To me, equity crowdfunding is one of the most fascinating types of alternative finance to emerge. For those not yet familiar with the term, equity crowdfunding is when a company raise funds from many (“a crowd of”) small investors using an investment platform.
Since the first days of equity crowdfunding (start 2010s), the concept has been the center of much attention. What a story. Mainstream media welcoming the new Robin Hood of alternative finance. Companies like Brewdog almost hijacking the concept to become the uncrowned punk rebels of the beer industry. Governments and politicians acknowledging its potential to ensure future growth, while regulators across Europe being increasingly concerned of its negative impacts. Local and European Crowdfunding associations lobbying for the best conditions. State funded institutions collecting research. It only gets more exciting when you throw in the many investment platforms competing head-to-head while continuously raising larger funding rounds to grab the-winner-takes-it-all market. It has come to an extent where even London’s underground is pervaded by huge posters of investment platform’s own funding rounds. Even sport stars and banks have joined the battle fields of equity crowdfunding. Lastly, the US has finally joined the party as well, with the recent launch of the JOBS ACT title III. The story of equity crowdfunding is only just about to begin.
But in all of this, what happened to the first generations of equity crowdfunded companies? How are they doing? What are the challenges and mindset of these first pioneers of alternative finance?
In the last year, I have met up with 100 equity crowdfunded companies from all over Europe, helping them with shareholding and investor organisation (full disclosure: I am the co-founder of the shareholder platform Capdesk).
I was quite surprised to meet with these equity crowdfunded companies and discover a very different picture from what is often portrayed by the media, platforms and associations.
Below, I have shared 32 insights I found when meeting with these companies. The insights are grouped into 4 chapters:
1. Why equity crowdfund and how
2. Managing 100+ investors
4. Trading and new funding rounds
These insights are based solely on my personal experiences. My goal with this walkthrough is simply to shed some informal light on equity crowdfunding seen from the companies’ perspective. I hope it can can be of inspiration to other fintech nerds, startups, crowd investors, investment platforms or regulators.
If you have any questions, please comment below and I would be happy to elaborate.
Why equity crowdfund and how?
So how does having a lot investors compare to having just a few? Specifically - what are pros and cons to equity crowdfunding a company?
Unsurprisingly, it turns out that many businesses have put a lot of initial thought into this before e.g. embarking on crowdfunding campaigns. Below follows a list of typical initial considerations of this kind as well as my own reflections.
#1. Marketing, but mostly for B2C
Most entrepreneurs’ central reason for choosing equity crowdfunding is exposure. By fundraising in the open, companies are effectively doing marketing already when raising capital.
Marketing effects seem great for easy-to-understand B2C products like beer, jam or clothing. However, the picture gets slightly more nuanced when asking to B2B companies’ marketing experiences, as their answers are mostly less enthusiastic.
#2. Investors are brand ambassadors
“You don’t just get money, you also get hundreds of sales ambassadors”. This pitch is used by many equity crowdfunding platforms to lure new cases to raise funding on their platform. Most equity crowdfunded companies also really do want to get their investors involved in sales and marketing, and some, correspondingly, get great results.
However, most of the time, this ambition becomes a castle made of sand - an objective that is never really followed through. This is a shame, as investors constitute a valuable resource.
#3. Stay in control with small individual investors
Having a large pool of investors can represent a “strength in numbers” when it comes to “crowd-branding” the company. At the same time, having many investors means that each individual investor has a relatively small stake in the company, and therefore perhaps less commitment than in a few-investor configuration.
Many crowdfunding cases I talked to reason that this reduced commitment can be a company strength too, as it is easier to remain in control of the company. Surprisingly many companies argue that with many small investors, they avoid giving away board seat(s) and having to report to more sophisticated investors.
#4. BYOB: Bring your own backers
Bring your own backers. This is a term preached by many investment platforms. In short, it means that if you want to succeed on the investment platform, you’d better bring a significant amount (or the majority) of the future shareholders yourself to the given platform. The platform will not magically generate all the eager investors you need. For many companies, indeed, the majority of a successful crowdfunding campaign consists of shareholders originating in the company’s network. It can be quite an undertaking to motivate your network to invest; and in fact, many businesses eventually end up disappointed with the amount of funding raised from the investment platform alone.
