Why it Matters Which Equity Crowdfunding Platform You Use – as an Investor and Would-be Shareholder
I thought it was time to look in some detail at the two distinct types of equity crowdfunding that have evolved since 2011. The two are distinct in a number of ways, but here we are going to look at how the differences affect shareholder rights...
Just over six years since the inception of equity crowdfunding in the UK, there are clear do’s and don’ts when it comes to choosing a platform. Why? Well, put simply, because there is now growing evidence that the ‘pile ‘em high, sell ‘em cheap’ model puts investors at greater risk of losing their money and their tax reliefs.
So, what are the differences, and what should investors be looking out for?
There are two distinct forms of equity crowdfunding from the investors’ perspective –
- ‘Free for all’ investors
- Nominee account held investors
Free For All
This is a model which does exactly what it says. Investors look at a variety of pitches and decide to invest in, say, three of them. The minimum amount they can invest is generally very small: as little as £10 on some platforms. So once the target has been reached, the campaign is successfully closed and the individuals who opted to invest are each given their individual holdings or shares. These smaller investments, of course, equate to practically zero equity share in the company.
Ignoring the burden that this mass of tiny investors puts on a company’s investor relations department, the deal leaves these small stakeholders with no position vis à vis the company, unless the platform has set up a system where their concerns can be heard.
The company can, and probably will, take decisions that are not in the best interests of these shareholders. The decisions may well be in the best interests of the larger stakeholders or the founders, but in all the cases I have seen, they simply ignore the ‘crowd’ shareholder. Since one of the key mantras of this model is that it democratises the world of investment, this is a pretty odd version of democracy... There have been examples of the more vulnerable, retail shareholders being mistreated by investee companies.
Platforms and, more specifically, the individuals responsible for performing due diligence, particularly in the retail investor context, have an unwavering responsibility to highlight the risks and potential downfalls of each investment to their investor base. What we’re seeing is that, once funded, decisions are being taken to follow courses of action of which there was absolutely no mention in the original pitch. Negligent platforms seem to be knowingly mistreating investors.
Examples of such actions, in which smaller investors have absolutely no say, include (but are not limited to) the following:
Selling the company to a third party or large investor for less than the value of the company when it raised equity crowdfunding. This also leaves investors with an EIS or SEIS headache if the action is taken within the 3-year limit.
Entering commercial agreements which, in effect, result in the company being taken over.
Closing the company via administration or voluntary liquidation whilst arranging a pre-packed deal to sell its ‘assets’ to a sister company which is normally set up by the old company’s directors. Administrators are simply bound to recoup as much cash as they can to repay creditors and have blatantly disadvantaged shareholders to achieve this.
Of course, in the real world, you cannot expect commercial decisions to be passed by hundreds of small shareholders on a daily basis, but you have to ask where the protection is for investors, particularly retail.
This kind of behaviour is, however, entirely unsustainable. The crowd is certainly becoming more and more savvy and will demand greater protection, placing further scrutiny on reckless platforms. Research by Asset Match, the P2P lending platform, has demonstrated that investors are becoming increasingly frustrated by the lack of transparency and communication from investee companies.
This brings us onto players in the space that operate a nominee shareholder structure.
The alternative to lots of unprotected small shareholders is to sell equity to a nominee account which is controlled by the platform and which holds within it these small holdings. This gives each small stakeholder a much greater collective force and allows far better communications from the company to its shareholders – they only need to send out one message.
The jury is still out as to whether having loads of individual small shareholders is detrimental to raising further institutional money. There have been cases, one recently, where an institutional investor agreed to invest in an already-equity-crowdfunded company but only if they got rid of their existing shareholders. The result was that the company closed and was phoenixed under a classic pre-packed deal with the new investment - leaving the original shareholders to lick their wounds and scratch their heads.
The very fact that the nominee accounts are held by the platforms using this model, means that they are on top of the information flow from the funded companies back to their shareholders. Investors in this sector expect relatively high risks and will not be deterred by failing companies, so long as they are kept informed. In fact, you could argue that the learning process for investors in what is, after all, a very new form of investment, is crucial to its long term survival. Investors seeing their money burnt without a good explanation or information flow are likely to avoid that type of investment again. Investors seeing their money burnt, but being given an explanation, are far more likely to want to learn from the experience and make better investment decisions in this sector in the future.
Whilst the nominee account approach doesn’t give a group of shareholders within it guarantees that the company will behave as expected, it has to be better than the individual approach and, in some circumstances, it might be possible for the nominee group to take action against directors of a company that has clearly broken the law – where, again, individuals would find this far harder.
In the end, it really comes down to common sense. If you are investing for the same reason that you play the Saturday Lottery, and with the same expectations, then it doesn’t really matter where you throw your money. If, on the other hand, you both care about the future of the UK’s SMEs and about investing in a tenable way, you will avoid the more cheap and cheerful options and opt for the packages that are made for purpose.
Who is Dexster?
Sometimes controversial, always trenchant, Dexster is Growthdeck's resident blogger. Dexster will bring you his/her views on the crowdfunding scene covering a wide range of topics, including the growth of the equity crowdfunding industry, the risks faced by platforms, how businesses are faring, what investors need to look for when choosing a provider and much more.