1 THE VENTURE CROWD Crowdfunding equity investment into business
THE VENTURE CROWD
INVESTMENT INTO BUSINESS
Liam Collins and Yannis Pierrakis
2 THE VENTURE CROWD Crowdfunding equity investment into business
Nesta is the UK’s innovation foundation. We help people and organisations bring
great ideas to life. We do this by providing investments and grants and mobilising
research, networks and skills.
We are an independent charity and our work is enabled by an endowment from
the National Lottery.
Nesta Operating Company is a registered charity in England and Wales with a company number 7706036 and
charity number 1144091. Registered as a charity in Scotland number SC042833. Registered ofﬁce: 1 Plough Place,
London, EC4A 1DE
© Nesta 2012.
3 THE VENTURE CROWD Crowdfunding equity investment into business
Crowdfunding is big business. The idea of ﬁnancing projects or businesses with small
contributions from large numbers of people is catching on in a big way and now accounts for
signiﬁcant amounts of money. In 2011 alone, $1.5 billion was raised through crowdfunding for
projects and businesses in need of funds. Not only does the model provide ﬁnance but also
access to a large number of people who can test and market an idea. Crowdfunding takes a
number of different forms, the most successful of which has been the reward–based model where
participants receive non–ﬁnancial rewards in exchange for donating to a project. The model
effectively harnesses not only the contributors’ desire for the reward but also the intrinsic or
social motivations to back a project. Other forms of the model are, however, also growing rapidly.
The most recent of these is equity crowdfunding, where individuals receive small stakes in a
privately owned young business in return for investment.
While equity crowdfunding shares many of the features of the reward model, one signiﬁcant
difference is the combination of both ﬁnancial and non–ﬁnancial motives for investing. The model
also differs from other forms of equity ﬁnancing. Crowdfunded businesses do not have to adhere
to the strict accounting standards required of public companies and unlike other risk capital
providers, crowdfunding investors may have no experience in making such investments.
Form of contribution Form of return Motivation of funder
Donation Donation Intangible beneﬁts Intrinsic and social
Reward Donation/ Rewards but also Combination of intrinsic
Crowdfunding Pre–purchase intangible beneﬁts. and social motivation
and desire for reward.
Crowdfunded Loan Repayment of loan Combination of intrinsic,
Lending with interest. Some social and ﬁnancial
socially motivated motivation.
lending is interest free.
Equity Investment Return on investment Combination of intrinsic,
Crowdfunding in time if the business social and ﬁnancial
does well. Rewards motivation.
also offered sometimes.
another factor for
4 THE VENTURE CROWD Crowdfunding equity investment into business
Investment via equity crowdfunding is facilitated by online platforms, which allow entrepreneurs
to connect with potential investors and seek funding from the crowd. Although there is some
variation in how platforms operate, the process usually follows the following steps:
Application to platform: Platforms vet submitted applications and decide which businesses to
allow on the site.
Raising the funds: Businesses create a pitch with information relevant to the fundraising and
have a certain amount of time to raise the capital. They market the campaign through their
networks and beyond, and interact with potential investors to address any questions.
Fundraising closes: If the target has been reached by the end of the period they receive the
funds following some further vetting by the platform. If they fail to reach the target money is
returned to investors.
Post–investment: Investors continue to have the option to interact with the entrepreneur. In
some cases they also receive voting rights.
Crowdfunding investment into business
Equity crowdfunding has the potential to be a complementary source of risk capital to the
traditional providers in the market, offering ﬁnance to many businesses currently struggling to
source investment. One such cohort of businesses is those seeking investment in so–called equity
gaps where it is difﬁcult to get ﬁnance from traditional risk capital providers. Another is businesses
that do not ﬁt the high–risk, high–return proﬁle served by the traditional risk ﬁnance providers
mentioned above, but still face ﬁnancial constraints. These businesses may not have the potential
to deliver the exceptional returns of venture capitalists targets, but they may also be less risky and
still provide signiﬁcant value to the economy.
Some challenges faced by the model
Multiple motives. Managing co–investment between various investors with different motivations
for investing is one task that businesses and platforms will need to master. As more evidence
becomes available about the mix of factors that drive crowdfunding investment behaviour, it will
become clearer how this can be achieved.
Reﬁning the process. During fundraising, it is important that investors make use of all of
the information available when assessing business pitches, and are active in interacting with
entrepreneurs to ﬁnd answers to any questions they may have. Being able to use tools to
assess the reputation and expertise of entrepreneurs and fellow investors, would be an aid to
the evaluation process. Platforms also need to ﬁnd the best ways of stimulating collaborative
evaluation by the crowd to give them every chance of selecting the best ventures. The process will
need to continue to iterate in order to ﬁnd the best ways to vet businesses for fraud, assign fair
valuations to businesses and ensure that managing many shareholders does not become a burden.
Getting the right participants. Other challenges include attracting high–calibre businesses and
investors to platforms. More experienced investors would be helpful in providing evaluation
support for smaller investors and platforms may want to consider how to entice them. Attracting
5 THE VENTURE CROWD Crowdfunding equity investment into business
the right businesses is another important task. Not all businesses will be suited to crowdfunding
and as the model develops, evidence needs to be generated to indicate what businesses it works
best for. This will include the identiﬁcation of those ventures that are most successful at harnessing
the non–ﬁnancial contributions from the crowd.
Regulation. One of the main barriers to the growth of the model thus far is regulation, which
has hindered the expansion in the number of equity crowdfunding facilitators. As interest in the
model grows, there is a greater need for clear legislation in the area and an efﬁcient process for
This report provides the ﬁrst account of how the crowdfunding model operates in practice as well
as some of the variation in the operating models of the platforms. Drawing on several interviews
conducted with key stakeholders, the report looks in detail at the opportunities for equity
crowdfunding, the challenges it faces and provides recommendations as to how some of these can
6 THE VENTURE CROWD Crowdfunding equity investment into business
The authors are grateful to the following people for their contributions to the report.
Martijn Arets (Brand Expedition)
Jon Bradford (Springboard)
Albert Bravo–Biosca (Nesta)
Stuart Chapman (DFJ Esprit and BVCA)
Kristof De Buysere (University of Tilburg)
Guillaume Desclee (MyMicroInvest)
Simon Dixon (Banktothefuture)
Ragini Ghosh (CrowdMission)
John Gibson (No 10 Downing Street)
Maurits Groen (WakaWaka)
David Gudgin (Albion Ventures)
Robert Hayes (Investor)
Sebastian Lewis (GetSiteTracked)
Jeff Lynn (Seedrs)
Louise Marston (Nesta)
Matthew Mead (Nesta)
William Reeve (DFJ Esprit)
Ami Shpiro (Investor and Founder of
Norbert Toepker (Innovestment)
James Watt (Brewdog)
Darren Westlake (Crowdcube)
Stian Westlake (Nesta)
Korstiaan Zandvliet (Symbid)
7 THE VENTURE CROWD Crowdfunding equity investment into business
1. The rise of crowdfunding 8
2. What is equity crowdfunding? 10
2.1. The stages of equity crowdfunding 12
Box 1: Case study of ‘GetSiteTracked’ on Crowdcube 13
Box 2: Matrix of currently operating equity crowdfunding platforms in Europe 16
3. The market opportunity for equity crowdfunding 17
3.1 . The equity gap 17
3.2. The risk–reward opportunity 18
3.1. What types of ventures may seek equity crowdfunding? 19
Box 3: Case study of WakaWaka light – Crowdfunding socially focused ventures 20
4. The crowdfunding model faces several challenges 21
4.1. The regulatory environment 21
Box 4: The current regulatory environment 21
Box 5: Case study of Brewdog’s ‘Equity for punks’ 22
4.2. Challenges with operating the model 23
4.2.1. Setting valuations 23
4.2.2. Fraud detection, selecting businesses and the wisdom of crowds 24
4.2.3. Investor types and visibility 25
4.2.4. The potential for co–investment with professional investors 26
4.2.5. Post–investment support and business governance 27
4.2.6. Consequences of openness 28
4.3. Potential returns from equity crowdfunding 29
5. The future for the model 31
6. Endnotes 33
8 THE VENTURE CROWD Crowdfunding equity investment into business
THE RISE OF CROWDFUNDING
On 8 February 2012 Doubleﬁne studios launched a campaign on Kickstarter, a crowdfunding
site, to raise $400,000 to ﬁnance a new game they hoped to develop in exchange for rewards to
donors such as copies of the completed games and lunch with the creators. While Doubleﬁne were
permitted 32 days to raise their target, they surpassed the $400,000 in just eight hours. By the
end of the 32 days they had raised over $3.3 million from people contributing on average less than
$40 each. This fundraise was the highlight in what has been a period of extraordinary growth for
The concept of crowdfunding ﬁnds its root in the broader concept of crowdsourcing, which uses
the ‘crowd’ to obtain ideas, feedback and solutions in order to develop activities. In the case of
crowdfunding, the objective is – also – to collect money from the crowd who can often participate
in strategic decisions or even have voting rights in a business.