#5. Equity crowdfunding campaigns takes time
Most companies having been through a crowdfunding campaign know that it is time-consuming. Equity crowdfunding, I believe, is even harder to get right. Creating an attractive investment case, defending the valuation and financials, while getting traffic to the campaign, is very, very tough.
For some companies, it seems, the results are meagre, and simply not worth the effort.
#6. A deal made of many
It is always fascinating to “undress” a successful equity crowdfunding case and look at its bits and pieces: the investor list and its distribution of shares and votes, also known as the cap table.
As it turns out, upon closer inspection, a crowdfunding round is usually not one deal, it is a deal made of many - including the founders reinvesting, the 3 old uncles, the VC (venture capital) covering its dilution, and the FFF (family, friends and fools). I am really looking forward to see how this trend will develop - and whether new tools will be crafted to disclose and investigate these sub-deals, as it is important for all investors to understand these dynamics.
#7. European platforms, international investors
Having investors from abroad is seen by many companies as a plus. As a result, there has been a fierce competition between the (equity) crowdfunding platforms (especially from European platforms outside the UK) about which is the more international and offers the most cross-border investors.
The contest may not have a clear winner, as it seems like the international spread of investors is the same no matter what platform you use. My take on this fact is that getting international investors’ attention mostly boils down to a company’s own marketing, more than the specific investment platform the company may use to raise capital. However, I do believe that the platforms are doing a great job creating a foundation for the companies to spread their message globally.
#8. Use investors for introductions
As a small, but fun, final note on having many small investors. It seems that another effective use of small investors is introductions. Apparently, most like to introduce themselves as an investor to their network and the connections generated this way is of immediate benefit to the company. So, if you have a lot of investors, go out and get some introductions!
Managing 100+ shareholders
So, you successfully funded your company and suddenly find yourself with 100+ investors. What are the main challenges you face? Let’s investigate what the practical challenges consist of, and how to solve them.
#9. Challenge: The cap table is a mess
A cap table (a listing of all investors’ holdings with percentages of ownership, equity dilution, and value) can be complicated enough to maintain if you have 6 shareholders.
Imagine now that you have 100+ shareholders from several funding rounds, share transfers, options, trades, warrants, a VC; a friend and 2 uncles also chipped in…. The cap table quickly becomes one big mess. If you try to fix it, you will discover that there is no universally agreed-upon standard for a “correctly formatted” cap table.
My friend and Capdesk co-founder, Casper Arboll, once helped a company with 2000+ investors (some investors were listed without name, address or e-mail), 8 funding rounds (one of the rounds lasting a year!) and 100+ trades to straighten out their cap table to something comprehensible … A rather grim task.
#10. Challenge: Investors change names, address - and pass away
Even if you succeeded in getting the cap table correct with 100+ investors, the table data is quickly outdated. Constantly, you need to update investor details! Even though this is not something we usually think about a lot, people do change e-mail address, name, and address quite frequently - also, they may pass away (sadly). Every time this happens, you must stop what you are doing, go to your Mailchimp account, Facebook group, and/or spreadsheet, to update the required details. Such a simple update can easily take 30 minutes to complete - and it does happen a lot.
#11. Challenge: Who is my investor?
Minor detail, but small investors also invest from their holding companies. This causes problems when you want to find out who your investors on your cap table actually are, as all you see is the company name. For some companies, this does become a bit of a pain.
#12. Challenge: Voting is tough
If you have to pass a shareholder resolution, it ought to be a piece of cake. In most situations, you only need 75% of the votes to get the particular resolution passed. The same should be true in case of a general assembly. But now suppose that, 30% of your company is owned by 400 different small investors with potentially different access to voting, depending on what type(s) of shares they hold. To calculate whether the resolution in question is passed or rejected, you may need to collect an additional roughly 400 votes, and then multiply each vote with the corresponding shareholder's voting weight. This is can be a painstakingly resource-heavy process, and perhaps it is one of the biggest pains of being an equity crowdfunded company.
#13. Challenge: Investor perks are messy
Something that has become increasingly popular when equity crowdfunding is offering additional investor perks.
As an example, a perk could be: “Invest more than $1000, and get one year of cat food”.
