Equity Crowdfunding: A Primer
Intro to equity crowdfunding
Thinking about raising your round via equity crowdfunding? Unfortunately it isn’t quite as easy as registering with one of the platforms, sticking your pitch up, and letting the crowd do the rest. There are lots of things to consider before choosing to go down this route. This includes fee structure, how much legwork you will have to do, what it means for follow-on rounds, and which platform to choose to raise on.
We hope this resource will help you decide whether crowdfunding is the right way forward for you.
The myth of the crowd
The first thing to know is that there are two crowds. The first is the crowd you know (your network). The second is the crowd you don’t know (investors you acquire through you or the platform marketing the campaign). In order to get the crowd you don’t know to invest, you largely need to have the crowds you do know be the first ones to take the risk.
The magic number is roughly 30 - 40% - this is the amount of your round that should already be raised before you go live, and the platforms will generally ask that you have this commitment before you go live. In fact, the vast majority of failed crowdfunding campaigns are the ones that never get past 50% of their funding commitment (Guardian). So, if you can get yourself past the 50% mark your chances of success are much greater in terms of the crowd joining in.
In many ways this is no different than how it works when fundraising in general through angels or VCs. If you can get the initial commitments and validation, then the rest comes much easier.
Equity crowdfunding is not a solution to finding your initial investors. Instead, it can be utilised for completion of the last 60 to 70%.
Anatomy of an equity crowdfund round
We ran a search for sub-£2m equity fundraises in 2016/17 to get an idea of what the general profile of crowdfunding campaigns is vs. non-crowdfunding and see what the key differences are.
Round size and valuation
This shows just how big of a player equity crowdfunding has become for this early-stage sub-£2m fundraise category, accounting for over a third of them.
What might also jump out to founders is that despite a lower average round size in the data (taken from Beauhurst), the valuations are higher, and the stake taken is lower.
However, a higher valuation is not necessarily a benefit! You are going to have to raise another round (probably). Make sure your valuation isn’t so crazy that you will struggle to justify a higher valuation later on.
Tech/IP businesses unsurprisingly lead the pack in both equity and non-equity crowdfunding in terms of percentage of fundraises. Drilling down a bit further, the biggest sub-category in crowdfunding is food and drinks processors, followed by mobile apps and internet platforms.
What seems to emerge from the sector data is that consumer-facing propositions have a higher hit rate in equity crowdfunding when compared to traditional equity raises. This is exemplified for instance in the higher number of food and drink processors, leisure and entertainment and retail companies.
There are some reasons why equity crowdfunding is a better choice for consumer-startups. For one, it gives their existing users a chance to invest in the business and drive further customer loyalty. Additionally, it can be a part of more traditional marketing and PR campaigns to build brand awareness.
In terms of stage, crowdfunding rounds tend to skew earlier than traditional funding rounds - making up 64% of the rounds we looked at, compared to 53%. There is relative parity at the venture stage, which disappears for ‘growth’ stage rounds.
This is consistent with our own anecdotal evidence from Capital Pilot users who tend to see crowdfunding rounds as a route to raise early-stage or even friends and family type rounds, where they plan later to raise from more traditional sources.
When comparing successful crowdfunding rounds to their traditional equity-raising counterparts, these companies tend to be more consumer-facing, raising a smaller amount at an early stage, with a higher valuation.
Where are they now?
Looking at outcomes (as of April ‘18) there doesn’t appear to be too much difference in outcomes. The bulk of crowdfunded companies are still at the seed stage. Roughly the same number of startups moved beyond seed that were crowdfunded versus traditional raises. Traditionally funded companies still make up the bulk of growth stage businesses. In terms of other outcomes, (becoming a zombie, dying, or exiting) the numbers are roughly the same between traditional and crowdfunded startups.
In the few years following the fundraise there isn’t much difference in outcomes between crowd and traditionally funded businesses.
Pros of Equity Crowdfunding
There are some clear benefits of equity crowdfunding over traditional fundraising. This list is not exhaustive, but covers the key ones we’ve observed.
Ease of transaction
The platforms do all the leg work in terms of collecting funds and issuing shares, making the transaction process easier. It also gives you a place to collect funds as people are willing to part with them, allowing you to avoid herding cats if you are raising from several angel investors when completing the round. In addition, crowdfunding platforms normally bundle all individual investors into a single nominee company, so your cap table doesn’t include each individual investor. Finally, since the lower transaction costs and single nominee makes collecting a smaller amount from each investor feasible, people can invest in you for as little as £100, thus potentially increasing your breadth of potential investors.
The crowd will eventually (hopefully) come
As mentioned - if you can get past the 50% committed mark you are generally in good shape, and the crowd is more likely to join in. This means you’ve made your fundraise that much easier - by drumming up the first 50% you are in much better shape to get the last 50% from existing platform investors.
