Crowdfunding: a beginner’s guide

Crowdfunding: a beginner’s guide

Billions have been raised via crowdfunding platforms, but they’re no quick-fix solution, and there are a number of things businesses need to get right before attempting to tap into this resource.

Crowdfunding has become a buzzword for SMEs seeking finance during and after the downturn. A plethora of online platforms with funky names such as Seedrs and Funding Circle have appeared, and can be split into those offering crowdfunding solutions for SMEs – namely a pool, or crowd, of investors taking equity stakes in return for cash – and those offering peer-to-peer (P2P) lending which, as the name suggests, is a more typical loan structure with rates agreed between the company and the group of lenders. The platforms facilitate and manage the process for a fee.

The numbers are impressive. According to TheCrowdfundingCentre, £113.4m was raised in the UK crowdfunding sector between January 2014 and July 2015. The Peer-to-Peer Finance Association says £1.2bn of funds were raised in 2014, with first-quarter 2015 figures of £459m, up 33% on the previous quarter.

But what do SMEs need to know before they take the plunge? Does it suit every business from every sector? What are the advantages and potential dangers?

Funding Circle is one of the primary P2P lending platforms. It mainly lends money to established UK businesses with an average age of 10 years and a turnover of between £100,000 and £1m. Loans are typically between £500,000 and £1m, with terms between six months and five years. Interest rates, which are set between investors and borrowers, usually start at 6%. Cash is used for a variety of purposes such as working capital, buying assets or property development.

Examples of platforms

Abundance is a crowdfunding provider that offers individuals the chance to invest in a range of UK energy projects including wind and solar opportunities. Businesses typically look for investment of between £600,000 and £2m. Investors are tempted by 7% debentures and the payment of regular cash returns.

Kickstarter is a crowdfunder site that helps fund creative projects, for example in games, technology or fashion. Creators set a funding goal and a deadline, and their pitch is placed online with the aim of gaining pledges from interested investors. Creators don’t offer equity; they offer rewards such as discounts on the products made, but funding goals must be reached or no cash is raised. Kickstarter takes a 5% fee and payment processing fees from the total raised. Most projects raise less than $10,000.

Indiegogo is also a rewards-based crowdfunding site, for individuals, start-ups and entrepreneurs launching new products; however, creators don’t have to reach their funding goals in order to receive the cash raised. Those who opt for flexible funding can do so even if they only achieve a third of their total. Again, there is a 5% fee on the total money raised.

Crowdcube enables start-up, early- and growth-stage businesses, from a range of sectors, to raise finance. Co-founder Luke Lang says there are two ways for businesses to raise finance: either through equity or its loan-based proposition, a Crowdcube mini-bond.

A flexible route to finance

Since 2011, nearly £100 million has been invested through Crowdcube, funding over 285 businesses as a result. Some of the more well-known brands to fund on Crowdcube include the Eden Project, which raised £1.5m in less than 24 hours through a Crowdcube mini-bond; and Hugh Fearnley-Whittingstall’s River Cottage, which raised £1m in 36 hours.

“Equity enables businesses to raise investment in exchange for an equity stake in the business, whereas a Crowdcube mini-bond gives the crowd the opportunity to lend money to more established businesses in return for a steady interest repayment over a number of years,” Lang explains. “It could be to help get a business idea off the ground, to fund global expansion or launch a new product.

“It’s not only an accessible and flexible route to finance, crowdfunding also enables businesses to engage existing networks and establish relationships with a crowd of potential brand advocates and customers. There’s also the post-funding benefit of being supported by a crowd of investors, which can prove to be a bountiful source of skills, contacts and expertise.”

The average amount raised on Crowdcube is around £350,000, but some are looking to raise upwards of £1m. Over the last year, around 55% of the businesses that pitched for investment on Crowdcube have reached their investment targets.

After a target is reached, Crowdcube takes a 5% success fee and helps close the deal by assisting with the relevant paperwork and issuing new share certificates.

