Finance · 16 February 2016

Debunking some crowdfunding myths that just aren’t true

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The “crowd” can bring collective wisdom to a startup alongside the pooling of capital

As CEO and co-founder of Crowdcube, Darren Westlake has seen the increasing popularity of crowdfunding as a financing method for startups mired by a lack of clarity around how the process works in practice. In his latest column for Business Advice, Westlake attempts to debunk a few common crowdfunding misconceptions.

Myths exist in every aspect of business life and our industry is no different. Our job is to set the record straight and give both businesses and investors the opportunities and rewards they deserve.

When you work in an industry that is breaking down barriers and challenging the status quo, it’s a pleasure – and sometimes a curse. It’s frustrating that after five years there is still a deep misunderstanding from some about how crowdfunding works.

Since day one, Crowdcube has always been a platform that enables entrepreneurs to harness the power of their own crowd of family, friends, customers, contacts and angel investors, as well as engaging with the company’s growing crowd of registered members.

Essentially this is no different to how the world operated before. Friends and family have always been a source of seed funding, whilst angel and venture capital investors have always acted as cornerstone or lead investors, which should be viewed as a positive sign of confidence in the business, rather than as an attempt to “trick” investors. The distinction is that crowdfunding has democratised this funding process by enabling everyday investors to back businesses they believe in, alongside professionals and venture capital firms.

As part of the crowdfunding process it’s commonplace for savvy entrepreneurs to seek investment from their own network while raising finance on a crowdfunding platform. Whilst this can happen at any point before and/or during the raise, all investments become legally binding at the end of the round.

As crowdfunding becomes more popular as a method of fundraising, it’s likely that myths and rumours will circulate and evolve around it, and it is worth addressing some of these for those considering crowdfunding as a route to finance. For those ill at ease, the first thing to remember is that hundreds of businesses, from startups to more established larger companies, and from all sectors, have successfully raised money via the crowd.

Crowd sophistication

One thing an entrepreneur might hear is that “the crowd” are unsophisticated. This often comes from those misinformed and unfortunately undermines the credibility of investors. Crowdfunding investors tend to be a sophisticated and knowledgeable bunch, highly educated and affluent, with many working for large global brands, like JP Morgan, IBM and Google. Around 60 per cent of over £100m invested through Crowdcube in 2015 came from “sophisticated investors” or “high-net-worth individuals”.

It’s also important to remember that the crowd brings a collective wisdom alongside the pooling of capital. Diverse experiences, backgrounds, expertise and capital all contribute to whether a business reaches its funding target.

Seeing returns

Another interesting myth is that investors will never see a return on an investment. Well it’s already happening with two exits in 2015. E-Car Club became the world’s first crowdfunded “exit” when it was sold to Europcar, giving the 63 people who invested £100,000 in 2013 a multiple return on their investment. Then, Camden Town Brewery sold to the world’s biggest drinks company, AB InBev right at the end of the year. In crowdfunding terms this was an important milestone and has finally seen the industry come of age. In addition, several businesses to raise finance through a bond on Crowdcube, such as the Eden Project, River Cottage and Chilango, have also made interest payments to investors.

Regulating crowdfunding

More recently we’ve seen concerns about the regulation of crowdfunding. So now is a good time to put some of these issues to bed. Crowdfunding platforms must be authorised and regulated by the FCA (Financial Conduct Authority), the same as any other reputable financial services provider. The UKCFA (UK Crowdfunding Association) and its members, of which we are one, have worked very closely with the FCA to create a new regulatory framework that balances consumer protection with regulation.

Commentators have also questioned whether companies raising money on crowdfunding sites are overvalued. It’s important to remember that a business’s valuation is subjective. If anything, valuations on crowdfunding sites are more transparent, open and fair because it’s the members of the crowd who decide whether the valuation seems accurate, and if the business is worth investing in.

Crowdcube has a team of experienced analysts who assess the businesses on the site. Investors discuss them openly on our forums, and often a company will re-evaluate its position based on feedback from the crowd. The industry is seeing higher valuations overall, which reflects the changing profile of the businesses that are pitching, many of whom are established businesses with proven track records of success looking to raise growth capital.

Future investments

We also get asked about future funding and whether a raise on a crowdfunding site will scupper plans for other forms of investment, such as venture capital funding. The truth is that it’s now commonplace for venture capital firms to collaborate with leading crowdfunding platforms.

We’re working with a growing number of Europe’s leading venture capitalists, such as JustPark, backed by BMW iVentures and Index Ventures, and Adzuna, backed by Index Ventures, Passion Capital and The Acceleration Group. In addition, Balderton Capital, DN Capital and the UK government through the mayor of London’s landmark London Co-Investment Fund (LCIF) are other prominent investors alongside the crowd on Crowdcube.

Myths exist in every aspect of business life and our industry is no different. Our job is to set the record straight and give both businesses and investors the opportunities and rewards they deserve.

Looking into the various financing options that could suit your micro business? Perhaps bridging finance could be a good route. Find out more here.

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ABOUT THE EXPERT

Darren Westlake is the co-founder and CEO of Crowdcube, an online platform that enables startup, early and growth-stage businesses, from a range of sectors, to raise finance with the added benefit of being backed by the crowd.

Business development