As equity crowdfunding grows in popularity, practitioners can play a vital role to help their SME clients navigate the complexities
This article was first published in the March 2016 UK edition of Accounting and Business magazine.
Reward and loan-based crowdfunding has been around for a few years, but investment crowdfunding - where investors back a company in return for shares rather than products or interest payments - is only now becoming a mainstream way of raising capital.
Last year saw several companies raise upwards of £1m in this way - and a couple of exits. Startup JustPark, which lets users rent out their unused parking spaces, was the biggest success story of 2015, with more than £3.5m raised. And after taking in £2.75m in crowdfunding in April, Camden Town Brewery was sold to Anheuser-Busch InBev in December.
While big crowdfunding campaigns like these are still rare, the scale of funding obtained by small and medium-sized enterprises (SMEs) in the alternative finance sector is likely to grow. The Future Trends in UK Banking report from the Centre for Economics and Business Research predicts that peer-to-business lending and crowdfunding could be worth £12.3bn a year by 2020.
Hospitality and technology sectors seem to attract more interest from crowdfunding investors than others. ‘Both of these industries are booming, and everyone likes the idea of having a stake in a bar or restaurant, especially if they are a little bit different,’ says Andrew Ball, partner and head of the hospitality industry group at accountancy firm Haysmacintyre. He adds that investors tend to go for business concepts that are likely to grow rapidly and provide a return on investment.
‘This is why restaurants are so much more popular to invest in than larger projects such as hotels. They need less capital to get going and start becoming profitable.’
SMEs join the party
But other industry sectors are getting on the crowdfunding bandwagon too. Research from UK Bond Network shows that 68% of SMEs would now consider using alternative finance to raise capital.
Alternative finance is not just for startups, either. Ball says: ‘Those already established have a much better chance of succeeding through crowdfunding platforms because potential investors can see that the business model works and can provide a return on investment.’
Clearly, the rise of crowdfunding presents a new business opportunity for accountants. ‘Even before going down the crowdfunding route, we can assess whether this form of financing is suitable for the client,’ says Ball. He points out that it may not be appropriate for businesses and concepts in the very first stages of development nor for those that need a hefty injection of funds to start out.
Martin Small FCCA, accountant and director of Ownse, is himself launching an app thanks to crowdfunding investment. ‘There’s a long way to go between an initial idea and successful implementation, and everything takes longer than one thinks,’ he warns. ‘So make sure the client has realistic timescales in which to complete each part of the project, from product development to marketing to eventual fundraising.’
Many startups also need a team of professionals to get the project up and running. ‘As an accountant, you may know other clients who could complement this team,’ says Small.
It’s important to think of the end-game too. ‘This method of financing could be a hindrance to raising further private equity down the line as the business may be seen as unstable,’ says Ball. ‘Selling the business may become difficult because of crowdfunding, as valuations may be affected by the way the business has been financed.’
Small explains: ‘If a business is seeking to raise £100,000 through crowdfunding in exchange for 12.5% of the equity, the company would have a value of £800,000 after the investment.’ Accountants may be asked to assess whether the valuation is justified. ‘The reality is that, in most cases, this is made up of a large amount of “hope value”, and the business does not support such a valuation.’
Assuming that crowdfunding is a suitable route, practitioners can assist clients throughout their crowdfunding campaigns, starting with advice on which platform to choose. ‘It’s important to pick an FCA-regulated crowdfunding platform,’ says David Webster, partner at law firm Russell-Cooke.
Webster also points out that taking investment from the ‘crowd’ can lead to the creation of a relatively large pool of individuals with an investment in the underlying business – and perhaps a belief that they should have a say in how the business should be run. This could cause problems when decisions have to be made, potentially slowing down the process of arriving at shareholder resolutions.
‘However, some crowdfunding platforms have created trust structures so that there’s just a single entity or person for the recipient of the investment to deal with,’ Webster says.
Small advises warning clients against releasing too great a percentage of the equity for crowdfunding. ‘Otherwise the founders of the business may one day start to think they are not benefiting sufficiently from their own hard work.’
Clients will need help with their pitch and financials to maximise their chances of attracting investors. ‘We’ve helped clients with their business plans, three-way cashflow, P&L and balance sheet forecasts, and advanced assurance for enterprise investment schemes [EIS] and seed enterprise investment schemes [SEIS],’ says Jon Dudgeon, director at accountancy firm Blu Sky.
Small says that accountants advising SMEs on crowdfunding must be fully conversant with the legislation behind EIS and SEIS. ‘Fundamentally, one gives the investor 30% income tax relief and the other 50% income tax relief. There are also capital gains reliefs, and these can result in no capital gains tax being paid on the eventual disposal of the shares. Investors will want it guaranteed that these reliefs are available, so the accountant should seek advance assurance from HMRC.’
Clients may also ask their accountants to help them spread the word about their campaign on social media. Small warns: ‘Care should be taken to ensure you are not endorsing the investment or providing investment advice if not authorised.’
For small business owners especially, crowdfunding will make their company’s finances more involved, adding extra accounting, tax and investor reporting obligations. ‘Company secretarial can also become a burden depending on the number of eventual shareholders the crowdfunding attracts,’ says Dudgeon.
All businesses that raise funds through equity crowdfunding will come under more pressure to succeed and grow. There is an opportunity for practitioners to advise about that growth too.
Iwona Tokc-Wilde, journalist
"Even before going down the crowdfunding route, we can assess if this form of financing is suitable for the client"