Crowdfunding: Caveat emptor or easy money?

While crowdfunding is often hailed as a more democratic form of financing, it is not just a matter of issuing shares. Benjamin James, a partner in the commercial team at McCarthy Denning, outlines what SMEs should watch out for when raising finance through crowdfunding.

For SMEs seeking to grow, crowdfunding is one of the current buzz words.  Crowdfunding allows companies, with relative ease, to seek investment from both individuals looking to put their toe in investment waters and Angels trawling the sites seeking to invest in the next Facebook or Airbnb.

An excellent source of fundraising for most companies, crowdfunding facilities loan finance, equity or a mixture. The process is also much easier for the company than the more traditional methods of actively seeking new investment from both individual and institutional investors. In effect, crowdfunding sites have made a stockbroking service available to a much wider group of companies.

Those seeking investment must still comply with the Companies Act requirements for seeking investments by issuing the correct documents and managing the process. However, the templates made available through the crowdfunding sites make the process much simpler and cheaper than many of the other options.

It is important that companies seeking crowdfunding, still take all appropriate advice. It is not just a matter of issuing shares. There is a lot to consider in growth and also how the company will operate in the future. For example, will multiple classes of shares be offered, what benefits will be offered and what will be the impact on the company of all of the new shareholders.

In many cases the risks to the company can be minimised, e.g. it is possible to offer a class of non-voting shares to small investors protecting the decision making of the company. In other cases a mix can be agreed, however, this does depend on the level of investment required by the company and is usually based on the overall investment need. If a company was seeking an investment of £1 million, investments of less than £25,000 could be offered a class of non-voting shares, but with full rights to share in dividends, buy backs etc. and investments of £25,000 or over could have full voting rights.

Following the successes of Ashton Kutcher many people wish to try their luck on investing. Crowdfunding is a sustainable source of funding. If a company gets its pitch right and shows that it is a good business there potentially is an unlimited number of people looking to emulate that success.

The risks for the company are generally low as it is the company that it making the offer and setting the terms of the investment. There are also advantages to the company as often there is not a market in the shares which makes trading difficult and locks investors in for the long term sustainability of the company.

The main risk for a company is that investor confidence is lost in the process. Whilst both Angels and small investors are investing through crowdfunding, the vast majority are not sophisticated and are getting involved with investing for the first time or at low levels without advice and without any personal connection to the company. If too many companies fail, especially through bad management, the entire process could be tainted.

Not every method of funding is right for everyone company. In some cases the alternatives of loan financing, a traditional stock broker or even a listing may be better for a company, but the flexibility of crowdfunding does make it a great option for many companies. However, the providers need to assist investors to identify the right companies and also to be selective in what they offer. Good, well managed companies, have to be the way forward, but even then there are risks.

Benjamin James is a partner in the commercial team at McCarthy Denning.

Praseeda Nair

Praseeda Nair

Praseeda was Editor for from 2016 to 2018.

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