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January 9, 2017

#Fintech: Seedrs + Equity Crowdfunding

crowdfunding

Equity crowdfunding is a key pillar in the creation of a new, more balanced global economy. In pure equity crowdfunding, companies can raise capital from a mix of non-accredited and accredited investors; with Seedrs, for example, investors across Europe can invest as little as £10 into a company for a legally-binding equity share. In other jurisdictions, investors must be accredited and regulations are much more patchwork.

Globally, the equity crowdfunding market is highly fragmented due to different regulatory environments and low penetration in developing markets, but is expected to grow significantly over the next decaded, with a CAGR (cumulative annual growth rate) of 26.9% globally.  The UK was the pioneer in equity crowdfunding, with Seedrs and Crowdcube emerging as the first platforms on the market and others such as Syndicate Room launching in later years.

equity-crowdfunding-uk

TechBullion

In the whole of 2011, only £1.6M was raised on equity crowdfunding platforms, and in early 2014 that started to scale up to £23.1M raised in the first half of the year. By the end of the year, £84M had been raised. 2015 was the year that volumes scaled exponentially, up 295% from 2014 with £332M invested on the platform (£245M excluding real-estate).  2016 marked a slowdown in volumes, potentially due to Brexit, and a shift in demand towards the dominant platforms.

Seedrs  was the first FCA (Financial Conduct Authority) approved platform in the world and launced in 2012.

 

seedrslogo

 

The product of years of groundwork by Jeff Lynn and Carlos Silva, the platform has revolutionized startup financing in the UK and across Europe.  Recently, in October of 2016, Seedrs broke a record for money moving through the platform:

“We broke all sorts of records this month, with nearly £20 million invested into campaigns on the platform.” Crowdfunding Insider

There are several reasons for Seedr’s success – rules-based regulation, nominee legal structure, SEIS tax incentives, investor support, UK startup ecosystem – but in the end, the impressive part of Seedrs is their execution of a model that has empowered the crowd and created a true community spirit around startup investing.

invest-in-businesses-you-believe-in

The Seedrs platform is beautifully designed, has a constant stream of high-quality live deals, and most importantly, let’s the crowd decide what should be invested in, not the ‘experts.’  Seedrs gets an excellent diversity across multiple sectors, and judging by their recent report on their return data, it appears to be an approach that works for investors as well:

  • 375 deals have been completed across 15 diverse sectors.
  • Platform-wide 14.4% non-tax-adjusted IRR (tax-adjusted: 49.1%).
  • Investors with portfolios of 10+ investments have, on average, outperformed investors with fewer

Portfolio Update

A look at three current live deals shows a tech company, a medtech company, and an ice cream company.

seedrs-live-deals

Sandbox + Rules-Based Regulation

Back in 2012, equity crowdfunding was pure hype. It was a big idea, fueled by the JOBS Act in the US, that required rewriting securities laws to be executed; while it took vision from the founders of platforms Seedrs + Crowdcube, it also took a lot of insight and gumption from the UK regulator, the FCA.  What did they do differently?

They sandboxed the regulatory system for a small group of platforms and applied a rules-based approach. At Seedr’s inception, companies could only raise up to £150K on the platform and investors were capped based on their income:

“With a £10 minimum investment, we saw no reason why someone’s net worth was relevant; and because these were not particularly complicated investments (even a basic mortgage or insurance policy is more complex than shares of a company), prior investing experience also did not seem very relevant to us.” Why Britain is Beating the US at Financial Innovation

The SEC (Securities and Exchange Commission) in the US, on the other hand, relies on a legal approach based on an archaic interpretation of finance where only wealthy people (ie. accredited investors) have the experience to make investments, regardless of the size that the investment is:

“Now consider the American approach. U.S. law has no principle about making sure investors understand the risks. Instead, there was a bright-line rule that says that unless an investor is wealthy (exceeding specified income and net worth tests), then with very limited exceptions, he or she cannot be offered shares in private companies. There is no exercise of judgment, no flexibility for the regulator (the Securities and Exchange Commission, or SEC) to make a case-by-case call.” Why Britain is Beating the US at Financial Innovation

The UK has blown the US out of the water in the equity crowdfunding market, one only needs to take the Tube in London and see campaign ads for Seedrs or Crowdcube to see the potential.  In the US, this lack of momentum has even led founders of platforms to declare that ‘equity crowdfunding is dead.

SEIS Tax Incentives

SEIS (Seed Enterprise Investment Scheme) was written about in depth on the original Lumos blog.

“SEIS incentivizes investors to invest in seed-stage enterprises (< £200,000 in assets) by reducing a majority of their risk. They get an instant 50% tax credit, a potential future capital gains exemption of 28.5% and the ability to write off an additional percentage of the investment if it becomes a loss. While there are a few details that need to be understood, the scheme gives investors the potential to receive up to 100.5% in tax writeoffs.” London + Crowd Finance

+ SEIS – How it Works

At the time, famous Dragon’s Den investor Doug Richards called SEIS one of the most extraordinary incentives ever created.” Furthermore, it dramatically reduces the risk of a startup investment:

“Seis changes the dimensions of the punt,” he says. “It makes an unaffordable risk an affordable risk.” FT – SEIS has the potential to be transformative

He further cautioned that it could take two to four years to take effect, at a cost to the government of approximately £50M. Indeed he was right. Since his assessment four years ago that ‘it’s the beginning of a golden age of startup activity in the UK,” London has morphed into one of the top spots to start and finance and innovative company,  gaining ground on Silicon Valley and other prominent hubs. SEIS has a lot to do with that.

