What companies need to know when considering equity crowdfunding

Equity crowdfunding is the modern way to raise capital, and it has escalated rapidly since it was regulated last year. There are now eight providers presenting a multitude of deals to everyday Kiwi investors at any given time.

As in any booming sector, fast growth has its advantages and drawbacks. There is no shortage of companies looking to raise fresh capital in this way, and there are many examples of successful equity crowdfunding offers having led to new products and services, investment in core operations, and expansion into new markets.

But the relative glut of equity crowdfunders, some of them extremely new on the block, creates a headache for would-be clients: how do you pick the best for your business?

Full disclosure: I run the New Zealand arm of Equitise, the only Trans-Tasman provider. We’ve given input into the legislation that is bringing the sector on-stream in Australia. I don’t hide my view that we’re a dominant platform, but this article does elucidate what to keep in mind if you’re an investor, or company raising capital.

Here are the big questions to ask when appointing an equity crowdfunding provider to help you do your deal:

1) How much curation should you expect from a platform?

This is the philosophical question at the heart of equity crowdfunding. Is it up to the market to decide what a good company is, or the platforms? How do the platforms make money: is it through only heavily curated deals? To what extent should deals fail? Does there need to be a certain ratio of success to failure in order for equity crowdfunding to be viable and credible?

To date, there has been a view that the average valuation of equity crowdfunding companies has been high, and it’s fair to say that equity crowdfunders in New Zealand operate on a spectrum.

There are those whose philosophy is to let the crowd decide, so they will put up any offer that is brought to them. There are those who will negotiate their clients down on everything from business plan to valuation. Recent feedback from the New Zealand Angel Association Conference was that equity crowdfunders need to meet best practice angel standards, and we agree. By the same token that means those detractors from the traditional investment community need to recognise equity crowdfunding is here to stay.  

Establish what your expectations are going in; if you want a practical middle ground that may include advice to delay an offer (a good partner will want you in the best position to reach your target), then be clear about that from the start.

2) What is the difference between rewards crowdfunding and equity crowdfunding?

Some equity crowdfunders confuse the two. There is definitely a place for rewards when raising funds, as it boosts retail investment. However, investors shouldn’t be induced to invest with a crate of beer or a case of wine each year; the focus should be on a return on investment. Anecdotally, we’ve heard that a deal or two has failed to reach target because the rewards weren’t good enough, but this should not be the main factor when you’re buying shares in a company.

Remember, equity crowdfunding doesn’t work like Kickstarter. Rather, it’s about a mid to long-term business investment. If your prospective partner is talking rewards, make sure they support the overall strategy.

3) Where is the equity crowdfunding sector going?

In 2014, the crowfunding market (rewards, equity, donation, and debt) saw global growth in “funding volume” of 167% on the previous year, to US $6.1billion; 2015 is expected see that increase to $34.4billion USD. [1]

Many Western economies are yet to fully legislate equity crowdfunding. With equity crowdfunding being hampered by stringent regulation, the market size for crowdfunding looks to be understated. As countries relax laws around equity crowdfunding and allow more retail investors to participate in private placements, the prominence of equity crowdfunding will only increase, contributing to greater growth in the broader crowdfunding market.

This growing segment of “alternative finance” is providing businesses with new avenues of capital, fuelling growth in companies that may not otherwise qualify under stringent, post-GFC lending criteria. Equity crowdfunding and the broader crowdfunding market look set to stay and are well on the way to becoming a more common source of capital.

With respect to our immediate region, the most dominant forms of crowdfunding will likely be a mixture of debt and equity – this will be more apparent as equity crowdfunders take on partners to enter new markets such as Australia. Some will specialize in the consumer space and others in business-to-business capital raises. This specialisation, or fragmentation of the equity crowdfunding market isn’t sustainable, and there will be consolidation.

There will definitely be more Trans-Tasman activity as Australia opens up to equity crowdfunding, so if your company has an Australian presence or goals for that market, think about which provider is best placed to serve those interests 12 months from now, and five years down the track!

4) What do success and failure mean in this context? How do I judge who is a good bet?

Equity crowdfunding is public – and the public will decide, quickly. Track record is hard to judge in such a new sector, so look at the principles of any equity crowdfunder you are considering – their credentials and experience; what they bring to your business. Ask about previous deals and why they’ve succeeded or failed. Ask if they have worked on similar deals to the one you propose, and whether they are familiar with your company and its industry. The success rate of all platforms shouldn’t be 100%. That’s not the model (the early years in the UK were more around the 30-40% mark). However, a platform should educate you as to your chances and it should do what it can to assist.

5) What is the tech capability?

Equity crowdfunding is fundamentally a technology-supported industry. In this era, raising funds from a large number of people in a secure manner requires sophisticated tech capability. Look at what your prospective equity crowdfunder offers on this front. Is there an in-house tech team? What are their measures for troubleshooting? How is their platform constructed and can it handle large volumes of traffic?

A rule of thumb is that second-tier platforms have second-rate tech. They might use white-labelled technology, developed and run elsewhere, over which they have no control. What would this mean in a prospective capital-raising? Test prospective suppliers yourself – is the level of security and capability enough for your business? All platforms meet required legislative hurdles, so the bar is high, but there are significant differences among platforms.

An indicator of reliability is a structure involving a trust account and the debiting of funds from an investor’s account into the trust account almost as soon as they click ‘invest’. (The use of a trust account, among other purposes, gives investors surety that if the target is not met, their investment is safe and will be returned to them directly.)

Ask a would-be provider at what stage of the process it does its anti-money laundering checks – before or after the raise is completed? When do they charge credit cards? Platforms should perform these checks in real time and debit investor funds as they hit the invest button and fill in bank details. If a platform uses credit cards and backends AML checks, this may slow the transaction down. It’s the modern way to raise capital – this should all happen in real time! Ask the provider what would take place if a bunch of cards bounced. If all this takes place after the deal closes, what does it mean for your deal?

6) Make sure it’s a fair deal.

The standard arrangement is that for any given offer, equity crowdfunders will typically earn their fee from a percentage of the capital raised, and receive close to nothing if the offer’s target is not met. This ensures they have skin in the game and should give you the best advice and support to get the offer over the line. If some other arrangement is proposed, such as one in which the equity crowdfunder gets a return no matter what, make sure it’s in your interest.

7) Consolidation

There will be a shake-up. There are too many platforms in the market. You should form a partnership with the platform that you crowdfund with, picking them for the right reasons. The Financial Markets Authority can’t legally stop licensing platforms if they meet the requirements of the Financial Markets Act 2013. Therefore as in any other market you have a choice to make, and hopefully you find this guide helpful. 

Will Mahon-Heap is the Co-Founder/NZ Manager of Equitise, New Zealand’s only trans-Tasman equity crowdfunding company.

 

[1] Massolution and Crowdsourcing.org, 2015