As well as permitting entrepreneurs
access to a new pool of capital, the model allows them to connect with potential customers or
users and test ideas before proceeding with the project. It also gives investors the opportunity to
feel part of the project from its very early stages.
Figure 1: Annual growth in the number of crowdfunding platforms worldwide
2007 2008 2009 2010 2012 (Est.)2011
9 THE VENTURE CROWD Crowdfunding equity investment into business
Crowdfunding has been growing rapidly in the past few years as advancements in technology
and the growth of social media has made it far easier for entrepreneurs to reach large amounts
of people at far less cost. The fundraising itself is usually facilitated by online platforms operated
by third parties who manage transactions and vet projects before presenting them to the public.
Crowdsourcing.org, an industry website focused on crowdsourcing and crowdfunding, estimates
that there were 453 platforms active at the end of 2011 and in that year they raised $1.5 billion
in project and business ﬁnancing.
And demand does not look to be slowing. Kickstarter, the
market–leading platform, is on track to facilitate the raising of $150 million of project ﬁnance for
its participants in 2012, more than the National Endowment for the Arts budget in the US.
projects with a creative or social focus, where non–ﬁnancial rewards(e.g. CD, ticket to a play) are
offered in return for donations, have been the most successful at raising ﬁnance from the crowd.
However, while crowdfunding has been primarily through the reward model, other forms, offering
the option for ﬁnancial return, are also growing fast. Crowdfunded lending to businesses has
grown in recent years as an evolution of the more established model of peer–to–peer lending.
Platforms give credit scores to businesses seeking loans and lenders can buy loan parts at an
interest rate which is often adapted to the market demand. FundingCircle, a London–based
provider of crowdfunded loans, has facilitated over £35 million worth of loans to date.
The form of ﬁnancing that platforms have found it most challenging to facilitate is investment
from the crowd for equity stakes in businesses. Unlike the Kickstarter model where donors receive
rewards for their contributions, equity crowdfunding allows anyone to take a stake in a young
business in the hope of making a ﬁnancial return if the business does well. However, like the reward
model, in many cases investment will also be motivated by non–ﬁnancial aims as the model taps
into the sub–section of the public with an interest in entrepreneurship. The intrinsic motivation to
become a part of an entrepreneurial venture or to support a particular individual or business, will
play a signiﬁcant part in many investors’ decisions to invest. The extent to which this occurs will
determine the level of returns the model is expected to deliver.
While web 2.0 has provided a transformative effect in bringing large numbers of people together,
regulation has made it difﬁcult for businesses to tap into these online communities for investment
and currently only a few platforms facilitate this process. Legislative changes recently passed in
the US have paved the way for growth in the model there, and the interest in the model on this
side of the Atlantic will likely increase as a result. However, there are factors other than regulation
that have also limited the growth of this model. These include investor worries about how much
protection they have against fraud, business concerns about making sensitive information public
on platforms and how to manage large numbers of shareholders.
The growing popularity of crowdfunding has increased interest in exploring how the model works
but research on equity crowdfunding has, to date, been very limited. Although, as Box 2 on page
16 illustrates, the model is yet to have a signiﬁcant impact on the market in terms of the amount of
investment it has facilitated, it has the potential to deliver a lot more. This report aims to highlight
the merits and also the limitations of this new form of ﬁnancing and its potential to become a
signiﬁcant source of ﬁnance for innovative businesses. Interviews with key stakeholders including
platform operators, entrepreneurs, and investors have been conducted, in order to identify the
challenges faced by the model and what solutions it can adopt to overcome them.
10 THE VENTURE CROWD Crowdfunding equity investment into business
WHAT IS EQUITY
For the purpose of this report, equity crowdfunding is deﬁned as the offering of securities by a
privately held business to the general public, usually through the medium of an online platform.
The model permits anyone to acquire a share in privately held businesses, i.e. those that have yet
to ﬂoat on a stock exchange, by allowing a business to offer a certain proportion of its equity for a
set amount of capital it is aiming to raise. Investors can then, through the platform, buy small parts
of this equity stake. While some may deﬁne investment into public companies on stock markets
as a form of crowdfunding, the deﬁnition used in this report differs from this form of investment
in several ways. First, acquiring shares through a stock market is already an established practice
where public companies are required to adhere to strict reporting standards. Private companies
seeking crowdfunding do not have to adhere to these standards. Second, companies in the stock
market are signiﬁcantly larger and more developed than those seeking ﬁnance through equity
crowdfunding platforms. And third, unlike stock market investing, crowdfunding platforms offer
the opportunity for direct interaction with both the entrepreneurs and other likeminded investors
interested in investing in the same company.
Other models that may be deemed as forms of crowdfunding that lie outside of the deﬁnition of
equity crowdfunding used here, are those that restrict membership of the crowd. Most notably
this includes those platforms that only allow accredited investors to participate in investing such
as Northern Ireland based Seedups,
or startup and investor community Angellist
platforms are a welcome innovation to the ﬁeld of business angel investing, bringing transparency
to what is an opaque process and greater visibility of potential investors for start–ups. They also
promote more opportunities for syndication amongst investors, creating a better connected
investor ecosystem. While this is a positive development and many businesses have had been very
successful in raising capital in this way, unlike crowdfunding, it does not necessarily facilitate the
tapping of new pools of capital for investment in innovation. It also doesn’t face the barriers equity
crowdfunding does when dealing with non–accredited and large numbers of investors.
11 THE VENTURE CROWD Crowdfunding equity investment into business
2.1. The stages of equity crowdfunding8
Getting on to a platform
The ﬁrst step of the crowdfunding process involves a business submitting its proposal to a
platform. The platform operators will then look at the plan and perform some level of vetting
of the business, looking at factors such as the likelihood the business could be fraudulent, the
business’s suitability to crowdfunding, the reputation of the entrepreneur(s) and other factors.
They then decide whether or not to allow the pitch to go live on the site. Some platforms like
Exeter–based Crowdcube do the majority of their vetting beforehand having a 75 per cent
rate for applicants. Others favour checking the business later, like Dutch platform
Symbid who perform due diligence once the target has been successfully raised but before they
release the capital to the business.
12 THE VENTURE CROWD Crowdfunding equity investment into business
Box 1: Case study of ‘GetSiteTracked’ on Crowdcube
In 2010, GetSiteTracked founder Sebastian Lewis noticed that like many sole traders his
father was ﬁnding it difﬁcult to adapt to using the internet to source new business. The
majority of sole traders, he discovered, didn’t have websites for their businesses as most web
hosting providers offered services that were overly complex and quite expensive. Out of this
realisation came the idea for GetSiteTracked, an online provider of affordable and easy–to–
use websites for sole traders. Like most young entrepreneurs, Sebastian needed to raise
external capital to get his business off the ground. He was advised not to approach banks as
without a sizable asset he would be very unlikely to secure any amount exceeding £10,000,
and in his search for alternatives he came across CrowdCube and decided to try raising
capital through crowdfunding.
In March 2012, over the course of ten days Sebastian raised £100,000 from 29 investors in
exchange for 33 per cent of his business. Recognising the difﬁculty in setting valuations on
seed stage businesses, Sebastian used the feedback from investors to judge what amount of
equity investors were willing to accept in return for investment, increasing the amount he
was initially intending to offer. According to Sebastian, one of the main beneﬁts of
crowdfunding is that once a round is raised it opens doors to other sources of ﬁnance.
An additional beneﬁt that Sebastian received from the process was the uncovering of a
valuable mentor who wanted to get involved in helping the business as well as providing
investment. “While it was not something I expected to attain from the process, Rob’s advice
has been of enormous value to the business.”
Robert ﬁrst came across Crowdcube in a local magazine and was intrigued by the prospect
of being able to invest directly into a start–up having successfully built a business himself.
Through the platform, he reviewed pitches and contacted the entrepreneurs behind some
businesses he was interested in. After discussing GetSiteTracked with Sebastian he decided
to both invest and to come onboard as a mentor to the business. Getting in touch with the
entrepreneurs, he felt was a key part of making the investment decision. Robert also points
out that would–be investors should always have an idea of how they expect to make money
from their investment i.e. via dividends, trade sale etc., before they invest. While Robert was
a heavily involved investor, the majority of Sebastian’s investors were quite passive in their
Providing information to investors
Once accepted onto the platform, pitches are uploaded for prospective investors to browse. These
are usually in the form of a video or text description explaining the business’s model, its roots
including some background on the business owners, how much capital it is seeking to raise and
13 THE VENTURE CROWD Crowdfunding equity investment into business
what it needs it for. Another important disclosure is how much equity it is offering, with each
investor getting a pro rata share depending on the proportion of the target amount they commit.