Building validation, customers and loyalty
Crowdfunding forces you to do a bit of marketing to not only build support for your campaign, but also get your brand out there. You are not only generating potential investors, but you are building name recognition and potential customers for your business. In addition, your investors are likely to be pretty loyal customers because they are part-owners of the business. You also get the added benefit of additional validation of whatever it is you are building.
Drawbacks of Equity Crowdfunding
Investors (can) add a lot of value beyond the cheque they write - with a vested interest in ensuring you succeed and don’t lose their hard-earned (okay, not always hard-earned) money. They might have relevant experience, whether they were a founder themselves, or worked in that particularly sector. They open up their networks and help you solve problems.
Crowdfunding, on the other hand, gives you a lot of investors with much smaller stakes, and thus less incentive to get involved in the business.
Crowdfunding isn’t cheap! Seedrs fees are 6.5% of funds raised + £2500 completion fee, while Crowdcube is 7% of funds raised, plus associated Stripe payment processing fees (0.5% for the UK, 1% for Europe and 2.9% for the rest of the world). This is slightly higher than average for most angel networks or syndicate (though some can run much higher).
A failed campaign can send a negative signal to potential future investors - so be sure you can raise the round.
You still do the legwork
As mentioned previously - you still have to do the hardest part which is get the first commitments. So, you will still have to do some traditional fundraising. Generally, once you build a bit of momentum the rest follows easier, but this is not always the case, so think about whether you want to just complete on your own with angel investors rather than go through a platform. Sometimes the effort required is the same, and you would be unwise to assume that the crowdfunding platform will deliver to you loads of investor appetite.
Pick your platform
Now that you have the facts and you still want to press ahead, which one to choose? We’ll try and help. There are three main players in the UK: Seedrs,Crowdcube and Syndicate Room so we will focus on those, although there are a number of other smaller platforms, sometimes focused on particular sectors.
Seedrs is the most active platform in terms of number of rounds, completing nearly 300 over the years/deal size we looked at. Crowdcube was close behind, with 237, and Syndicate Room a distant third at 88.
However, when looking at total funds raised in this same range, Crowdcube leads the pack with over £120m raised via the platform. Seedrs managed a bit north of £90m, and Syndicate Room raised £54m.
In terms of round sizes and valuation, Syndicate Room has the highest average deal size, at £614k, followed by Crowdcube (£510k) and Seedrs raising the lowest on average (£316k). Reversing that order is the relative valuation, with Seedrs campaigns giving up the least ownership (11.6%), followed by Crowdcube (17.6%) and then Syndicate Room (19.8%). The latter is likely a byproduct of having a lead professional angel setting the deal terms, and the difference between Crowdcube and Seedrs could be due to differences in sectors (see below).
Another important factor to consider is the fee structure. Syndicate Room takes the lowest success fee, but charges an ongoing 1% to maintain the nominee structure (the entity which invests in the business on behalf of the end investors). Seedrs and Crowdcube differentiate slightly on the success fee, with Crowdcube not charging a flat fee.
Stage difference is most apparent when comparing Syndicate Room against both Seedrs and Crowdcube. The bulk of Syndicate Room deals are 'venture' stage (60%) which is more than double its counterparts. Seedrs and Crowdcube are more active early stage, with Crowdcube having a slight edge in the 'growth' (aka most advanced stage).
In terms of sector focus, Syndicate Room has the clearest focus on tech/IP businesses, including what are likely to be more non-consumer sectors such as software-as-a-service and pharmaceuticals. Seedrs has a clear tech preference, with the lead subsectors being mobile apps and internet platforms, which are perhaps more consumer facing than Syndicate Room. Nearly 1 in 5 Crowdcube deals are food and drinks.
If you are an early stage tech startup with a consumer focus, Seedrs is the most common choice. Food and drinks startups are most common on Crowdcube and the deal size is slightly higher. Later stage startups with a non-consumer tech focus are more common on Syndicate Room.
We hope this primer has been helpful in gauging whether crowdfunding is a good fit for your startup. Equity crowdfunding is an early market that will likely evolve and improve over time. It is therefore too early to make a final judgement on outcomes. There may also be some regulatory and competitive shakeups to come in the not too distant future. It is worth watching for this, and we’ll aim to update this article as/when these things happen.
To reiterate a few things - crowdfunding is not a panacea, fire and forget solution to fundraising. You will have to do the bulk of the work yourself to raise initial funds. This includes driving potential investors to your campaign. There is, of course, the added benefit of being a marketing exercise for your business in a way.
The sweet spot tends to be:
- Seed stage businesses
- Some tech angle (or a food.beverage business)
- Generally consumer facing
- Raising between £150k and £500k
The fees are relatively high, and there are differences among the platforms. Syndicate Room has the most unique model and a slightly more tech focus.