Bubble & Balm, the first company to raise finance through Crowdcube, has closed its doors. This is probably the first UK equity crowdfunded business to fail and it is unlikely to be the last. However, this doesn’t change a thing. In fact, anyone surprised to see a startup fail, be it crowdfunded or not, should stay well clear of investing in startups. The others should praise the entrepreneurs for trying their best and wish them all the best in the future. According to the Financial Times in 2011 the company raised £75,000 in return for 15% equity from 82 investors, with investment amounts ranging from £10 to £7,500.
First the facts: most startups fail. A Nesta report entitled “Siding with the Angels“ shows that an average of 56% of angel investments return less than the capital invested, but the remaining 44% saw substantial gains. The failures occur much earlier than the successes, often years earlier. Any investor considering investing in startups must understand that they will run into losses with some of their investments. These losses are part of the overall picture of how investing in startups works, and only highlight the importance of diversifying investments.
The risk of startups failing is contrasted against the potential for very high returns from the startups that succeed. Had Bubble and Balm succeeded and eventually been sold for say £10m, investors would have made £20,000 out of their £1,000 investment. Returns like this would mean the profits from Bubble and Balm would have covered losses from other companies in your portfolio (assuming you invest roughly the same amount on each one) and still have profit leftover. Since Bubble and Balm failed, it is now up to investors to have other good investments in their portfolio to make up for it. Investors that understand the risk/reward profile of angel investing have a portfolio approach. They invest in several different startups, often in different industries, to reduce exposure.
As an aside, Bubble and Balm offered investors tax relief through the government’s Enterprise Investment Scheme and Seed Enterprise Investment Scheme. The great thing about these schemes is that investors would have only lost around 50% of their investment even though the company went bust.
Be it crowdfunded or angel funded, a lot of businesses will go bust. Angel investors) (and hopefully crowd investors too) are both aware of this and savvy about it. They know that some businesses they invest in, no matter how great they might be, can still go bust.
The big difference is on the upside. What do angel investors know that the crowd by itself might struggle with?
1) Maximise the likelihood of investing in winners by carrying out detailed due diligence; eliminate companies that are more likely to fail or are not telling the whole story.
2) Angel investors only invest at valuations that will mean high returns if things go well. This means that they can still make a great profit after losses elsewhere.
However, there is something that the crowd brings that angel investors struggle with - perception of market potential. Angel investor groups tend to be made up of relatively small numbers of individuals, and are thus susceptible to ‘group-thinking’, meaning each individual in the group tends to come to a similar conclusion. This is not so with the crowd, who have limited direct contact between them. Angel investors may think that there is/isn’t a market for a product or service, but a large crowd is, in our opinion, a better gauge for measuring the support for a product or service in the marketplace.
That is why at SyndicateRoom we bring the angels together with the crowd. The best of both worlds, with both parties having a lot of value to add to the mix, which can ultimately only be good for investors.
1) Syndicate Funding 2.0 - the answer investors in startups have been waiting for
2) The hidden problems of equity crowdfunding
3) 9 reasons why you have to invest at the right valuation to get awesome returns out of the 10th reason