There are a number of ways entrepreneurs can decide on the proportion of equity to offer,
occasionally using the help of the platform and investors.
14 THE VENTURE CROWD Crowdfunding equity investment into business
Connecting with investors
While some investors may browse the platform for pitches,
the entrepreneur needs to make a
conscious effort to market the pitch as widely as possible outside the platform. They need to tap
into their network and beyond, to get people interested in the business and in becoming investors.
As the campaign advances, it is important that interaction between the entrepreneur and potential
investors continues via discussion forums on the platform or via email, phone or even meeting in
person to address questions and give updates on the fundraising progress.
15 THE VENTURE CROWD Crowdfunding equity investment into business
The ‘all–or–nothing’ model
A speciﬁc time allowed for the raise or the ‘funding window’ is also set in advance with platforms
usually having either a standard ‘funding window’ or a limit on the time that can be taken. London–
based platform Seedrs, for example, operates a three month standard funding window. As is
prevalent in the ‘reward’ model of crowdfunding, all equity crowdfunding platforms currently in the
market operate the ‘all–or–nothing’ system of funding where the venture has until the end of the
funding window to raise its target or else it receives nothing and money is returned to investors.
It can also raise no more that its target. The fees charged largely depend on whether funding is
successful or not, with platforms usually charging businesses a percentage of the amount raised
should they reach their target. Some also charge investor fees as Box 2 illustrates.
After the target is reached
The facilitation of the actual money transfer usually involves an escrow account,
of both the investor and business, where the investment is held until the total target is reached, or
failing that, returned to the investor.
Post–investment practices are also varied depending on the approach taken by a given platform.
Seedrs, for example, operates a nominee and management system where it represents the
interest of the investors with the business whereas others like Crowdcube and Symbid allow the
entrepreneurs to manage their own interests. In the latter approach, investors have the option
to be as passive or involved in the business as they choose. As is explored later, there is similar
variation across sites in terms of voting rights.
16 THE VENTURE CROWD Crowdfunding equity investment into business
Box 2: Matrix of currently operating equity crowdfunding platforms in the Europe13
raised so far Vetting/Due Decision on how
through the How investment dilligence much equity Funding Post–
Location platform Fees is facilited by platform to offer window investment
CrowdCube UK £3.7m For businesses: 5% of Both investor and Vetting done Entrepreneur 60 days Business
amount raised + £1750 business become before businesses decides. Can as decides
legal fees if successful members of accepted on increase equity standard threshold
Crowdcube Ltd platform during funding for voting
for the period of window rights
Symbid Nether– €<1m For businesses: €250 up Investment is via a Perform due Entrepreneur Maximum Indirect voting
lands front for existing co–opertaive diligence once decides. Can of 1 year rights for all
businesses (start–up established in the target raised increase equity investors via
ideas can place for free) Netherlands during funding co–operative
+ 5% of amount raised window
+ legal fees – only
payable if successful
For investors: 2.5% of
investment amount +
MyMicro Belguim €500K For businesses: 12% of Investment through Board of professional Agree ment 1 month as Voting rights
Invest from amount raised if an investment investors do their reached after standard for professional
professional successful vehicle own due diligence negotiation investors only
WiSeed France €2.5m For businesses: 10% of Investment through Perform due Negotiation 3 months as Platform
amount raised if dedicated investment diligence before between platform standard manages voting
successful. vehicle for each raise and business after rights
For investors: 5% of raise due diligence is
amount invested if performed
Innovestment Germany €0.5m For businesses: 10% of Investment through Selection process Uses auction to 30 days as No voting rights
amount raised if dedicated investment with multiple stages decide on valuation standard for investors
successful. vehicle for each and a board before
raise business allowed on
Seedrs UK Launching For businesses: 7.5% of Seedrs hold shares Approve disclosures Entrepreneur sets 3 months as Operate nominee
in July 2012 amount raised if on your behalf as a as ﬁnancial promotions amount which standard model where they
successful. nominee manager beforehand and cannot be altered represent the
For investors: 7.5% of perform legal due interests of
proﬁt from investment diligence once target post
BankToThe UK Launching For businesses: 5% of Facilitates ﬁnancial Vetting performed Entrepreneur makes Maximum Investors are
Future in July 2012 amount raised + £1750 promotion via before business decision. of 90 days collected into
Company Secretarial Fee membership model. allowed on to BankToTheFuture private group for
Working on next platform provides training to updates.
phase with FSA assist them Entrepreneur sets
to qualify for
voting ri ghts
Crowd UK Launching For businesses: 5% of Both investor and Initial vetting Entrepreneur sets Still Still
Mission in September amount raised business become undertaken before amount which considering considering
2012 members of business accepted cannot be altered options options
CrowdMission for on to platform.
the period of the Further vetting done
raise if target is reached
17 THE VENTURE CROWD Crowdfunding equity investment into business
THE MARKET OPPORTUNITY FOR
3.1. The equity gap
The demand for accessing risk capital via crowdfunding platforms is potentially extremely large.
Quite often, start–up entrepreneurs are unable to access debt ﬁnancing due to their lack of
collateral and the risky nature of their venture. As a result, they tend to be reliant on generating
revenue, ﬁnancial help from friends and family and external sources of equity ﬁnancing, in order
to fund the early stages of their development. As many businesses are not capable of generating
revenues in their infancy, friends and family tend to be the ﬁrst port of call for external ﬁnance. Jeff
Lynn, founder of crowdfunding platform Seedrs says this has led to something of a class bias in
entrepreneurship with only those having access to wealthy friends and family being able to source
the capital for their business. In any case, friends and family ﬁnancing is often an insufﬁcient
source of funds and in order to achieve scale, larger sources of risk capital are often required.
The traditional sources of risk capital, business angels and venture capitalists, have increasingly
been moving their investment activity upstream in recent years, making bigger investments into
more developed companies.
Many angels tend to only consider businesses looking to raise
larger amounts with the majority of rounds raised from business angels in 2009/2010 greater than
Venture capitalists have largely left the seed stage space, with the ratio of transaction
costs to investment size for small deals being less and less suited to their business model. One
reason this ratio has increased, especially in sectors such as software and internet start–ups, is
the decreasing costs of starting a business thanks to innovations such as cloud computing and
£100K £1m £2m
F+Fs BAs VCs
18 THE VENTURE CROWD Crowdfunding equity investment into business
greater processing power.
This has created two markets
where crowdfunding could play a
valuable role. One is the initial seed money to start a business, where friends and family ﬁnance
may be unavailable or insufﬁcient, and amounts required are too small for business angels to get
involved. There is also the gap above the level where business angles are usually active, but where
the capital required is too small for venture capitalists to get involved. The majority of equity
crowdfunding raised thus far, has been in the lower gap but the model may also have the potential
to raise large amounts, especially if it can entice larger, more sophisticated investors to participate.
3.2. The risk–reward opportunity
Another issue with traditional risk capital providers is their focus on high–risk, high–return ventures
shying away from those that may not have the potential to deliver the exceptional returns they
usually seek but also have less risk attached. This is the category that has the potential to achieve
signiﬁcant growth but perhaps not the level of growth that would get a venture capitalist or
business angel interested. Whether these businesses can deliver sufﬁcient returns to justify long–
term illiquid investment, and how they deliver those returns, are important issues to consider. As
discussed in section 3.3, crowdfunding may also have the potential to deliver ﬁnance to ventures
that have greater levels of risk attached relative to the potential ﬁnancial gains they can deliver.
Non–ﬁnancial beneﬁts of investment such as rewards and intangible beneﬁts from being part of an
entrepreneurial venture may mean some crowdfunding investors will be willing to accept more risk
or less return than traditional risk capital investors.
Figure3: Business risk–reward proﬁle where crowdfunding may ﬁt
In previous years, UK governments have intervened in order to increase the ﬂow of seed and early–
stage capital with initiatives such as publicly–backed venture capital funds focused on early stage–
businesses, co–investment funds and tax–breaks for investors. However, the effectiveness of these
schemes has been mixed.
Privately–led initiatives such as the growth in start–up accelerators,
provide another potential solution to this problem but these are still quite few in number.
way of increasing the supply of ﬁnance to seed and early–stage companies is the facilitation of
19 THE VENTURE CROWD Crowdfunding equity investment into business
purely business angel investments through online platforms, as mentioned earlier. This model,
most successfully demonstrated by Angellist in the US, allows for more efﬁcient syndicate
investing into start–ups by accredited investors.
