If you think that equity crowdfunding platforms are all the same, you really should read this post to the end.
Thanks to crowdfunding, investing in startups is no longer just for the very wealthy. With minimum investments of as low as £10, almost anyone can invest in start-ups through one of the increasing number crowdfunding platforms available to those who reside in the UK.
There has been a lot of interest from the media, and a huge hype building around crowdfunding, which is how it should be. However, there are considerable differences between the equity crowdfunding platforms out there, and you, as a potential user of any of them, should be aware of what these differences mean to you as an investor.
Disclaimer: I'm the founder of SyndicateRoom, an equity crowdfunding platform that gives the crowd the chance to invest together with experienced Business Angels. Our vision is to bring crowdfunding, as it should be done, to the general public, and we won't rest until there is enough information out there for investors to make well-informed decisions.
4) FCA authorisation
If the platform is not compliant with Financial Conduct Authority (FCA) rules (either directly authorised by the FCA or an appointed representative of an authorised firm) walk away immediately. The way money ought to flow internally through a platform is strictly controlled by the FCA. If a platform is not FCA-compliant you cannot be sure of how your money will be handled, and your money may not be safe during the transaction.
3) Nominee structure or direct shareholding
Investing as part of a nominee structure is like having a 'middleman' hold your shares on your behalf. A number of investors come together as a group and are represented by an individual or organisation, who vote on behalf of the group when it is necessary for shareholders to vote (they are the 'nominee').
This protects against not-so-honest entrepreneurs (relatively rare) and/or future institutional investors/venture capitalists (rather less rare) pushing out the 'little guy' (or small, individual investor, whose vote or votes tend to count for less when taken alone).
However, investors may prefer to hold their own shares directly and take control over their vote for themselves (after all, you might disagree with the majority view taken by a nominee structure). Furthermore, some platforms take a cut of the investors' earnings from any sale of the start-up, which the industry refers to as "carry", for acting on their behalf in the nominee structure.
From a company's perspective, having a nominee structure makes the administration of the shareholders less cumbersome. However, there are easy ways to manage a larger number of shareholders effectively: from companies that deal with all Companies House related issues for just £10/month (Inform Direct), to companies that organise all investor reporting for the same amount (Invrep.co).
2) B-class, non-voting shares
You find an opportunity you like on a crowdfunding platform (that isn't SyndicateRoom), invest £1,000 and get 'B-class non-voting' shares. What does this mean? It means that entrepreneurs will not have to worry about you; they can pass any resolution without so much as asking you (or anyone else in the same share class) your view on it. B-class shares do not always come without votes. But if you get B-class shares with no voting rights, entrepreneurs could change the company's Articles of Association, and steer the business in an entirely different direction, without your say so. No Business Angel would ever buy such shares, so why should the crowd get left with them? Platforms offering non-voting shares know exactly what they are doing and I find it shocking that there is such a disregard for investors and their interests.
1) Pre-emption rights
For those of us that have watched the movie The Social Network about Facebook and wondered how they managed to sideline one of the founders, this is how. Any shareholder that has no pre-emption rights may as well have just given their money away to the company for nothing. The worst part is that this can be done through an entirely legal process if you don't pay attention upfront.
This is how it works:
A company has 100 shares. Say that your investment bought you one share out of the 100. You own 1% of the company. Now imagine that you invested in the next Facebook and it is going to be sold for £100m next week. You get your calculator out and find out that you would get £1m, which is pretty cool. So you treat yourself to a Ferrari and a nice sailing boat on credit (you will pay the bill next week when the company gets sold and you get your £1m). Except that you don't. In an entirely legal process, the entrepreneur could issue 1,000,000,000 new shares the day before the company gets sold, then buy them all for £1. Because you don't have pre-emption rights you cannot buy any of them yourself. Now, instead of owning 1% of the company, you owe 0.0000001% of the company and will be paid £0.10. Ouch.
All because the crowdfunding platform you invested through didn't give you pre-emption rights. Again, platforms offering shares with no pre-emption rights know exactly what they are doing and it's shocking.
I cannot stress how important investors' protections are. You are investing your hard-earned cash. Investing in start-ups is risky as it is, but if you don't make money when you back the successful companies it doesn't matter how good you are at spotting the next great opportunity, you are still going to lose your money.
Platforms that do not take steps to protect investors are basically allowing the crowd to give their money away and disguising this as investments in start-ups. The crowd seems to be buying it but hopefully I've just helped you, dear reader, to make a slightly more informed decision on how and where to invest your hard-earned money. Now it's up to you: do you want to invest in start-ups or give your money away to startups?