That’s entertainment

High-profile crowdfunding platforms Seedrs and Crowdcube have both been highlighting their successes recently. The former celebrated raising funds for 66 food and beverage businesses since 2012, which is its most successful sector, accounting for more than 11% of its completed deals, while the latter pointed to the fact 100-plus companies had raised more than £1m on its platform since 2011.

While looking at the number and value of deals is one way of determining success for the crowdfunding industry, I would argue a more valuable measure is the return generated for investors.

Beyond the sale of Camden Town Brewery to AB InBev in 2015, it has been slim pickings for investors who have put money into leisure and hospitality companies through crowdfunding. Crowdcube, for instance, lists only eight exits (across all sectors) on its website that have generated positive returns.

Camden Town Brewery: A crowdfunding success story

More meaningful numbers can be found when looking at the level of failures from companies that have crowdfunded. Research from startup database Beauhurst found that of 685 UK deals across 28 platforms, including Crowdcube and Seedrs, more than one-fifth (21%) had gone bust. Although it is a fact about half of all startups fail within three years, my issue with crowdfunding surrounds its lack of due diligence and the fact valuations of funding companies are way out of kilter with comparable businesses that have received money from professional investors.

What is particularly telling is Crowdcube and others like it don’t take funds from US investors. If they did they would have to follow the stricter Securities Law in the US that is designed to protect investors’ rights. The fact is, investor protection is lax in the UK when it comes to crowdfunding, highlighted by the frequent issue of “B investment shares”. These are different to those held by the founders and early investors in the businesses that are using crowdfunding.

Such B shares are offered to investors who want to put small sums into a business and, rather than including any protection of the investors’ rights, they come with various freebies such as access to exclusive launch parties and free products.

What these people are also buying into are overvalued businesses. Leisure sector investor Luke Johnson has said crowdfunding companies can be valued at up to five times the level they would fetch from a professional investor.

These valuations are a manifestation of a lack of financial knowledge of the companies themselves, which are simply plucking numbers out of thin air in many cases. But this is compounded by the lack of due diligence undertaken by the platforms, whose primary objective is arguably to ensure a constant deal flow rather than entangle their clients in red tape and place obstacles in front of them.

These share offers are then glossily marketed – along with the freebies – to unsophisticated investors. Although the defence of crowdfunding chiefly involves the argument these investors aren’t looking for any return on their money but simply want to help these businesses grow and to feel part of the “club”.

Seedrs: one of the leading crowdfunding platforms

This is a fair point but I’d suggest many of these people will be disappointed when their clubs close and any returns from the remaining assets (if there are any) from these failed businesses flow through to the protected investors. They, in contrast, will lose all their money.

Crowdfunding is an animal that has grown fat in a low interest rate environment during which time people have been more than willing to put their money into a variety of schemes rather than into the bank, where returns have been non-existent. But as we move into an era of higher interest rates the days of the easy money for startups from crowdfunding will come to an end.

It has certainly been entertaining to watch the constant stream of food and drink businesses jump aboard the crowdfunding bandwagon. But that might be all it ultimately proves to be – entertainment and not a serious long-term route to raising funds.

Glynn Davis, editor of Retail Insider

This piece was originally published on Propel Info where Glynn Davis writes a regular Friday opinion piece. Retail Insider would like to thank Propel for allowing the reproduction of this column.