Equity crowdfunding may have the potential to offer an alternative or, in some cases,
complementary source of ﬁnance for businesses in this space, offering risk capital for early–growth
or new product development. By design, this ﬁnancing model is perhaps suited to smaller amounts
due to limiting factors related to the size of a crowd a given business can tap into and the amount
of capital individual investors can or are willing to contribute. This does, however, depend on the
extent to which larger investors participate in the process and there have been some cases where
the potential of the model to raise larger amounts has also been shown.
Another factor that
may make crowdfunding particularly suited to seed and early–stage risk capital, is that it allows
investors to commit smaller amounts to many ventures allowing them to effectively spread their
risk, in a cost effective way.
3.1. What types of ventures may seek equity crowdfunding?
In time, the primary determinant of the type of businesses that attempt to raise capital via
crowdfunding will be the model’s success at delivering returns, ﬁnancial and non–ﬁnancial, and the
beneﬁts businesses get from raising capital through it. Other important factors include:
First, there is the ability of the mechanism to provide follow–on funding to businesses. Some
ventures may prefer more conventional providers of risk capital in the hope that they can use
the establishment of this relationship to seek further funding in later rounds. The endurance of
relationships between venture capitalists may also become a factor when thinking about the
quality and experience of the entrepreneur. Research has shown that serial or repeat entrepreneurs
tend to have far more success at growing new ventures.
These entrepreneurs will often have
existing relationships with institutional investors as well as signiﬁcant personal resources which
they may deem preferred alternatives to crowdfunding.
Second, some business models and sectors may be more suited to raising funding through
crowdfunding than others. One obvious example of this is consumer–facing businesses. For
start–ups in this sector, traction with the potential customer base is an integral part of proving
to investors the viability of the proposition. Korstiaan Zandvliet, founder of Symbid, believes that
the proof of traction gained by raising a crowdfunded round from investors, who are themselves
consumers, will be a signiﬁcant asset to companies seeking follow–on ﬁnancing. On the ﬂip side of
this are those business models that are based on complex IP or innovations in very high–tech and
cutting edge areas. Without in–depth knowledge of the speciﬁc area, amateur investors may be
hesitant to commit their cash to a venture.
Third, as discussed later, other types of ventures that may be unlikely to seek crowdfunding are
those that feel sensitive about making ideas and ﬁnancial details public on platforms. Those
businesses that are particularly capital–intensive in early stages or those that require the types of
post–investment support that can only be provided by institutional investors may also not ﬁnd the
crowdfunding model a good ﬁt.
20 THE VENTURE CROWD Crowdfunding equity investment into business
Finally, ventures with a focus on generating social gains as well as proﬁt are one category that
could be a good ﬁt for equity crowdfunding. The non–ﬁnancial motivations for investing, will be
stronger in these instances, meaning businesses may not need to deliver as high returns to attract
investment. These motivations may also mean investors would be a more effective marketing
force for the business in general but especially for getting others involved in the crowdfunding
campaign. These businesses could be focused on addressing large international social problems
such as in Box 3, or on local issues such as employment in a given area. One investor pointed
out that a major opportunity for crowdfunding was allowing people the chance to contribute to
businesses starting up in their local area. Karen Darby of CrowdMission, which aims to facilitate the
equity crowdfunding of social ventures, says there is a signiﬁcant population of businesses that
would avail of this form of ﬁnancing.
These factors may determine how similar the cohort of businesses seeking crowdfunding will be
to those seeking risk capital in general. By extension, this will impact on how likely crowdfunding
returns may mirror those of other risk capital providers.
Box 3: Case study of WakaWaka light – crowdfunding socially focused ventures
1.5 billion of the poorest people on the planet have no access to a safe and affordable source
of light. This is the problem Maurits Groen and Camille Van Gestel set out to tackle with
their business WakaWaka light. Their product, a highly efﬁcient solar–powered LED light for
use in developing countries is designed to be more cost–effective and efﬁcient than other
solar–powered alternatives and aims to reduce the use of highly toxic kerosene lamps that
are the current norm. Having already committed a signiﬁcant amount of their own capital to
the business, they successfully raised just under €50,000 from reward–based crowdfunding
platform Kickstarter. But needing further capital to get production moving they approached
Dutch crowdfunding platform Symbid.
In just over two months they successfully raised €75,000 from 320 investors for a 2.5 per
cent stake in the business. Investors contributed a wide range of investment amounts from
as little as €20. The average investment was €234. Founder Maurits said the main attraction
of crowdfunding was that they could access investors that shared their vision of tackling the
social problem and were not solely focused on making a proﬁt. As part of their campaign
they did not make the IP around the design of the light public but he was not overly
concerned about security as solving the wider social problem was more of an aim than
capturing market share.
21 THE VENTURE CROWD Crowdfunding equity investment into business
THE CROWDFUNDING MODEL
FACES SEVERAL CHALLENGES
4.1. The regulatory environment
Regulation in the area of issuing securities to the public has been the biggest barrier in the growth
of crowdfunded equity to date. By its very nature, risk capital investing in young businesses
involves the potential that investors may lose part or all of their money. Crucial decisions in relation
to due diligence (including vetting for fraud), the setting of valuations, information veriﬁcation
and input to the governance of the venture, often need to be made in the absence of important
information that is usually available for more mature ventures. Currently, those engaged in equity
investing in young companies such as venture capitalists or business angels, have experience of
both management of these types of ventures and knowledge relevant to the speciﬁc sectors or
technology. The natural worry from a regulatory point of view is that a lack of experience of non–
professional investors may lead to investments made into fraudulent businesses or in businesses
that, although genuine in their intentions, have little chance of success.
The current regulation relates to equity crowdfunding primarily in two respects. One is the
promotion of a share offering and the other is the offering itself.
At present, the regulation states that a company must not promote a share offering to
people in order to engage in investment activity unless, either:
(i) they produce a prospectus which is approved by an authorised person; or
(ii) they offer the shares only to exempt persons.
The most common examples of ‘exempt persons’ mentioned above are high–net–worth
individuals/sophisticated investors or investment professionals such as business angels of
venture capitalists. There is an exemption to the rule requiring an ofﬁcial prospectus for those
raises of less than €5 million
but even for these, the promotion needs to be approved by an
FSA authorised person
who requires it to meet near–prospectus standards and have much
of the same costs associated. Darren Westlake, founder of UK platform Crowdcube estimates
that meeting the standards for approval can cost anything from £20,000 to £100,000.
The second aspect in relation to the underwriting of the shares is where private companies
can only offer shares to individuals who have a ‘private concern’ in receiving it, loosely
meaning that they have some relationship with the business.
22 THE VENTURE CROWD Crowdfunding equity investment into business
Box 4: The current regulatory environment
Similar legislation is found worldwide and it has forced platforms to operate a variety of
different models to facilitate equity crowdfunding. Some, like French platform Wiseed, allow
investors to take a stake in a dedicated vehicle that takes an equity share in the business.
Crowdcube currently requires both the business and investor to join a limited company for
the period of investment. But regulators in the UK are moving to create a framework where
funding can be facilitated under their supervision. Seedrs will be launched with oversight by
the FSA, but only after a very long authorisation process.
BrewDog, Scotland’s largest independent brewery was one of the very few companies that
raised money via the crowdfunding model before online platforms popped up to facilitate
the process and reduce the costs. To secure the capital needed to grow their young business,
the co–founders decided instead of seeking funds from more traditional sources to leverage
the growing fan–base of the brewery and raise money from the crowd. In 2009 and again
in 2011 they issued FSA approved share offerings that raised £750,000 and £2.2 million
respectively. The second and most ambitious of their ‘Equity for Punks’ campaigns raised
capital from almost 6,000 investors with an average contribution of £372.
It cost Brewdog around £150k to set up the scheme in compliance with FSA regulations.
This was spent on auditing accounts, legal veriﬁcation of prospectus, authorised person
under section 21 of the Financial Services Act and a receiving agent. Crowdfunding could,
depending on the amount of capital a company is seeking to raise, offer a much more cost
effective way of raising funds. While, CEO James Watt likes the model of sourcing capital
from fans, he points out that it is extremely important to ensure that crowdfunding raises are
Barriers also exist in the US but these will, to an extent, be removed once the JOBS act
was passed in April 2012 comes into effect at the beginning of 2013. The change allows for
individuals to invest the greater of $100,000 or 10 per cent of their annual income or net worth
($2,000 or 5 per cent for those with net worth of annual income less than $100,000) into
privately held businesses. Businesses can raise a maximum of $1 million and must do so through
a ‘funding portal’ which is subject to SEC supervision.
