What’s one of the most important things to consider when you invest in a company via equity crowdfunding?
How about the investment model? In the equity crowdfunding space there are two approaches. We call them ‘investor-led’ and ‘company-led’.
Investor-led refers to an opportunity where the investment terms, including the valuation of the company and legal agreements, are set as the result of a negotiation between a lead investor or business angel and the company raising finance.
As an individual online investor, you are given the opportunity to invest in the company on the same class of shares and at the same price per share as the lead investor. Imagine that Peter Jones or one of the other Dragons found an opportunity they wanted to invest in, they negotiated the price and share they wanted, and then they gave you the chance to invest with them.
However, with the company-led approach, the company sets its own terms of investment. This means there’s no lead investor to negotiate terms for themselves and the other investors. Instead, investors like you simply choose whether or not to invest under the company’s terms.
Naturally, the company will push to get the best possible valuation for itself, for obvious reasons. The owners would much rather give away just 5 or 10% of their company instead of giving away 20 or 25% for the same amount of investment.
But if you agree to invest under those terms they might not be the best for you.
How the investor-led approach works:
If the approach is investor-led then you get to invest under the same class of shares and at the same price per share as the lead investor who has agreed the terms and is putting their own money into the company alongside you.
Negotiating a valuation for an early-stage company is very subjective as there’s often little in the way of revenue or assets on which to base it. Get the valuation wrong and you won’t make much money from your investment. That’s why if you watch Dragons’ Den you’ll see how fiercely the dragons negotiate the terms.
Business angels don’t tend to be quite as aggressive as the dragons but they will negotiate to a value they are comfortable investing in. One that they’re confident will make them money.
In other words, with the investor-led approach, the goal is to arrive at a negotiated valuation of the company that both the company and the lead investor are happy with.
Other benefits of the investor-led approach
Getting the right valuation can make all the difference to your investment. However, there's more that the lead investor brings to the table than just the terms and valuation.
Many lead investors have ‘been there and done that’ having founded and run successful businesses of their own. Lead investors or business angels can help a company to succeed by offering advice, opening the door to partners within their network, or perhaps sitting on the board and helping shape the business and the strategy.
They can also hold the company to account in a way that an individual investor putting just £1,000 or £5,000 into a business cannot.
Disadvantages to an investor led approach?
Are there any disadvantages to an investor-led approach? Well, the investor-led approach is a more curated one meaning that poorer-quality investment opportunities get weeded out reducing the number that are put in front of potential investors like you.