How golden is the glitter of crowdfunding?
May 10, 2019
If you had a spare £100 to invest, what would you do? Cash ISA – generally better than a deposit account and no chance of losing it all, but it’s hardly exciting. Fund of funds – quite good return over the past few years, but up and down recently. For a more leftfield option, what about crowdfunding?
Seedrs has published figures showing an internal rate of return (IRR) across its crowdfunding platform of around 12%, with some sectors such as finance & payments and home & personal delivering more than 20%. And for the really impressive returns on crowdfunded investment look at companies like FinTech Revolut (19x) and beermaker Brewdog (177% on 2016 EFP IV and even bigger returns on earlier rounds).
Can you put a value on it?
As a valuation specialist, I’m sometimes asked “does investment raised via crowdfunding reflect the market value of the company or at least provide a proxy for it?”
Those that are used to valuing companies based on fundamentals such as profitability and growth would say no. The mainstream valuation techniques such as market multiples or discounted cash flows just aren’t relevant for companies with little track record and which are often looking to disrupt existing markets or develop new markets altogether.
Techniques such as milestone analysis and decision trees might help an investor to justify their investment, as well as understanding previous funding rounds and what has happened at the company since the last investment. Further possibilities include more qualitative techniques such as SWOT analysis, looking at the management team and their previous track record, the potential market opportunity, how advanced the product is and barriers to entry from other competitors.
These techniques should allow an investor to understand whether the investment has some merit. Yet before you put all of your life savings into the next crowdfunding opportunity, you have to remember that for every Brewdog and Revolut there have been an awful lot of flops. Anecdotally, we’re looking at 60% of companies failing, 30% just about earning investors’ their money back and 10% being a success.
Spread the risk
It therefore makes most sense to spread your investments rather than putting all your eggs in one basket. As crowdfund stakes can be as little as £10, you can cover quite a lot of companies with quite a modest outlay. The crowdfunding platforms now make it possible to invest in a range of companies through passive funds or select your own portfolio.
It’s also important to think about liquidity as it may be quite a few years before there is an exit opportunity, even if the company is performing well. A crowdfund share only has a monetisable value when a secondary investor either buys a stake or takes over the company. Until then, your investment is locked in and the valuation is speculative.
Not for the fainthearted
So, in conclusion, crowdfunding is generally directed at companies that are just getting started or outside the mainstream. You can’t justify your investment using typical valuation techniques – these are high risk, potentially high reward investments, and certainly not for the fainthearted.
But some will eventually become targets for mainstream investment and acquisition in a market that’s on the look-out for transformational opportunities (our Creating value beyond the deal report explores this further).