Box 5: Case study of Brewdog’s ‘Equity for punks’
23 THE VENTURE CROWD Crowdfunding equity investment into business
The remainder of this report seeks to identify the potential beneﬁts of, and concerns about,
the equity crowdfunding model. It aims to inform entrepreneurs and investors interested
in participating in the model and also policymakers considering regulation in the area and
4.2. Challenges with operating the model
4.2.1. Setting valuations
As mentioned previously, one of the ﬁrst stages in the crowdfunding process requires setting
a valuation for the company so the entrepreneurs can decide how much equity to offer for
the amount of capital they are seeking to raise. This is an important part of the process, as it is
necessary to ensure that the entrepreneur gets a fair valuation for their business while ensuring
shares are not too expensive. But the difﬁculty in estimating the value of a company must not
Much of the assets held by the business may be in the form of intellectual
property and valuations are largely based on risky predictions of future market size, competition,
revenue and other variables.
The most common practice on crowdfunding platforms is for entrepreneurs to set the valuations
themselves based on what they perceive the business to be worth. However, should they get this
valuation wrong it may have a signiﬁcant, adverse affect on the entire fundraising. A mechanism
used by some platforms, that attempts to overcome this valuation problem, is to allow upward
ﬂexibility in the amount of equity that is being offered, as the fundraising progresses. In this way
the entrepreneur can increase the amount of equity that is being offered if they think the rate
of investment to that point is indicating that they may not reach the target before the deadline.
Alternatively they may have received feedback from investors that they think the venture is over–
valued. Any increase in the equity would also apply to those that had invested before the change
with their equity stake increasing too.
Other, more innovative methods of setting valuations are also possible. Innovestment,
platform, operates a market–driven approach to setting valuation. The entrepreneurs set out the
amount of equity and number of shares they are offering and investors bid for the shares with
those investors willing to pay the most for the shares getting in on the deal. A reversal of this
could also work with investors bidding down the amount of equity they are willing to take at a
ﬁxed investment amount, thus avoiding the business raising more capital than it needs. There are
some issues with this model also. Auction theory literature
indicates that by construction those
who win in this dynamic pay more than the larger pool of bidders believe the item, in this case
business, is worth and thus may be overpaying.
Another practical move is to ensure entrepreneurs are educated about how to value their
businesses. UK platform BankToTheFuture addresses this by offering training to entrepreneurs
from ex–investment bankers, fund managers and venture capitalists. Platforms could also explore
the potential of allowing entrepreneurs to benchmark their valuations against other similar
businesses raising funds on the platform.
Flexibility around setting valuations is essential for very early–stage businesses and allowing
the equity stake to be increased or bid for seem sensible approaches. However, just as there are
implications for entrepreneurs of offering too little equity, entrepreneurs and investors also need
to be aware of the consequences of offering too much equity such as its effect on the business’s
ability to secure follow–on ﬁnancing.
24 THE VENTURE CROWD Crowdfunding equity investment into business
4.2.2. Fraud detection, selecting businesses and the wisdom of crowds
One of the main concerns about crowdfunding equity is that funds could be taken from unwitting
investors for ventures that have no intention of creating a proﬁtable business. This fear is the one
that has been touted most
by those arguing against the easing of regulation and promotion
of the model. This is an important concern but a closer look reveals that there are a number of
safeguards in place to prevent fraud occurring.
The administrators themselves perform some level of vetting of applicants for fraud and as more
platforms enter the market the thoroughness of this will become a point of competitiveness.
Another protection is the ‘all–or–nothing’ model operated by platforms where those raising capital
only receive the money if their target is reached. One entrepreneur who raised ﬁnance through
crowdfunding, stated that the ‘all–or–nothing’ model is crucial as only if a venture has sufﬁcient
support from a number of investors does any individual investment become real. The theory
here is that the more people that have performed checks for fraud, the more likely a potentially
fraudulent proposal will be identiﬁed as such. However, this implies that potential investors
perform such checks and do not entirely rely on the fraud vetting performed by the platform. This
method of crowd vetting also only works when platforms accommodate forum discussions where
one can alert others to issues they come across when assessing the quality and validity of a given
Another protection that could be incorporated would be the introduction of a staggered release of
funds linked to milestones. This may encounter regulatory barriers as the platform may be required
to hold investors’ money for a longer period, and an administrative burden as the platforms would
need to check milestones, but it would protect a proportion of the capital from being collected by
In addition to the above, the proliferation of social media is increasing the ability for the online
measuring of people’s social creditworthiness or trustworthiness, creating tools which will become
invaluable in vetting for fraud. These types of recommendation tools
will also be extremely useful
when trying to assess the competencies and experience of the entrepreneur or the team. As Simon
Dixon, founder of platform BankToTheFuture notes, one–seventh of the world has volunteered
their data to social networks and this data tells us a lot about the true nature, inﬂuence and
identity of people. While some level of fraud may be inevitable, it has thus far been negligible.
Crowdcube, crowdfunded lender FundingCircle, peer–to–peer lender Prosper and Anglelist all
report zero fraud so far.
As the model grows, and information becomes more readily available,
fraud will become even less of an issue.
Examples of tools being developed that can be used to facilitate the
25 THE VENTURE CROWD Crowdfunding equity investment into business
The tools mentioned previously for facilitating the assessment of individuals online, also play a part
in what might be considered a more important concern, whether crowds will be able to distinguish
between good businesses and bad (non–fraudulent) ones. This closely relates to the literature
on the ability of crowds to effectively make decisions, and most notably James Surowiecki’s The
Wisdom of Crowds. His theory states that in many cases, the crowd can perform as well as or
better than a limited number of the relevant experts in the ﬁeld. This occurs when individuals from
diverse backgrounds, with expertise in different ﬁelds, bring various pools of local knowledge
together. This assessment of proposals permits all members of the community to beneﬁt from the
feedback of the individual.
As well as the tangible information that potential investors get from each other, there is also
a signalling effect, where merely the decision of individuals to invest inﬂuences the decisions
of others to follow. In the ideal scenario, each individual’s decision is inﬂuenced by his or her
own critical assessment of the proposal, based on personal knowledge and the information and
signals provided by others. However, the balance between the weights attributed to these factors
effecting the investment decision is of great importance. One of the problems with signals is that
investors may assign too much weight to them, leading to the potential of a ‘cascading’ effect or
what is termed ‘herding’.
This occurs when a smaller number of investments made in the early
stages of the funding window entice others to invest, whose investments serves as a further
incentive to even more potential investors and so on. In this way the likelihood that a venture gets
funded is overly reliant on the decisions of those few initial investors and less on the objective
analysis of the crowd as a whole. Herding is a problem with any such group–based decision
system. Practical measures such as educating investors and compelling them to perform their own
evaluation of prospects will minimize the inherit risk of such investment activities.
4.2.3. Investor types and visibility
The ability to view information about other investors could be extremely important with regards
to signalling effects. One group of investors are the people that have a personal relationship with
an individual or individuals within the business seeking ﬁnance. While for all investors there may
be some element of a non–ﬁnancial motive for investing this would be far greater amongst those
than have a personal tie to the business. Examples of non–ﬁnancial motives could be the aspiration
to support a local business or entrepreneur, to be involved with an exciting start–up technology
or social factors such as the prestige of investing in young businesses. This mix of motivations
becomes important when signals are received by the crowd. On the one hand, investments from
friends and family, if not identiﬁed as such, could be interpreted by other investors as investing
primarily based on the perceived ﬁnancial prospects of the venture. This would lead those
receiving the signals to have a positive bias on what the crowd perceives these prospects to be.
On the other hand, however, the presence of funding from friends and family can send a positive
signal in respect to the trustworthiness and ability of the entrepreneur(s) and their likelihood to
endeavour to make a return for investors. These signals may offer reassurances to ‘strange to
the entrepreneur’ investors who are worried how committed the entrepreneur is to making the
business a success. For both reasons it is to the beneﬁt of the model to ensure such investments
are transparent, so all investors can accurately judge the signals they receive. These signals are
also important for those raising capital who may want to deviate from the traditional strategy of
raising money from friends and family before seeking external capital and instead ‘save’ them for a
Evidence from some of the few platforms currently operating in the area indicates that high–
net–worth or sophisticated investors also invest via crowdfunding. Symbid says about 30 per
cent of their investment comes from accredited investors. Aernoud Dekker, who sourced capital
for his business SellAnApp through crowdfunding, raised two–thirds of his target amount from
26 THE VENTURE CROWD Crowdfunding equity investment into business
professional investors. The presence of these investors may have a signiﬁcant bearing on the
ability of the crowd to select the best businesses and also perhaps which types of ventures they
may be able to evaluate. Investment received from a professional investor, if identiﬁed as such,
would serve as a strong signal as to the prospects of the venture.