Be proactive

Frank Webster, campaigns director at equity crowdfunding group Seedrs, which helps raise cash for start-ups and established firms such as English winemaker Chapel Down, says: “This is for everyday people to get excited about growth businesses. You can raise cash from friends, families, suppliers and even customers. We facilitate the process, but you will need to work very hard and be proactive during the process or you will fail.”

He urges SMEs to engage a party of committed investors, usually known to the company such as family or customers, to join the pitch before launch.

“Your pitch needs to outline your business, what you need the money for, and must be engaging and passionate. Showing that you already have a community of investors supporting you is also powerful,” he says. “You can’t be passive after launch – get the link out to your customer database and onto social media and in the press.”

Neil Sebba, finance director of healthy eating chain Tossed, says it launched its Seedrs crowdfunding campaign to raise £750,000 to support its store expansion plans and to engage more with customers. “We are continuing with our banking partners but we felt it would be a nice thing for our loyal customers to own part of the brand. We chose equity raising because it is less risky than raising debt. Your fellow shareholders’ interests are aligned with yours,” he says.

It has already attracted funds of £1.1m for 8% equity, with one of the investors being tennis star Andy Murray.

What to watch out for

Sebba advises other SMEs not to take the process lightly. “It took us two weeks to draft our pitch, with Seedrs doing due diligence and asking for evidence for certain claims,” he states. “You also need a business plan which interested investors can request to see privately. Be prepared for emails and phone calls from those investors as well during the process. They will drill you!”

He says having a new pool of investors can bring “suggestions and ideas”, but it highlights the potential dangers of going down the crowdfunding route.

“It’s full on and does take time out of your day-to-day business. It can be quite distracting. If people think crowdfunding is the easy way to raise money then they clearly haven’t done it.

“Also, be careful not to set too low a funding target, because you will look silly – or an over-optimistic one, because you may fail to achieve it and get no money,” he adds.

Webster of Seedrs says: “It is a very public forum and if you are worried about sharing information on your business online, then it isn’t right for you. If you are also concerned about having a new crowd of 200 or 300 investors then, again, it isn’t for you. It can be an extra pressure on a business because you have to provide value and achieve what you said you would achieve in your pitch.”

Failure to reach your target is another potential pitfall for SMEs.

Katy Payne, company director at luxury lingerie brand Bosom Galore, says it recently tried to raise £10,000 on Indiegogo for manufacture, design and materials of a new range.

“It was easy to get online and we were given plenty of tips about the pitch and preparing a video and putting high-quality photos on our page. But we only raised £820,” she says. “We should have researched it more and had a bigger marketing campaign around it. We did one month’s preparation and we should have done at least three months. We should have rallied people up beforehand. It took a lot of time, stress and effort and we still need funding.”

Checklist

  • Do your research and find the best platform for you. This could depend on funding need and whether you are looking for equity or debt arrangements.
  • Get your financial records in order – Crowdcube, for example, requires evidence for any of the claims being made by a business, such as market size and contracts, to ensure it is accurate and can be verified. In fact, 80% of the businesses that apply to Crowdcube don’t make it through this due diligence and onto the site.

When it comes to the pitch, Luke Lang of Crowdcube says: “To be approved to list your business, you will need to provide a business plan, financial forecasts for the next three years and a compelling video pitch that clearly explains the investment proposition. Investors also want to be inspired and excited, so show your enthusiasm in both your pitch and your video. There are four key elements to get across in your pitch: your idea, how it could impact the market, the team behind the venture, and how investors could see a return on their investment.”

Regulation

The Financial Conduct Authority introduced a new regulatory framework for the investment crowdfunding industry in 2014. Platforms have to have plans in place so that loan repayments continue to be collected – even if they get into financial difficulty or go bust. They are also required to have enough capital in place to withstand financial shocks, and marketing material must fair, clear and not misleading.

 

 

Your pitch needs to outline your business, what you need the money for, and must be engaging and passionate. Showing that you already have a community of investors supporting you is also powerful.
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