Crowdfunding platforms have opened up the opportunity to invest in exciting early stage businesses to many more investors.
But if you are tempted to try to back the next Monzo, Revolut or Brewdog, what do you need to watch out for.
Luke Lang, co-founder of crowdfunding platform Crowdcube and an investor himself, gives us some tips.
Digital bank Monzo raised £20million from crowdfunding last December
In less than two-and-a-half days last December, digital bank Monzo raised £20million from 36,000 of its account holders.
The funding round was the largest in UK crowdfunding history.
Four months earlier, it was revealed that crowd investors, of which I was one, who backed Revolut another digital bank that also has a valuation of over £1billion, had realised returns of around 19 times on their original investments.
We now live in a world where the majority of us have the opportunity to participate in the extraordinary wealth creation brought about by technology and market economies.
The platforms throwing open access to investment opportunities have been instrumental to this.
According to the Cambridge Centre for Alternative Finance, the UK’s alternative finance industry market reached £6.19billion in 2017 – 35 per cent larger than a year earlier.
The democratisation of investment is here to stay, and that means everyday investors now have a golden opportunity – at a time of deep political uncertainty – to back the businesses that drive the UK’s economy.
Over £316million has successfully been raised on crowdfunding platform Crowdcube by businesses that qualify for EIS, and £38million by SEIS-eligible start-ups
How the EIS scheme works for crowdfunding
For a quarter of a century, UK investors have been supported by the same government scheme that has bolstered our industry: the Enterprise Investment Scheme, and its younger sibling, the Seed Enterprise Investment Scheme.
Launched in 1993, EIS helps smaller, higher-risk companies raise finance by offering a tax relief to investors, with SEIS targeting even smaller businesses.
Since the inception of EIS, almost 30,000 qualifying companies have raised over £18billion. Over £316million has successfully been raised on Crowdcube by businesses that qualify for EIS, and £38million by SEIS-eligible start-ups.
This is a government initiative that has proved a dynamo for small business – the UK’s economic lifeblood which accounted for 99.3 per cent of all private sector businesses at the start of 2018.
For investors, EIS offers income tax relief of 30 per cent on investments of up to £1million in a given tax year, meaning a maximum tax reduction of £300,000.
Shares are free from capital gains tax if they are held for at least three years, and income tax relief was claimed on them.
If shares are disposed of at a loss, the investor can elect that the amount of the loss, less income tax relief given, can be set against income of the year in which they were disposed or, on income of the previous year instead of being set of against any capital gains.
If you have maxed out your Isa allowance, you can still take advantage of EIS, which can be utilised via an EIS fund, venture capital trust, or you can pick the businesses you want to invest in and do so direct via a crowdfunding platform.
The risks of investing in early stage companies
Of course, investing in early-stage businesses comes with risks.
EIS and SEIS investments are designed to limit some of those risks, but that also means they are fairly illiquid.
You must, for example, hold your shares for three years in order to receive the tax relief. If your shares are sold before then (for instance, if the company exits), you will have to inform HMRC and repay any income tax relief you have claimed.
What’s more, your stake in a company can be diluted. This does not always mean your shares will do down in value, however.
My ownership stake in Revolut has reduced because the company has raised more capital, but the value of my shares has gone up 19 times over.
EIS investments enable you to be more adventurous with a small portion of a diversified portfolio, giving you the opportunity to invest in some of the UK’s most exciting companies, from Monzo, to Mr & Mrs Smith and BrewDog.
Be careful with valuations – and ask questions?
Crowdfunding platforms have really allowed EIS to come into its own.
Our investors are usually from the UK and Europe with a healthy household income. Many of them live in London or the South East, and tend to work in finance, professional services or in tech.
Not only can we offer them access to deals previously the preserve of high net-worth individuals, but we can make the information and processes around those investments, including how they are structured and how they can develop, transparent and straightforward for anyone to follow.
One area where it is vital to do this is regarding valuations.
Valuations are not an exact science – valuing a business can be difficult, and doing so will impact future returns for investors, and a business’s ability to raise further capital.
But communicating these factors in a transparent way has never been more important. Investors and potential investors need to understand the thinking and processes behind valuing a business.
Crowdfunding platforms enable an open dialogue between investors and the company fundraising.
Seeking investment from the crowd: Monzo, to Mr & Mrs Smith and BrewDog are some of the UK’s most exciting companies that have raised business capital through crowdfunding
Often, and particularly with later-stage start-ups and businesses, valuations will be set by a lead investor or venture capitalist firm also participating in the funding round.
Leading crowdfunding platforms place an open, forum-based discussion between investors and companies at the heart of what is offered – a world away from the traditional closed-door discussions of investment banks and other ivory tower financial institutions.
We find that companies seeking to raise business capital on our platform will explain the rationale behind their valuation if asked, and take on board feedback.
Crowdfunding has democratised valuations: now, it is the retail investor who decides if the valuation is right.
Supporting UK businesses now is not just about responding to a rallying cry in the face of Brexit. For investors, they prove their mettle.
E-Car Club, Camden Town Brewery, Mettrr Technologies, BrewDog, Bidstack, Movem and Revolut are just some of the (now far larger) companies that crowdfunded with us and delivered multiple returns to investors.
UK investors should remember that, in EIS and SEIS, they have a unique boon – one which they should be making the most of.