Recognising the presence of different types of investors can make crowdfunding operate more
effectively. A future version of the model may consider having a mechanism that applies weights
to the judgement of a given investor, depending on their expertise, experience of making
investments, track record on the site etc., while allowing investors to remain anonymous. In this
way signals from investors become far more accurate and decisions are less likely to be inﬂuenced
by investors making poor decisions. The crowd itself can be used to reﬁne the weights assigned
to investors by capturing the crowd’s rating of an investor’s contributions to forums discussing a
4.2.4. The potential for co–investment with professional investors
Some of the business angels and venture capitalists consulted for the report believe that the
participation of experienced investors should be a necessary element of crowdfunding which
offers protection for the non–sophisticated investors. This co–investment model between
professional and amateur investors (or crowdfunders) is one that is worth exploring further.
Professional investors bring expertise across a range of factors that contribute to an investment
decision therefore ensuring there are no knowledge gaps in the crowd. However, the challenge for
platforms will be to incentivise them to participate in the model.
A business angel and venture capitalist commented that deals tend to ﬁnd business angels rather
than angels seeking out businesses. His assertion that many deals are found via introductions
from people in their network highlights that knowing entrepreneurs is of paramount importance
and that investing in people who are (at least initially) strangers through a platform may be
unappealing. Another investor said he would be unlikely to want to invest through a system that
charges a fee when he could do so ofﬂine for free. He did, however, think a crowdfunding model
might have potential as a source of top–up funding to a round being completed by accredited
investors ofﬂine. Belgian platform MyMicroInvest
offers a similar model to this, in which
professional investors invest ﬁrst with the crowd then having the opportunity to contribute 20–50
per cent of the total round amount afterwards.
This allows the angel investors to control the
amount of crowd participation and to avoid situations where their investment could be followed by
a lot of crowd money.
Any co–investment activity faces additional challenges. One is ‘investment terms’ as professional
investors will likely want to be rewarded for the time they put into evaluating and supporting a
venture and may be unwilling to invest on the same terms as the crowd. Another challenge is the
ability of syndicate partners to provide follow–on ﬁnancing. Crowdfunding may not be deemed
attractive in this regard unless it has the potential to provide more capital if the business needs
it in the future. Platforms tailored speciﬁcally for sophisticated investors may also hinder any co–
investment as crowdfunding platforms compete with these for investors.
But on the plus side, doing angel rounds can be quite time consuming and expensive on admin
and legal costs. Crowdfunding offers a streamlined alternative and the option of an investment
process that cuts on transaction costs would be attractive. The non–ﬁnancial beneﬁts businesses
can receive from crowdfunding may also be an attraction for professional investors as they seek to
use the crowd to gain traction or feedback for the business.
27 THE VENTURE CROWD Crowdfunding equity investment into business
It should, however, be pointed out that the polarisation of professional and amateur investors
used to outline the issues above does not present an accurate composition of the crowd. The
sophistication of investors will likely be on more of a spectrum. Jeff Lynn states that Seedrs hope
to target the so–called ‘mass afﬂuent’, those who have signiﬁcant wealth without being business
angels. He refers to people like small business owners or middle managers in large corporations
that while not professional investors are far from being naive about the realities of what makes
a good or bad business. Not only would these people have a better chance of knowing the
difference between good and bad businesses, they may also be better at collaborating and would
potentially be seen as more desirable syndicate partners by larger investors.
The participation of professional investors provides signiﬁcant beneﬁts to the crowd investors. As
these investors have the opportunity to invest outside of the crowdfunding mechanism, platforms
may need to think of how to incentivise their participation and overcome some of the problems
outlined above. Low cost and ease of use should be selling points, using tools such as standardised
terms sheets and streamlined due diligence processes that will allow larger investors to take more
and smaller bets on businesses if they wish. Platforms also need to convey to large investors the
beneﬁts the crowd can give to the business.
4.2.5. Post–investment support and business governance
Research by Sorensen (2007)
on venture capital investments showed that post–investment
support was almost twice as important as selection when explaining the likelihood that
a business becomes successful or not. One venture capitalist identiﬁed the provision of
corporate governance, an integral element of the support given to businesses, as an area where
crowdfunding could face challenges. Again, in theory, the crowd could perform well for some
types of post–investment support. Raisers of crowdfunding will have access to many individuals
feeding in their opinions on the business and will need to ﬁnd an effective way of capturing and
using these. They also have the opportunity to harness the mass marketing power of the crowd
and other beneﬁts of this large network. In practice however, this may only work, or at least work
best, for some types of businesses. Those producing consumer facing products and services
for example may get signiﬁcant beneﬁt with investors providing active feedback as users of
the product or service. This, however, depends on the extent to which investors engage with
businesses and investors’ small stakes may mean they chose to remain quite passive.
How much of any potential feedback is actually taken on board may depend on the inﬂuence
crowd investors will have on the ongoing management of the business. The few platforms
currently in operation offer a variety of different ways of managing investor involvement after the
investment has taken place. While all investors can contact the entrepreneurs, some platforms
also allow for even small shareholders to have a voting share in the business. Crowdcube allows
entrepreneurs to set an investment amount above which investors get voting shares. Dutch
platform Symbid allows all investors to have a voting share in a co–operative entity that then
manages the interests of the group. Another option is the nominee–management model operated
by Seedrs, where the platform manages the corporate governance and other post–investment
issues for the investors.
There are arguments for and against awarding voting rights to small investors, which one
entrepreneur who raised crowdfunding for his business, describes as one of the more difﬁcult
aspects in relation to the model. One of the main justiﬁcations against issuing voting rights is
that the practicalities of managing that many voters would be quite cumbersome and may lead
to inertia in the decision making process, especially in cases where the founder does not hold a
majority stake in the business. Not giving the small investors voting rights overcomes these issues
but may leave the investors vulnerable once their investment is made, for example they may be
open to excessive dilution of their equity stake in later rounds of funding.
28 THE VENTURE CROWD Crowdfunding equity investment into business
The nominee approach overcomes this problem but the success of investments is then partially
reliant on the abilities of the nominees to manage the investors’ interests. One experienced venture
capitalist believes building good reputations will be key for crowdfunding platforms if they are
hoping to get more sophisticated investors to get involved with them.
There is a lot of room for innovation around how investor interests and interaction with
entrepreneurs can be efﬁciently managed. While it is important to ensure that the burden on
entrepreneurs in dealing with investors is not too much and that businesses remain attractive to
follow–on investors, small investors’ interests need to be protected once the round has closed.
4.2.6 Consequences of openness
For the crowd to make judgements on whether or not to invest in a given venture, they will
need to be privy to the full details of the company’s ﬁnancial performance, business plan and
other relevant information. How willing entrepreneurs are to open this information to the public
could be another limiting factor in the growth of crowdfunding equity. In certain instances,
entrepreneurs may fear that their ideas could be copied or that competitors may use the details
of their ﬁnances and IP to their advantage. Actual evidence to what extent these are real problems
and perhaps more importantly to what extent entrepreneurs perceive them as being problems is
scarce. However, what is clear is that the risks will vary greatly dependent on how sensitive such
information is. One way of overcoming this is to offer entrepreneurs the option to require investors
to sign non–disclosure agreements (NDAs).
Seedrs offers this option to businesses but founder
Jeff Lynn believes the need for NDAs will be quite rare. Only one of the ﬁrst 20 submissions it has
received to date has asked for NDAs to be part of their fundraising. As one entrepreneur we spoke
to pointed out, the execution of an idea tends to be far more important than the idea itself.
The platforms themselves may also fall victim to potentially negative consequences of openness. If
businesses seeking funding are allowed to upload their plans to the platform without an obligation
to accept the ﬁnancing they raise through the platform, platforms may be susceptible to investors
shopping for businesses on their sites and transacting with them ofﬂine. In this way they avoid
paying the commission charged by the platform. Although currently business angels tend to be
sought out rather than seek out deals, as crowdfunding grows this could become an issue.
Finally, investors themselves may be exploited if they feel they are contributing disproportionately
to the development of a given venture but not receiving what they believe are suitable rewards
for their contributions. This may not be a big issue in the immediate future but more sophisticated
iterations may want to create a system where investors can be rewarded and incentivised to
contribute above and beyond what would be representative of their ﬁnancial interest in the
venture. A potential reward that entrepreneurs could give to those who contribute signiﬁcant
amounts of time and effort to the business is the option to invest in a later round at a discount.
For entrepreneurs the ﬁrst step is to decide to what extent openness is likely to be a hindrance to
participating in crowdfunding. Once established, if this is believed to be a signiﬁcant worry, efforts
need to be made to either protect IP that is made public on platforms or to enable a system
where one can seek investment from the public while not sharing excessive amounts of sensitive
information. NDAs are one option but will add an extra administrative cost to the model. Co–
ordination across platforms will aid the identifying and exclusion of those investors that are using
platforms to ‘poach’ investment opportunities.
