast majority of other crowd funding platforms.

The £1000 minimum investment rule is put in place partly to make CEOs’ lives easier. If you only invest, say, £10, you are not really investing. The amount of money is pretty insignificant. But CEOs need to treat all shareholders as equals, so they need to keep them all up to date with the same information, be it a million pound or ten pound investor. The idea behind our £1000 minimum investment rule is that it makes you think before you invest. We want you as an investor, not just making a punt.”

It is a strategy that has worked: many heads of life science companies laud the ability to concentrate on their science rather than having to devote most of their time to PR. Ulf Pommerening, head of EBS Technologies, a German firm developing treatments for neurological disorders caused by stroke or brain injury, states:

“Communication with the crowd takes up far too much of the entrepreneur’s time. This is especially exasperating when you have to deal with people that have invested just the minimum amount of €5

Meanwhile, according to Annie Brooking, chief executive of Bactest – whose ‘Speedy Breedy’ portable contamination detector can return sample results in as little as two or three hours – SyndicateRoom’s minimum investment level is a good thing:

“I don’t really want a thousand shareholders. And I wouldn’t want to deal directly with the questions and concerns of two hundred people. That would become impossible to manage.”

Along with the requirement for professional backing during screening, this minimum investment amount is likely the main reason why SyndicateRoom is currently leader of the pack in early stage life science crowd investment in Europe. Not only is life science its largest investment area, occupying over thirty percent of its investments by industry, but it also boasts having completed sixteen European life science raises since its formation in 2014 – nearly forty percent of the forty two life science raises carried out by European crowd investing sites since 2010.

Want to understand why equity crowdfunCROWDFUNDING EBOOKding is suited to life sciences and get some advice for startups?

FAR FROM THE MADDING CROWD
Crowdfunding ebook: How equity investment platforms are taking life sciences by storm

This ebook will guide you through the basics of equity crowdfunding, how their models are taking life sciences by storm, and finally offer some advice to startups wishing to explore this route of fundraising, with expert advice from industry leaders Christian Girard, of Orphan Drugs Industry, and Gonçalo de Vasconcelos, of crowdfunding platform SyndicateRoom.

Download the ebook to:

  • Know how equity investment works
  • Understand why equity crowdfunding is suited to life sciences
  • Get some advice for startups


    DOWNLOAD THE E-BOOK

 

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