There is no question that the proliferation of various forms of alternative finance has proven vital for Britain’s scaling businesses attempting to secure growth funding. In the UK, the alternative finance industry traded a staggering £3.2 billion worth of business in 2015, an increase of 84% on the previous year. Within this rapidly expanding market, equity crowdfunding emerged as a particularly popular method of growth finance – up by 295% from last year’s figures – leaping from the modest £84 million raised in 2014 to a massive £332 million worth of investment in 2015.
Whereas the opportunity to back high-growth companies has traditionally been the reserve of banks, hedge funds, VCs, and angels, crowdfunding has played a pivotal role in the true democratization of SME investment. Within the last year alone, over 100 businesses have collectively raised more than £150 million through the top four UK crowdfunding platforms, with retail investors now supporting more companies than ever before. From a corporate perspective, crowdfunding platforms have created a wealth of new opportunities for Britain’s growing collection of 5.4 million SMEs, which are no longer solely reliant on bank loans and institutional lending to secure growth finance. A staggering 254,721 companies and individuals in the UK that turned to ‘the crowd’ for funding last year, while 1.09 million people invested, donated or lent via online alternative finance platforms.
These statistics, courtesy of Cambridge Center for Alternative Finance & Nesta’s ‘Pushing Boundaries’ report, paint a positive picture for SME finance in Britain, and rightly so; the alternative finance industry has transformed a traditionally cumbersome investment model, capitalized on only by the lofty echelons of corporate investment, into a much more accessible market. However, for equity crowdfunding to be truly democratized, the market must develop yet further, particularly concerning how businesses are securing pre-crowd finance. Specifically, when a start-up or scale-up chooses to launch a crowdfunding campaign, business owners must appreciate that the success or failure of the funding round can be influenced in part by the level of investor interest, and subsequent finance, the company, has generated before it even appears on the platform itself.
The Value of Momentum
In the 11 months to the end of March 2016, CrowdRating.co.uk monitored 678 campaigns that have completed on the top 12 crowdfunding platforms. The study found that on average 55% of campaigns succeed, although there was a variation between the platforms in question, which is to be expected. This success rate is not a problem in itself; it is inevitable that not all of SMEs’ crowdfunding campaigns will achieve their full target. But, with almost half of equity crowdfunding campaigns failing, we must acknowledge some factors that can make or break a project.
One of the most decisive factors in determining the success of an equity crowdfunding campaign is the amount of investment secured in the early days of the business appearing on the platform. In a report entitled ‘Equity Crowdfunding: A New Model for Financing Entrepreneurship?’, Saul Estrin and Susanna Khavul, two professors from the London School of Economics, state that;
“one pound invested on one day of the pitch generates an additional 51 pence in the subsequent day, and an additional 76 pence over five days”.
These figures demonstrate the importance of early momentum in equity crowdfunding campaigns and how investors can respond to initial interest in a `funding round.
For businesses, generating this momentum from the start is of utmost importance. Major crowdfunding platforms – encompassing all types of lending, be it equity investments or even donation-based contributions – have recognized this point. Kickstarter, for example, has stated that once a campaign raises 20% of its funding target, the project has an 80% chance of successfully reaching its total, while Seedrs has previously reported that once a campaign hits 30% of its funding goal the success rate climbs to 90%, a huge improvement on the almost 50/50 odds that statistics suggest a campaign has at launch.
Generating Early Traction
The psychology behind this trend is simple – it is fundamentally the herd mentality of human beings, in which one person will follow the decisions made by others, particularly those deemed to be experts in a given field. To use the analogy of a tourist choosing a restaurant to eat in, if they have no prior knowledge of an area and are confronted with two options, one eatery is bustling with diners while the other is empty but for a solitary customer; the out-of-towner will typically opt for the busier restaurant. They trust the judgment of those who know the two restaurants and have decided accordingly. This can be applied to the world of alternative finance to an extent, as investors could be more inclined to gravitate towards equity crowdfunding campaigns that have already secured backing from other investors and have a healthy forward momentum.
And so we come back to the issue of an imbalance between businesses attempting to secure growth finance on crowdfunding platforms. Although the progress of a crowdfunding campaign is just one of many factors that an investor must consider before backing a company, on first glance, that progression could prove decisive as to whether the investor pursues the campaign any further. Conscious of this, many SMEs when they launch an equity crowdfunding campaign ensures they already have potential interest lined up, be it from investors, their wider network, or friends and family – this initial traction, generated prior to a business appearing on a crowdfunding platform, then helps to provide the initial burst of momentum and push the funding round through the first 10%, 30% or even 50% of the target figure. In doing so, as illustrated above, these businesses dramatically increase their chances of successfully hitting their overall target and walking away with the investment they need.
However, not all companies are in the position to list on a crowdfunding platform with initial investment already in the pipeline to build this momentum. Some will be able to generate this organically once their campaign is live on the platform, but others may risk being overlooked as investors may be initially swayed to back businesses that their peers are already on board with. Therein lies a problem that is restricting the chances of many talented, promising small businesses across the UK from securing vital growth finance.
SMEs Must Be Proactive
Proactive action must be taken to enable SMEs to enjoy the best possible chance of succeeding when launching a campaign on a crowdfunding platform. One means of achieving this could be to facilitate greater levels of co-investment within a network of more seasoned investors before releasing the campaign to the wider public. Importantly, to ensure that the process remains democratic and stays true to the value of crowdfunding, the terms of the investment must be equal for the initial investors and the wider public. The group of seasoned investors would be well-positioned to negotiate a fair valuation on behalf of the crowd and in doing so this could stir up the initial momentum needed to insight interest in that campaign. If the company seeking investment did not have its own pre-arranged network of investors or friends and family to turn to in the early stages of the campaign, then interest from investors well versed in the industry could give that raise an initial boost.
Aside from the platforms integrating greater volumes of co-investment, it is also the responsibility of the wider industry to generate more awareness of this route to funding and for the business owners themselves to research the opportunities available to them.
Greater levels of networking and communication between businesses and private equity specialists are one such course of action – this will help small businesses create a pipeline of investors who are keen to back their cause once they appear on a crowdfunding platform. Likewise, doing as much promotion around the business as possible could also prove beneficial; greater awareness of the business, the brand or the entrepreneurs behind it will draw the crowd in when it comes to securing growth finance.
Ultimately, creating more opportunities for SMEs to secure pre-aligned funding before launching an equity crowdfunding campaign is a critical development that will likely become more and more commonplace over the coming years. As the alternative finance industry matures – and greater volumes of statistics and case studies become available – investors, platforms, and businesses will develop a more comprehensive understanding of how to influence a crowdfunding campaign to ensure it has the maximum chance of succeeding. But it has already become clear that SMEs ought to focus on the value of establishing early investor interest to boost the momentum of their campaign and, in turn, help increase the probability that they will achieve their target and walk away with the funding they need to take their business to the next level.
Luke Davis is the CEO of private equity firm IW Capital, Co-Founder of crowdfunding specialist Crowdfinders and Co-Founder of P2P lending platform Money&Co. He offers his insight into the evolution of equity and debt crowdfunding and how we can ensure the alternative finance industry is truly democratic.