29 THE VENTURE CROWD Crowdfunding equity investment into business
4.3. Potential returns from crowdfunding
Equity crowdfunding is a very new model and therefore no data on returns to investors is currently
available. However, for crowdfunding to become a viable model, investors will need to make a
return large enough to encourage participation in the market and the bearing of the risk inherent
with these ventures. This return can be ﬁnancial or non–ﬁnancial but given that the non–ﬁnancial
returns that some businesses can offer may be limited, and that many investors, especially larger
ones, will likely invest primarily for ﬁnancial reasons, the potential of the model to deliver ﬁnancial
returns is an important issue.
To put into perspective the level of returns that the model could generate, it is useful to consider
other forms of risk capital. Since the dot.com boom, despite top quartile funds performing well,
the venture capital market as a whole has generated relatively poor returns.
There is some
evidence to suggest that business angels have been faring better
but unlike VC returns these
do not incorporate the cost of the investors’ time and effort. Another relevant comparison is
with the FTSE AIM index of small and growing businesses, which has lost 25 per cent – including
dividends – since inception in 1995.
These show that while the potential to make generous
returns is present, the risks associated with this type of investment mean that signiﬁcant losses
are also a real possibility. The main source of this risk is the majority of new businesses that fail,
and a potential worry with the crowdfunding model is that non–professional investors may not
appreciate just how many. Nesta data shows that only 40 per cent of businesses are still alive after
their ﬁrst ten years and less than 10 per cent of these achieve signiﬁcant growth in employment.
Source: (2011) ‘Vital Growth: the importance of high–growth businesses to the recovery.’ London: NESTA.
All businesses that
started with at least
survived to 2008
Survivors with ten or
more employees in 2008
Survivors that achieved at
least one year of high growth
30 THE VENTURE CROWD Crowdfunding equity investment into business
Schemes currently being run by the Government to incentivise investing into young businesses
can bolster the real returns investors can attain. The Enterprise Investment Scheme(EIS)
Seed Enterprise Investment Scheme (SEIS)
allow investors to claim tax relief on investments
made into qualifying businesses, including those investing through crowdfunding. The latter allow
investors to write off 50 per cent of the amount of an investment into a qualifying seed company
against their tax liability while the EIS offers a smaller beneﬁt for investments into more developed
qualifying businesses. So even if the investors’ were to just break even or perhaps even make a
small loss on their investment, crowdfunding may still prove an attractive prospect if the business
qualiﬁed for the scheme. Take up of relief has already started and Crowdcube has facilitated
investment into EIS and SEIS qualiﬁed businesses. HM Treasury has also made efforts in recent
times to simplify the process of claiming such relief.
The ability to provide follow–on investment to businesses may also affect the returns that
crowdfunding can deliver. A strategy commonly employed by business angels and venture
capitalists is to invest in a few businesses at early stages of their development and use this access
to pump more money into the businesses that do well. In many cases these one or two businesses
will receive the majority of the investors’ contributions and will deliver the bulk of the returns.
Equity crowdfunders may not be able to do this, either because they are not aware of the strategy,
may not have the knowledge to identify those businesses that are doing well, or not have the
opportunity to participate in follow–on rounds.
Equity investing is long–term illiquid investing and potential crowdfunders need to be very aware
of this. Unlike the reward model where returns are received quickly, equity investors may have
to wait ﬁve to ten years for a return. Many operators have expressed the intention of providing
investors access to a secondary market in the future to increase liquidity. As independent
secondary markets such as Secondmarket
grow, they may also facilitate the
trading of shares either independently or through partnerships with platforms allowing investors
to buy and sell stakes after the round is raised.
Platforms need to ensure that investors are adequately informed of the risks involved in investing
in businesses for equity. One experienced venture capital investor noted that over–optimism on
the part of amateur investors could be one of the greatest barriers to ensuring the success of
31 THE VENTURE CROWD Crowdfunding equity investment into business
THE FUTURE FOR THE MODEL
As many of the platform operators that were consulted pointed out, the model for facilitating
crowdfunding equity will continue to iterate as more information on how it functions in practice
becomes available. There is signiﬁcant scope to incorporate further innovation in what is a fast–
growing area. An advantage crowdfunding has over other forms of ﬁnance is that the process is
facilitated largely, if not entirely, online. This should spur the harnessing of other online tools that
can help increase the connectivity of the crowd and make the most of the networks that the model
allows entrepreneurs access to.
One direction the model could take is the application of equity crowdfunding to more specialised
sectors. Just as the reward model has platforms that target speciﬁc niches such as artists raising
money for a record release
or a game development,
equity crowdfunding platforms may decide
to focus on software development or consumer goods. Another evolution could be the emergence
of hybrid models that incorporate other forms of crowdfunding. BankToTheFuture
aims to allow
businesses to raise a round combining reward–based crowdfunding and equity ﬁnance. It then
hopes to use the information gathered from businesses during this process to offer crowdfunded
lending once the business starts to generate revenue. Tying crowdfunding closer to other funding
innovations such as accelerators is another potential option that should be explored.
This is the ﬁrst attempt to present the equity crowdfunding model in detail and gives some further
food for thought. The success of reward–based crowdfunding offers the hope that the application
of the model to equity investing can funnel much–needed capital towards innovative ventures.
As illustrated in this report, equity crowdfuding faces many challenges and will need to continue
to adapt if it is to prove a viable model for investors and businesses. Some recommendations for
consideration by key stakeholders are outlined below.
From investors: Equity crowdfunding offers the opportunity for individuals to be a part of an
entrepreneurial venture, an exciting prospect that was up to now reserved for a small population
of professional and institutional investors. Those investing largely, or entirely for ﬁnancial
returns need to be aware of the risks involved in equity investing in young businesses and that
many businesses will be unsuccessful and fail to make any money for investors. As part of their
evaluation of businesses, investors need to make use of all of the tools and knowledge available
to them. Interacting with the entrepreneur and fellow investors will assist with the unearthing of
all of the necessary information and help in the performing of effective collaborative evaluation of
For platforms: The success of the model will largely be dependent on platform operators’ ability to
continually iterate as more information and tools become available to them. They need to innovate
to assist business to deliver returns, ﬁnancial or otherwise, to investors as well as to make sure
the model can be an aid to the growth of the businesses it serves. Difﬁcult tasks such as vetting
for fraud and assisting investors in choosing the best businesses will need the assistance of other
online tools that can help them evaluate entrepreneurs, ideas and markets. As these become more
sophisticated, platforms need to incorporate them into their process.
A more developed model could also assist investors with harnessing the knowledge of the crowd
to make decisions. Transparency around investors would allow people to accurately interpret
32 THE VENTURE CROWD Crowdfunding equity investment into business
the signals received by investment from other investors which may be important when there are
investors with varying levels and types of expertise, and different motivations for investing.
Larger and experienced investors would bring value to the process, especially in the model’s
early stages, if they could be enticed to participate. Larger investors will also allow the model to
deliver larger amounts of funding. Platforms need to demonstrate the value of the model to these
investors, highlighting where they provide value such as a streamlined process and the ability to
make more and smaller bets. Platform credibility will be another important factor to help attract
a good pipeline of businesses seeking ﬁnance and to make businesses attractive for follow–on
For businesses: Businesses need to be aware of the beneﬁts and limitations of raising equity
crowdfunding when deciding if the model is suitable for them. While there are beneﬁts such as the
opportunity to leverage the ability to give rewards to raise ﬁnance and the advantage of accessing
a large number of advocates, businesses need to consider if these beneﬁts will be signiﬁcantly
important to them.
Interacting with the business through the funding process is of critical importance to investors.
Entrepreneurs need to keep investors engaged to ensure they maximise the beneﬁt of having
access to the crowd.
For policymakers/regulators: The current regulatory model requires platforms to go through a
lengthy process to become authorised by the FSA, such as Seedrs’ experience, or alternatively
to require platforms to set up administratively cumbersome constructs to facilitate fundraising.
Should regulation be eased, following the US example, is one approach but not necessarily the
best one. Darren Westlake of Crowdcube points out that the limits in the US legislation on what
can be raised and invested are quite small and any UK version should consider increasing them.
Seedrs founder Jeff Lynn comments the current UK approach is superior as it ensures that
platforms offer greater protection to investors post–investment.
While the protection offered by the UK regulation may be better, the process for allowing
platforms to gain accreditation needs to be improved. Once regulators have developed a clearer
view on how the model works, guidelines on what the requirements are to gain accreditation
should be made public and efforts made to speed up the process. All platform operators consulted
in this study, agree that clear and deﬁned supervision of activities in the area will go a long way to
improving investor conﬁdence in committing capital to business through the model and will also
increase the number of businesses willing to raise this type of ﬁnance. As this is quite a new model
of ﬁnance, it is important that those providing oversight are sufﬁciently knowledgeable of the
nuances of the model and the protections that are required for investors.
