Crowd Funding

sjp1966

Hi

I recently realised that my dream of owning a bar is not going to happen so I was thinking of investing some of the money that I had saved into crowd funding projects like those on Crowd Cube. However I've not really invested before in things like this and don't want to just take the blurb that is written against the portfolios as 100% accurate.

I was wondering if someone out there is experienced at investing in these kinds of things whom could outline some pointers that I would look out for or take into consideration when choosing a crowd fund to invest in.

Thanks

Steve

Alexland

It might be safer than owning a bar but looking at their trendy website I am not sure their ideas are entirely investment grade opportunities. They have a few 'success stories' but they seem to focus on how happy the founders are to receiving the money with general undertones of entrepreneurial achievement and modern looking brand logos. They also focus on how enjoyable the investment process is but it's not clear how happy the investors are at receiving whatever returns, if any, have occurred.

ValiantSon

Alexland wrote: »

It might be safer than owning a bar but looking at their trendy website I am not sure their ideas are entirely investment grade opportunities. They have a few 'success stories' but they seem to focus on how happy the founders are to receiving the money with general undertones of entrepreneurial achievement and modern looking brand logos. They also focus on how enjoyable the investment process is but it's not clear how happy the investors are at receiving whatever returns, if any, have occurred.

I'm sure the founders are happy to receive the money they wanted, and I'm delighted to hear that the investment process is enjoyable (however that works), but like you I'm a little stumped at the information on returns on investment (or rather the lack of information).

I wouldn't put my money in any of the ideas I saw on the site. Maybe I'm just a curmudgeon, but if I'm going to invest in something then I want to have a clearer sense of how that investment might lead to me making a decent return. I'll stick with equities traded on the stockmarket.

sjp1966

Thanks both... So with a little bit of money, say 1 to 4k, what kind of investments should I be looking at? Yes I was taken in by that website a bit and the marketing etc but I guess that just shows my inexperience.

ValiantSon

sjp1966 wrote: »

Thanks both... So with a little bit of money, say 1 to 4k, what kind of investments should I be looking at? Yes I was taken in by that website a bit and the marketing etc but I guess that just shows my inexperience.

The first question is, do you have other savings that will act as a rainy day fund (often recommended to be around six months' worth of spending)? If the answer is 'yes' then investments are sensible; if the answer is 'no' then you'd be well-advised to build that fund up first.

Assuming you have the 'spare' money to invest then you want to create a diverse portfolio at a low cost. The simplest way of doing this is to invest in a multi-asset fund. Good options include Vanguard LifeStrategy Funds, HSBC Global Strategy Funds and Blackrock Consensus Funds. Each of these invest your money broadly across a wide range of different companies around the world, and also in bonds (there are some versions of these funds that don't use bonds in the mix - they are the highest risk). For an individual investor to create a portfolio like this would be very time consuming in setting it up and managing it (and likely to be only be of value with much larger sums to invest).

When you choose a fund you will see a charge called OCF. This is the ongoing cost of owning shares in the fund on an annual basis. You will need to use a platform to buy and hold the fund, who will also charge you a fee. For smaller investments, per centage based platforms are normally cheapest. With a multi-asset fund you should reasonably be able to keep the combined cost below 0.5% per annum.

Links below to information on each of the different fund families mentioned above:

Vanguard:
https://www.trustnet.com/fund/search/vanguard%20lifestrategy (Top 5)

HSBC: https://www.trustnet.com/fund/search/hsbc%20global%20strategy (Top 4)

Blackrock: https://www.trustnet.com/fund/search/blackrock%20consensus (Top 5)

Vanguard LifeStrategy costs 0.22%.
HSBC Global Strategy costs between 0.17% and 0.21% depending on specific version.
Blackrock Consensus costs between 0.22% and 0.23% depending on specific version.

Broadly speaking equities are more volatile than bonds and are therefore a higher risk investment. People tend to use bonds in their portfolio to reduce that volatility, and therefore, risk, so funds with higher levels of equities are riskier. However, the important thing to do is establish what your risk tolerance is. You'll find guidance on that online, but ultimately boils down to how likely you are to panic if your investments fell in value by a certain per centage. If you panic and sell then you turn a paper loss into a real terms loss, but if you hold your nerve then history shows that markets recover relatively quickly and you will recoup your losses an make further gains.

Another important factor to keep in mind is that investments are long term. As a minimum, you should be intending to invest for at least 10 years, and preferably longer, so that you can ride out downturns in the market.