Perks turns out to be a great way to convert interest into new investors or to entice existing investors to invest more. However, neither the investment platforms, nor the (newly-funded) companies are well-equipped to handle, say, 10 different perks and 400 investors. As a real-life example, a company gave away a certain amount of free consultations a year to a certain selection of investors each year. But how do you control and manage the perks offered while growing your company? In most cases, time-consuming manual processes are the answer. Perks are great, but costly.
#14. Challenge: Managing SEIS (Seed Enterprise Investment Scheme) / EIS (Enterprise Investment Scheme)
The UK deserves a medal for the incredible tax schemes to early stage investors, the so-called SEIS and EIS. In short, SEIS and EIS means that investors can get a tax break by investing in a “qualified” UK company (to qualify, a company must be founded in the UK within recent years and not exceed a certain turnover threshold).
SEIS and EIS are undoubtedly the main reasons why equity crowdfunding has taken off so rapidly in the UK, both absolutely and relatively to other countries. However, for the companies to successfully manage SEIS and EIS, paperwork and bureaucracy at its worst is required.
Hopefully, the UK tax department HMRC will soon open up and let platforms like Capdesk integrate, thereby helping companies cut through the red tape and easily submit the data needed by the authorities.
Investor relations (IR)
Having a healthy relationship with investors matters. When relations are well-managed, both company and investors benefit, but managing a large investor pool brings hurdles to.
It is a central challenge for crowd equity companies to maintain healthy, mutually beneficial investor relations. However, outdated tools and processes often block the thriving of this very important factor.
#15 Investor relations are often overlooked ...
Just when closing an equity crowdfunding campaign, most companies seem to still be in a “honeymoon phase”. They answer all the investors’ questions, give frequent updates and plan an investor relations strategy carefully. But then reality hits and they stop giving updates. The best-in-class companies give between 1-2 updates a year, where many just don’t. This leaves investors in the dark about company performance, and companies get out of touch with investors.
#16 .. or deliberately ignored: Don’t want to wake the beast
There might be several reasons for a decline in investor engagement after the initial phase. Companies might be very enthusiastic about investor collaboration and engaging investors in sales and marketing, preparing funding rounds or getting connected to certain persons or companies. But just when they are about to really start the process, many companies freeze and ask themselves the question: “Do I prefer idle investors more than the having them engaged and potentially ‘over-active’?” Many actually go with the idle investors. Companies, perhaps especially new ones, can be afraid of “waking up” a potential lively “beast”.
#17 Better IR means better funding rounds
Having quality investor relations helps a company raise funds faster and at a better price. Tapping into an already established network is easier than drumming up new interest. I have seen that existing investors who already have a stake and deep knowledge of the company is more likely to invest in new funding rounds than new investors.
As an example of just how far good investor relations can take you, an equity crowdfunded company declared bankruptcy on their Facebook group and had to refuse several funding offers from investors (at a decent valuation!).
#18 Maintaining IR: Facebook groups and Mailchimp
The fraction of companies that actively choose to focus on investor relations tend to make use of tools like Facebook groups and/or Mailchimp. On Facebook, you can invite the shareholders to a private group where you can publish news or even favours. One of our clients got a place to stay from one of his investors through the investor Facebook group when travelling to Germany. Mailchimp is a great way for companies to send content-heavy mails to investors and track whether or not they have opened the mail.
While these tools have clear advantages in being easily set up and free or cheap to use, there are also shortcomings. For instance, managing different sub-audiences for differentiated investor communication and keeping groups and mailing lists up to date with an ever-changing body of shareholders.
#19 Direct relationship with investors
To help companies manage many shareholders, some platforms offer the service of representing and organising the new shareholders in structures that ease the task by “hiding complexity”. These structures include SPVs ("special purpose vehicles"), where a pool of shareholders are grouped into a new company (the SPV) that can then act as a single investor, with one voice, and nominee structures, where, broadly speaking, the pool of actual shareholders act through a nominee (a person) being the “formal” shareholder.
Such structures protect the company as well as the investors from some of the previous described challenges, such as the fears of “waking the beast”.
However, I have encountered several companies explaining how they explicitly did not want a SPV or nominee-like structure, as they wanted a direct relationship with their investors.