Tax incentives are a useful tool to funnel more capital towards innovative business but it is
important for policymakers to take account of how these work in crowdfunding. Important
considerations include how effective the equity crowdfunding model is at ﬁnding the best business
and how tax reliefs impact the behaviour of crowd investors as opposed to the sophisticated
investors the scheme was set up to incentivise. Another important issue is the practicalities of
As this is a new model with limited data on its operation available to date, many questions still
remain unanswered and are potential topics for future research. These include:
How effective is the crowd at evaluating the potential of young businesses?
What types of businesses does the model work best for?
33 THE VENTURE CROWD Crowdfunding equity investment into business
What is the balance between the ﬁnancial and non-ﬁnancial motivations of equity
crowdfunders and how does this affect the operation of the model?
What ranges of funding can equity crowdfunding raise for businesses?
What levels of returns can equity crowdfunding deliver?
What are the best ways of harnessing the crowd of investors to assist with the businesses
How successful are businesses at raising follow-on capital after crowdfunding?
1. Lambert, T. and Schwienbacher, A. (2010) ‘An empirical analysis of Crowdfunding.’ Louvain–l a–Neuve : Louvain School of Management, Catholic University of Louvai n.
3. Kickstarter Is On Track to Out–Fund the National Endowment for the Arts. http://www.popsci.com/technology/article/2012–02/kickstarter–track–out–fund–
4. Accredited investors, also referred to as professional or sophisticated investors in this report, are those that have experience of investing large amounts of capital
into unlisted young businesses.
8. This is representative of the most common process. All platforms operate their own variation of the model.
9. Interview with Darren Westlake, Founder, CrowdCube.
10. In many cases contributions largely come from people in your network. Slava Rubin of the world’s second largest reward–based platform IndieGoGo states that
only 20 per cent of contributions come from complete strangers. See: http://www.readwriteweb.com/start/2012/04/jobs–act–fallout–making–crowdf.php
Due to the fact that equity crowdfunding offers the potential for proﬁt it is more likely investors will actively seek out investment opportunities.
11. For more information on the speciﬁcs of how the transactions are handled see: De Buysere, K. (2012) ‘Venture capital 2.0: Obstacles in using the internet for
equity raise campaigns.’ Tilburg University (working paper).
12. An escrow is an arrangement made under contractual provisions between transacting parties, whereby an independent trusted third party receives and disburses
money and/or documents for the transacting parties, with the timing of such disbursement by the third party dependent on the fulﬁlment of contractually–
agreed conditions by the transacting parties, or an account established by a broker, under the provisions of license law, for the purpose of holding funds on
behalf of the broker’s principal or some other person until the consummation or termination of a transaction. See: http://www.wikipedia.org
13. The table includes data for the most visible platforms currently active as of May 2012 and those soon to be launching in the UK. For more information, see the
14. Venture capital deals, see: (2011) ‘BVCA Private Equity and Venture Capital Report on Investment Activity 2011.’ London: BVCA. http://admin.bvca.co.uk/
15. BIS (2009) ‘Annual report on the business angel market in the United Kingdom.’ London: BIS. See: http://www.bis.gov.uk/assets/biscore/enterprise/
16. BIS (2010) ‘Annual report on the business angel market in the United Kingdom.’ London: BIS. See: http://www.bis.gov.uk/assets/biscore/enterprise/
17. Miller, P. and Bound, K. (2011) ‘The Startup Factories: The rise of accelerator programmes to support new technology ventures.’ London: NESTA.
18. Equity gaps will vary by sector. The diagram is a representation of the most common areas where businesses ﬁnd it difﬁcult to source ﬁnancing.
19. NESTA, BVCA (2009) ‘From funding gaps to thin markets: UK Government support for early–stage venture capital.’ London: NESTA.
20. Scottish Enterprise(2008) ‘Evaluation of the Scottish Co–Investment Fund: a report to Scottish Enterprise.’ Glasgow: Scottish Enterprise. See: http://www.
21. Miller, P. and Bound, K. (2011) ‘The Startup Factories: The rise of accelerator programmes to support new technology ventures.’ London: NESTA.
22. Although crowdfunding decreases the cost of raising equity capital, legal fees are still present and can run into the thousands. Martijn Arets who ran the ﬁrst
equity crowdfunding campaign on Symbid says that legal fees make the model impractical for those raising very small amounts.
23. In late 2011 The Rushmore Group raised £1 million pounds through crowdfunding platform Crowdcube. See: http://www.crowdcube.com/investment/the–
24. Gompers, P., Kovner, A., Lerner, J. and Scharfstein , D. (2010) Performance Persistence in Entrepreneurship. ‘Journal of Financial Economics.’ 96 pp: 18–32.
34 THE VENTURE CROWD Crowdfunding equity investment into business
25. Zurutskie, R. (2008) The Role of Top Management Team Human Capital in Venture Capital Markets: Evidence from First–Time Funds. ‘Journal of Business
Venturing.’ 25, 155–172.
26. UK Financial Services and Markets Act 2000, c.8 Part II, 21 (Financial Promotion).
27. EU Prospective Directives 2010/73EU and 2003/71/EC.
28. UK Financial Services and Markets Act 2000, c.8 Part II, 21 (Financial Promotion).
30. Zacharakis, A., and Meyer, D. (2000) The Potential of Actuarial Decision Models: Can They Improve the Venture Capital Investment Decision? ‘ Journal of
Business Venturing.’ 15, pp. 323–346.
32. Thaler, R. H. (1988) Anomalies: The Winner’s Curse. ‘Journal of Economic Perspectives.’ 2 (1): 191–202.
33. Forbes (2012) ‘Crowdfunding,The JOBS Act And Scams In You r Inbox.’ See: http://www.forbes.com/sites/johnwasik/2012/03/23/potential–and–obvious–scams/
and JOBS Act becomes law, but questions linger about potential for fraud.
34. Examples of theses include the recommendation function in LinkedIn, eBay seller ratings, Klout, (for measuring inﬂuence) and Kred.
35. Although some of these are different models to equity crowdfunding they are the most similar in the market in regards to susceptibility to fraud.
36. US Senate Committee hearing. See: http://banking.senate.gov/public/index.cfm?FuseAction=Files.View&FileStore_id=395de986–77d8–45f6–886d–
37. Baddeley, M. (2010) Herding, social inﬂuence and economic decision–making: socio–psychological and neuroscientiﬁc analyses. ‘Phil. Tra ns. R. Soc.’ B 365, 281–290.
38. A similar model was used by the platform VenC or ps (ceas ed operation December 2011) where participants receive rewards for their contribution to investment decisions.
40. The crowd votes on pitches to select those businesses that are to be evaluated by the professional investors. The professional investors then select businesses to
invest in from these, allowing the crowd to invest also and on the same terms.
41. Sorensen, M. (2007) How Smart Is Smart Money? A Two–Sided Matching Model of Venture Capital. ‘The Journal of Finance.’ Vol. 62, Issue 6 pp 2725–2762.
42. A non–disclosure agreement (NDA), also known as a conﬁdentiality agreement (CA), conﬁdential disclosure agreement (CDA), proprietary information agreement
(PIA), or secrecy agreement, is a legal contract between at least two parties that outlines conﬁdential material, knowledge, or information that the parties wish
to share with one another for certain purposes, but wish to restrict access to or by third parties. It is a contract through which the parties agree not to disclose
information covered by the agreement. See: http://www.wikipedia.org
43. Lerner, J., Pierrakis, Y., Collins, L. and Bravo–Biosca, A. (2011) ‘Atlantic Drift: Venture capital performance in the UK and the US.’ London: NESTA.
44. Wiltbank, R.E.(2009) ‘Siding with the angels: Business angel investing – promising outcomes and effective strategies.’ London: NESTA.
45. Why AIM shares underperform. See: http://www.investorschronicle.co.uk/2011/10/24/comment/chris–dillow/why–aim–shares–underperform–
46. NESTA (2011) ‘Vital Growth: The importance of high–growth businesses to the recovery.’ London: NESTA. It should be noted that this data is for all business
start–ups and some of these would unlikely be suited to raising crowdfunded equity e.g. very capital intensive businesses, corner shops. Also, those that were
acquired are not included in the count of businesses that survived.
47. For more information see: www.hmrc.gov.uk/eis/
48. For more information see: http://www.hm–treasury.gov.uk/d/seed_enterprise_investment_scheme.pdf
35 THE VENTURE CROWD Crowdfunding equity investment into business
FINANCIAL PLANNERS AS CATALYSTS FOR SOCIAL INVESTMENT 35
36 THE VENTURE CROWD Crowdfunding equity investment into business
1 Plough Place
London EC4A 1DE
Nesta Operating Company. English charity no. 7706036. Scottish charity no. SC042833.
9 7 8 1 8 4 8 7 5 1 3 8 5