Here is a link to the Monevator site which is well worth reading to learn a bit more about investing http://monevator.com/ . You might also want to take a look at their platform comparison table that shows all the costs http://monevator.com/compare-uk-cheapest-online-brokers/

There's lots more that I could say, but this might be a good start. Do come and ask more questions as you learn more. There are lots of knowledgeable people on her who will help.

bowlhead99

I have some investments through crowdcube - only EIS and SEIS qualifying ones to help with the risk. Time will tell. There were a couple more I liked over the last couple of months which I would have done as a punt and signed up, to but then I cancelled at the very last minute - due to deciding I would rather spend money on nonessential home improvements and get something tangible for my money, rather than waiting several years and perhaps have even more money for the home improvements but perhaps not have any....

If you were keen on understanding the process as a prospective investor in a private company, but don't want to spend a few years as a practitioner employed in the investment sector, you could spend a couple of thousand pounds on going on a course run by BVCA such as https://www.bvca.co.uk/Calendar/Training-Details/DateId/871 . There you would meet other junior investment professionals who might be surprised you wanted to join them in finding out how to properly kick the tyres on a private business when you don't have millions of pounds of investible capital behind you.

Still, after a two day overview of the process finding out about legal, commerical and management due diligence processes, what you would learn is that as one small face in the crowd you will not get the kind of privileged access to management and data that one really requires to properly evaluate the opportunity in front of you from all angles. If you are only investing £50 to £500 to £5,000 to £50,000 for example, it can't possibly be worth doing what a private equity /VC firm contemplating a much larger investment would do. And so you can't possibly have the same chance of success.

What they (the VC firms) would do might involve spending tens of thousands of pounds commissioning advisors to write lengthy independent reports on the relative merits of the proposition and the robustness of the business plan and legals, state of the market and competitive threats etc and then reviewing those reports in conjunction with the highly detailed material they can get out of the prospective investee company with a decent non-discloure agreement and some industry credibility and the carrot of having large sums to invest.

Unlike the other junior execs in the room on a training day, when you are sitting at home thinking about having a punt into crowdfunding, you won't get support of an experienced senior partner of the firm to challenge your assumptions and conclusions, and you won't really get the access to go and kick the tyres yourself to see if they wobble, even if you knew what you were looking for and could spare the time.

What you can sometimes do is see that VC firms and other wealthier angel investors are putting money into the deal as a cornerstone investor and take some comfort that they wouldn't have done that without doing their own research, which may compensate for not being able to do the work yourself.

However, those investors likely have much deeper pockets than you and some may have a bit of a scattergun approach to funding a bunch of pet projects which they think are worth a look. They may see that out of every ten, two or three work out 'just about OK', one or two are good, hopefully one will be a shining star, and up to half of them are dogs which they should with hindsight have avoided. Overall they will hopefully make money - but you won't if you don't pick as wisely or broadly to be able to either avoid the losses or afford the losses as part of a wider portfolio.

So, following 'the crowd' into an investment of equity or loan into a private company is very high risk; many in the crowd are morons, and the educated ones whose presence encourages you to part with cash, might only be doing it as a punt among other punts. And the educated ones making a greater commitment to the deal might be getting better terms than you, or may have invested in an earlier funding round and be happy to see new money come in to join them at a high price when their original investment that they are still sitting on was much cheaper.

I am kidding about signing up to a BVCA course, there is of course no point in you really doing that if you don't have an employer who'll sponsor it - but the syllabus might give an indication of themes to look at. But so would watching a lot of back editions of Dragons' Den where people with business plans and ideas are grilled and scrutinised by people with capital to deploy. It is an entertainment show really but it does involve some real concepts of challenging the validity of business plans put forward by the current owners of the business.

When you go to somewhere like crowdcube there are a few steps, here's a quick brainstorm:

1) Request access to the prospectus document or business plan so you are focussed on that and not the shiny fun headlines.

2) Read it several times and note what the implied valuation is after they raise the money they hope to raise.

3) Evaluate whether the current business model justifies the current valuation in terms of what it is doing now 4) and what it might be worth in the future with assets of x and profits of y.

5) Assess how realistic it is for them to reach the point they project in their business plan where assets are x and profits are y, without running out of cash along the way: what critical milestones do they need to achieve and 6) how can they be confident they will hit them.

7) Understand what the potential exit route will be (Crowdcube *might* roll out a 'secondary market' for people to sell their private crowdfund assets - but you should probably assume that nobody will want to buy just your own shares off you unless they are a third party who are buying everyone elses too).

8) Understand who the key individuals are behind the business and what they have in their background that seems positive for what they need to do for the business and what negatives there are. 9) What are their motivations, how are their interests aligned with yours? 10) What happens if something drastic happens to one of those individuals - does the business survive and recruit someone in their place, or is it totally screwed?