There are many pros and cons of each organisation model and it will be interesting to see if any preferred “standard forms” will emerge.
For the companies actively caring about investor relations, I spotted one major shared concern: transparency. How much information should be disclosed to whom? What stakeholders should be encouraged to collaborate with whom about what? Should investors be urged to discuss the company publicly?
Indeed, transparency is somewhat a taboo in equity crowdfunding, but it is definitely a matter that needs more attention. A couple of key observations in this context is listed below.
#20 If things are going bad, just be quiet
When companies have over-promised and are not delivering the expected results, often, they simply don’t communicate it to investors. “I haven’t given my investors any updates, since I don’t have any good news” is unfortunately a very frequent excuse.
This is a shame, as I believe that by being honest, it is easier for companies to receive timely and suitable help, advice or other inputs needed from the investors. If investors do not know the actual situation, any help or feedback may simply “misfire”.
At times, it seems that companies forget that their investors want them to succeed (nearly as) much as themselves.
#21 Who owns what and what is it worth?
Some entrepreneurs do not feel comfortable sharing the cap table, funding history and share transactions with their investors.
Unfortunately, this is sometimes because the company made some sketchy deals (share discounts to selected investors, new share classes with other rights, etc.) during the funding round. Sometimes, they knowingly have raised capital at a too high valuation, and are already planning a down round with a traditional investor. In short, these entrepreneurs are afraid that if they disclose the complete funding history, the investors will discover that they have been cheated.
When companies themselves believe that the ownership and its history is correct and ethical, they will have no issue disclosing this information, at least partially.
#22 Sensitive data and the fear of spies
Some European investment platforms allow investors to invest as little as $5 in a company. Companies can have hundreds of such micro-investors. If it gets out of hand, it can be next to impossible to monitor the intention of each and every one of them. Companies are therefore nearly always afraid of leaking valuable company data to potential competitors having “sneaked in” as micro-investors.
#23 Afraid of ganging up
Even if the fear of spies is overcome, there are other reasons for attempting to restrict investor communication. One of the most popular reasons for not inviting your investors to a proper discussion forum, such as a Facebook group, or for not providing access to a fully detailed cap table, is the fear of the investors “ganging up”.
Even though the investors by law (in most countries) have the right to see at least a high-level version of the cap table, companies may fear that investors will contact each other and team up to act against the founders’ desires. While I completely understand the founders’ concerns of being “trampled”, it also clearly reflects a clash of “the old world” of anonymity, confidentiality and paperwork, versus “the new world” of sharing, collaboration, and the web. Nowadays, in the web based economy, by default, investors can contact whomever they want, whenever they want. So if investors really want to “gang up” - they can easily do so, no matter what tools and/or restrictions the founders may put at their disposal.
However, although I have been in the business for years, I still haven’t heard of a single example of this situation - which might suggest, that there really rarely is a reason to be concerned? If you have heard of anything like this in an equity crowdfunded company, please let me know in the comments or by email - it is a subject of much interest.
#24 It takes one to ruin the party for everybody else
Many companies would like to allow the investors to comment, engage and collaborate actively. But then there is the concern of this one investor who is a proper d***. Some companies have one investor who is always complaining, asking weird questions, behaving rudely and plainly takes too much of the company’s time. We call investors like this “Mr. D”. Most of the time, Mr. D owns a very small stake in the company, but loves the attention he can get. The noise created by Mr. D is often the (only) reason why a company chooses to have restricted transparency and limited communication with the shareholders.
Trading and new funding rounds
Equity crowdfunded companies have different stories, but most commonly, a large crowd of investors is a central financial enabler. Without the many investors, the company would often not get the starting capital needed.
But how do the new ownership structure compare to more traditional ones and how does it affect the future funding of the companies? Below, I have listed some observations.
#25. VCs and equity crowdfunded companies
VCs have always been skeptical towards equity crowdfunded companies. At one time, the platforms were looked upon as the creatures that “ate” all the rejects and leftovers from the established BA (business angel)/VC industry. But the picture has changed. Now, we are seeing cases like Monzo (former Mondo), led by well-known VCs, in their crowdfunding round. However, despite this trend towards a broader recognition, I still hear many stories of VCs not wanting to touch a company with many smaller investors and a messy cap table.
