So you've decided to make the jump into early stage investing and want to know what each platform has to offer. There’s much to learn, but to kick-off your research we've outlined the 5 key factors you should review.
Is the platform entrepreneur-led or investor-led?
This is huge. Entrepreneur-led means the entrepreneurs set the investment terms, including share price and the amount of equity being sold. Some platforms will discuss the terms with the entrepreneur though the final decicion regarding the terms ultimately rests with the entrepreneur.
With Investor-led, a lead investor negotiates the terms of the investment, invests their own money, and then allows the crowd to invest and receive the same price per share, and same class of share that the lead investor receives. If you think of Dragons’ Den, entrepreneur-led platforms allow you to invest on the terms the entrepreneur first pitches to the Dragons, whereas with the investor-led approach you would invest once the Dragons had negotiated the terms.
|Investment Terms||Set by entrepreneur|
|Pre-emptions rights||Dependent on investment size|
|Voting rights||Dependent on investment size|
|A' class shares?||Dependent on investment size|
|Direct ownership or nominee||Deal dependent|
|Set by entrepreneur|
|Dependent on investment size|
|Same as lead investor|
Am I protected in terms of dilution? (Pre-emption rights)
Having pre-emption rights means that investors have the right to ‘follow’ their money in subsequent funding rounds, protecting them from future dilution.
You’ve seen ‘The Social Network’ and cringed as Facebook diluted the shareholding of co-founder Eduardo Saverin, from 30% to just 0.5%. Any investor without pre-emption rights could invest in the next Facebook but not see any returns, all in an entirely legal process. This is how it works:
A company has 100 shares. If you bought one share then you own 1% of the company. Hurrah! It’s the Uber for freshwater fish, and is going to be sold for £100m next week. You’re on for a cool £1m, so you charter a plane down to Nice and put down the deposit for a yacht, which you’ll pay for next week when the company gets sold. I suspect you’re ahead of me on this one.
Legally, the entrepreneur could issue 1,000,000,000 shares the day before the company gets sold, then buy them all for £1. Without pre-emption rights you can’t buy any of these shares. Grab your calculator. You now own 0.0000001% of the business, so you’ll get £0.10 in the sale. All this because the crowdfunding platform you invested through didn’t give you pre-emption rights. Seriously, don’t be that guy.
Read more about this in an excellent article by Investors Chronicle here
What is the due diligence like?
Due diligence is a detailed investigation of a company by a potential investor, to evaluate the investment opportunity. It’s extraordinarily important.
Unfortunately, due to financial regulations and fear over potential liabilities, the due diligence that is carried out is often hidden away in a dark corner.
Direct shareholding or nominee structure?
There are two perspectives here, the investor's perspective and the companie's perspective.
From an investors’ perspective, having a ‘middleman’ hold the shares on your behalf (i.e. a nominee structure) can be beneficial, as a group of small investors can act as protection from not-so honest entrepreneurs (less likely) or future institutional investors or venture capitalists (a lot more likely).
From the company’s perspective, a nominee structure makes the administration less cumbersome, leaving entrepreneurs to focus their time on running the business rather than managing a large base of investors.
Is it FCA authorised?
It’s rather simple. If a platform is not authorised by the regulator – the FCA - you cannot be confident that your money is being handled correctly, or that it is safe during transaction.
Updated on 10/11/2016