Investors have been warned to question the valuations of companies using crowdfunding to raise finance, as research suggests that the model could leave them vulnerable to paying too much.
An analysis of hundreds of companies who have used equity crowdfunding to raise money directly from the public showed they were typically parting with a much smaller stake than those seeking funding elsewhere.
Nearly two-thirds of companies seeking to crowdfund up to £500,000 sold less than 20 per cent of the equity to investors. This ratio compares poorly with those turning to private equity, who typically parted with a 44 per cent stake in their business in return for a similar-sized investment, and 28 per cent for those funded by angel investors, according to Beauhurst, a data firm.
This implies pre-money valuations of £2m or more for companies using crowdfunding, indicating that private investors using this model may be vulnerable to excessive valuations.
Even removing very small deals — those raising below £100,000 — the same trend was clear, Beauhurst said.
“This ties up with anecdotal evidence we’re hearing: that companies are attracted to crowdfunding platforms partly because they are able to dictate their own valuation,” Beauhurst said.
“With direct investors apparently happy to accept lower equity stakes for the same investment amount . . . than angels or VCs (venture capitalists), the company is able to part with fewer shares and relinquish less control to investors.”
Equity crowdfunding has grown rapidly, with investors committing £84m to small companies via crowdfunding sites last year, according to Nesta, an innovation charity.
But many in the industry are concerned about what they say are excessive valuations put forward by companies in parts of the market, meaning that investors may not be in line for the high returns they hope for if their high-risk investments succeed. Some recent craft brewery listings have attracted particular criticism.
SyndicateRoom, one of the biggest equity crowdfunding sites, is this week launching an online “Investor Academy” in tandem with the law firm Taylor Wessing to inform people about key concepts in early stage investing.
These include valuations and how they are calculated; the site also tackles pre-emption rights, which enable investors to “follow their money” in future funding rounds if they do not want their stake to be diluted.
“We know that there is a huge lack of information on the investors’ side,” said Goncalo de Vasconcelos, chief executive of SyndicateRoom.
“This is about helping investors to make well-informed decisions, including to walk away if it’s not for them.”
Mr Vasconcelos said there was a risk of some investors “losing money right, left and centre” if they did not understand the key ideas that underlay investment in unlisted equity and the differences between crowdfunding sites.
Crowdfunding venues vary widely in the due diligence they carry out on companies and the extent to which more experienced investors get involved in negotiating terms.
InvestingZone, a rival backed by the venture capitalist Jon Moulton, has also launched an educational page aimed at tackling some of the same problems, while All Street, the first firm of analysts focusing on crowdfunding, launched in March, is aiming to sell its reports to retail investors.
“If a lot of investors lose a lot of money through crowdfunding, that’s not good news for the industry as a whole,” said Adrian Rainey, partner at Taylor Wessing.
He said that crowdfunding was “here to stay” but it was not yet clear whether it would be a small or large part of the market in funding for early stage companies.
“In the UK over the last five or 10 years, you have an economically active populace that is interested in entrepreneurialism in a way that it wasn’t before that,” Mr Rainey added.
“But there’s a long way to go for retail investors in understanding the highs and lows of investing in private companies with a long-term investment horizon.”
Found at FT