Looking at Seedrs portfolio data above, it’s clear that returns are good without tax incentives (14.4% non-tax-adjusted IRR), but with tax incentives applied (49.1% tax-adjusted IRR) they are remarkable!

Redefining the VC Model

The great part about Seedrs is that as a citizen anywhere in Europe, you can sign-up for an account and make an investment in any of Seedrs crop of companies for as little as £10. Seedrs applies their nominee model to simplify the legal structure and protect investors in future rounds, and the investment is in every way as legal as a VC (Venture Capitalists) or angel making an investment:

“While it may seem like a technical point, this type of structure is actually essential to any equity crowdfunding model: it is necessary not only to enable startups to raise follow-on funding but also to ensure that investors’ interests are protected.” Why a Nominee Structure is Vital to Equity Crowdfunding

The streamlined structure and strong deal flow is so good that many VCs invest on the platform. Going forward, we think this structure will help to redefine the model and enable more entrepreneurs in a diverse number of sectors to access financing.

Funding innovation requires capital at various stages. Getting capital at the seed stage is the most difficult. Most of the deals in today’s current world rely on an individual’s proximity to investors with the capital. One of the big problem with the VC model is that the majority of VCs fund people in their own networks.  They either fund people who they know or those who have previously had their startup acquired. ‘Bros fund bros’ as a (female) colleague once said. The equity crowdfunding model dramatically reshapes the network of investors and democratizes who has access to capital. Big problems are typically solved by people at the edges of markets/problems, not those inside the tech community. Programs like the Unreasonable Institute have demonstrated that applying a model of education + mentoring + capital for high-impact enterprises can lead to scalable businesses that become profitable over the mid/long-term and solve big problems for humanity as a whole. Eventually, these types of structures can be platformized to increase access to capital and fund deeper innovations across an array of sectors.

crowdfunding

Another problem is the term sheets, legal structures and administrative work when trying to raise capital. Innovation happens at the edges, and most people outside of venture finance, in any vertical, have no clue what a term sheet is. Seedrs, for example, streamlines all of the legal elements and even wrote their own ‘plain English term sheet‘ to help make it easier for everyday investors and founders to understand, which helps democratize who can enter the platform for funding. Platformizing equity finance can rapidly increase the efficiency of legal/regulatory compliance and help more entrepreneurs raise capital on their terms.

The third problem with the VC model is returns.  The Kauffman Foundation, which itself invests in VCs as a Limited Partner (LP), put together a report demonstrating that the majority of VCs underperform public markets, which they pin on the broken LP  model and misaligned incentive structures, among other problems.  If everyday retail investors with a diversified portfolio can earn a 14.4% IRR on Seedrs before SEIS is even applied, the logic of regulators about ‘protecting’ investors and backing ‘experienced’ VCs is thrown out the window. Seedrs and other equity crowdfunding platforms bring a type of deal flow to everyday investors that they can’t find in public markets, sourcing deals that the ‘retail public’ usually don’t see.

In the UK, many VCs and angel investors use the platform to make investments and many funded companies go on to get followup funding from VCs or funds in later years. Seedrs recently signed deals with EY and KPMG to connect into their European innovation hubs and help early-stage companies in their accelerators access financing. The crowd for companies like Seedrs includes everybody, from armchair investors to accelerators to funds. But it is a crowd, a passionate, engaged crowd that owns an important part of the something they believe in, not just another overhyped company getting funding from a rolodex of 20 VCs. This is why Seedrs has revolutionized not just startup finance, but global finance.  They are already expanding their model, and companies can now raise large rounds on the platform from a variety of different investors.

+ The 18 biggest UK equity crowdfunding deals of the last year 

Going forward, the platformization of finance will distribute the deal flow to more members of the retail public and ensure that VCs don’t have the stranglehold on the capital ecosystem that they currently enjoy, funding only run-rate tech companies from within their networks, on their terms.  Intuitively, it makes sense that venture capital plays a huge role in the innovation ecosystem, and thus society; The Kauffman Foundation has put together an excellent array of data to support this.  Therefore, we hope that a real venture capital makes its way back into society, aided by equity crowdfunding. Combining platform efficiencies with visionary investors can lead to a robust innovation ecosystem that creates a more balanced and inclusive global economy.

Future Finance

Seedrs structure, ethos and return data to date demonstrates that new models for funding innovation can be developed using a combination of technology, crowd wisdom, new regulatory structures and tax incentives. Equity crowdfunding is set to blow up in 2017 in the UK:

“This will be the year in which institutional capital begins to play a meaningful role in equity crowdfunding. We are now beginning to see the first exits from investments made at the beginning of the equity crowdfunding era, and on top of that, platforms like Seedrs are releasing comprehensive portfolio data which is showing highly encouraging performance numbers.” What’s in store for 2017 – Jeff Lynn

And going forward, it should start to expand in regions around the world in order to fund innovation and stimulate growth as we gear up for the 4th Industrial Revolution.

+ BMi – the Fourth Industrial Revolution

To rebalance the economy requires putting capital in the hands of entrepreneurs, young and old, who have the vision, energy, and abilities to build innovative companies that can make a large impact and generate significant returns. Risk capital and a more diverse crowd of investors are required to ensure that capital moves towards an array of businesses that can impact both the local and global economy.