#26. Companies don’t mind trading - and investors want to trade
This might be one of the biggest surprises to me. Companies do not mind their investors trading shares, in fact they often endorse it. The most common and sensible argument is that funding rounds become easier when you allow shareholders to have liquidity. Another argument is that you can get rid of the investors who are unhappy.
Many investors are already trading shares among each other. At Capdesk, we have been flooded by investors asking us to build support for investor proposals, buying and selling. People would like to buy more and sell - great news to the industry.
#27. Companies wants to buy back shares
A tattoo might seem like a good idea at 5am in Bangkok, but might be regrettable later on. The same phenomenon occurs within equity crowdfunding. Many successful companies become keen to buy back the shares of their minor investors to “clean up” their cap table when they become a bit more mature. Such buy-back deals would often constitute a win-win, even though a buyback is often very pricey.
#28. New funding rounds using same investors - and non-platform tools
As already mentioned, equity crowdfunded companies often use previous investors to close new funding rounds. This is hardly a surprise, but it is changing the “funding ecosystem” somewhat.
Many investment platforms have noticed the shift and correspondingly set up sales programmes to get companies to raise again on their platform.
It is perhaps the most painful thing for a platform to see a previous case (along with its investors) raise money on a competing platform. Actually, some companies are beginning to arrange funding rounds themselves using tools such as Google Forms. We might see the investment platforms begin to fix this leak by, for instance, offering discounts to previous cases.
#29. No loyalty to investment platforms
Whereas I expected companies to remain loyal to one investment platform, when talking to companies about which platform they are most likely to use “next time” to raise capital, the common reply is “the one that gives me the best deal”. This makes sense and makes the competition of the investment platforms even more fierce.
#30 Most don’t plan any liquidity events
You might be a very successful and sexy beer, clothing, food, event or creative company. But, to be honest, the likelihood of you exiting successfully is close to zero (unless you are a giant, like Brewdog or Camden Beer Brewery). And, to be fair, your company is probably never going to prioritize dividends or an IPO. Most mature equity crowdfunding companies do not plan any form of exit or liquidity events.
This eventually becomes a bitter-sweet cocktail for the investors. On the one side, it is great that the company is doing good; on the other hand, as investor, you are never going to get your money back.
#31 Exits are expensive
Those of you who know me have heard this story hundreds of times (bear with me).
But: Last Christmas, I got a UPS express with wonderful news: Camden Town Brewery (an investment of mine) had been sold to a big company and I had earned some money. The UPS express envelope contained 3 letters: Information letter (what is going on, what action is required, etc.), shareholder consent (to be signed) and how many shares do I want to sell (options 1-3). After filling out the required documents, I had to post my reply by snail mail to somewhere in the UK. When my letter arrived, details had to be sorted out and sent to Computershare. Computershare then issued a check with my name on it and snail mailed to my address. Finally, I had to physically visit the bank to cash in the cheque in order to retrieve my … $150! Having bought the shares on a high-tech platform, physically cashing in a cheque was quite an anticlimax.
Camden Town Beer brewery had about 2000+ investors! Imagine how expensive this most how been. Having an exit as an equity crowdfunded company seems to be expensive in both time and money.
#32 Most companies are doing good
One of the most surprising reports to come out within the last year was made by Altfi. It showed a surprisingly impressive performance of the UK equity crowdfunded companies. This probably indicates a healthy company selection by the campaign platforms. Further, I believe that many of the popular investments are cash-driven and low-risk, such as restaurants and food and clothing companies, which are more tangible to investors.
In conclusion, I have both positive and troubling observations. Companies and investors seem to embrace the new company forms with many investors. At the same time, the companies often struggle to strike a rewarding balance: How to benefit from investors and let them benefit from liquidity, and at the same time, get transparency right and spending too much time managing the investors.
The companies needs to find a way to make their shares liquid and ensure transparency - or else, I fear that investors would get impatient and move on.
However, like I mentioned in the introduction, the story of equity crowdfunding is only just about to begin. Who knows how equity crowdfunding will look like in one years time?
I would love to keep on discussing this, so please don't hesitate to contact me if you wish.
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