11) Who are the key customers and major suppliers and what does the pipeline of new business or supply chain look like? Is the business very reliant on those certain key parties and what might happen that could cause those relationships to break down or for those parties to suffer problems in their own business which meant they didn't want to or couldn't continue to buy or sell to your target company - 12) and what would the conseqences be for that target company without customer X or supplier Y?

13) Who are the current competitors and why don't they already do what they do the way your target company does it instead? 14) What are the barriers to entry for a new competitor who wanted to work in the same space - or in some space that's a decent substitute for the solution or product or service that your target company provides?

15) What changes might be on the horizon for the company's market sector such as regulatory or legal, shifting customer prerferences etc etc

That's 15 or so out of the many things to do or questions to ask, off the top of my head so seems a good place to cut short the examples - each one could be broken out into more sub-points and there are probably twice as many major things as that to consider anyway, but it gives you a flavour.

Crowdcube offers a discussion area on each pitch where people can ask questions of the business management and try to draw out some of the points that are not covered very well or appear internally inconsistent between some parts of the pitch and others. Sometimes you get quite insightful and useful answers that should really have been in the core offering materials. Other times you get referred to the answers given to other people in earlier postings, even though the questions might not be the same. Sometimes they simply can't answer for confidentiality / competitive reasons but may open up more if you are willing to sign a nondisclousre agremeent and talk to them outside the public domain discussion forum. That is not to say the answers will always be truthful and devoid of marketing spin.

Of the 15 things I suggested, and all the ones I didn't, there will be some things you can't answer or don't know how to go about doing. At that point you have to toss a coin. If you get to the point where too much of it is a coin toss, you give up the investment.

There will be some of the actions where an inadequate response or not knowing how to find out the answer is more of a dealbreaker than others. If you don't know the first thing about company valuation principles (some useful concepts about reporting fair value of private companies within an investment fund's portfolio are in in this document from the IPEV board), that's a bigger problem than not knowing some other 'nice to have' fact, and the success of your investment is ultimately driven by whether you pay a good price for it and what someone will pay you later at the time you exit (if you ever can).

On the 15 things I mentioned (I only stopped because it was a round number), if you only spend a cursory four minutes on each, that's an hour of work to even come up with cursory bullet point summary of what you know about the basics of the company and how many coin-tosses you have. But some of the areas would take a lot more than four minutes. Thankfully some investments on that site take a lot less to conclude it is a terrible investment with plenty of warning signs or inadequate info and you can move on. The others that you stick around for would have you spending much more than an hour of your hard-earned leisure time, looking at it and asking questions of management.

You need to place that in context with how much you are investing. If you value your leisure time at £50 ph and you are only going to invest £100 in a particular deal because it seems a bit of a punt, then a 2-hour review of the opportunity means you need to double your money just to pay yourself back for the 2-hour review you did, and a lot more than double your money to actually make profits. And most of these opportunities could easily go titsup instead, and many of them will take several hours to properly understand.

EIS and SEIS will take some of that pain away by givng you income tax relief and then loss relief if things go badly. Buying in at an outrageous £10m valuation maybe isn't so bad if it only really cost you an effective £7m or £5m after the reliefs and you have some downside protection in the form of more reliefs to come later if it's a loser.

I mentioned that you could spend several hours looking at these sort of things to sort the wheat from the chaff, and that's important if you are making large investments - the sort of large investments one might make as an alternative to following a dream of opening their own bar business which would also be a risky investment. Of course, if you are only having a punt with small amounts of money instead, you don't have to follow a disciplined approach.

So you could instead think to yourself that even if you spend a whole week on it (40 mins per question instead of 4 mins per question is 40 hours to cover 15 actions...), you're still going to have things you can't get to the bottom of, with the level of detail these entrepreneurs are willing or able to give you. And if it comes down to a coin toss anyway because you can only adequately resolve 14 of the 15 questions, you might like to just skip the 40 hours of work and cut to the coin toss.

The way to look at it though, if you are considering putting material amounts of money into such investments, is that the difference between failure and success can be that one person will toss a coin to find which prospects they should buy out of the whole population of prospects, and ther other will first work as hard as his money deserves to filter down the population to a set of reasonably investible things first, and only then toss the coin. The 'element of luck' is helpful but you have a better chance of picking the ace of spades if you remove all the jokers and non-face cards from the deck first.

sjp1966

massively detailed responses, thank you. I will read through these carefully

Thanks again

Steve