The CEO of a top City of London stockbroker believes crowdfunding will become "a massive part of fundraising" but thinks the regulator needs to take more action to make sure people are not being "ripped off" by "sky-high valuations."
Sam Smith, CEO of finnCap, told Business Insider: "It’s got a long way to go. But I think it will be a massive part of the fundraising market and should be, because it’s great to get retail money involved in startups."
Crowdfunding is where ordinary people — so-called retail investors — put money into startups, investing as little as £10 or £20 at a time. A huge number of platforms have sprung up in the last half a decade. The biggest is Crowdcube, which has raised over £185 million ($243.9 million) for 438 companies.
Smith says: "I think it needs to develop a process of working out what it’s going to be: is it funding startups, is it funding slightly bigger businesses? How do you do due diligence things and make sure people aren’t been ripped off and put into sky-high valuations?"
The risks involved with investing in startups
There have been several high-profile failures of crowdfunded businesses in the last year, but Smith says most crowdfunding platforms do a good job of conveying the risks involved with investing in startups. The vast majority of startup businesses fail, but Smith believes people should be allowed to take that risk. For those that do succeed, the returns to investors can potentially outstrip investments in publicly listed companies.
But Smith is concerned about investors falling foul of unrealistically high valuations, which mean crowd investors could end up with little or no profit when the business is sold or listed.
Smith told BI: "I hear plenty of times an institution will come into something at one valuation but it will say, ‘On the crowd, we can get double that valuation so we’ll go there.’ To me, that’s saying I know I can rip off the retail customers so I’m going to do that."
The lack of independent valuations
Most crowdfunding platforms do not have independent valuations, letting companies pick their valuations and then advising on them.
Luke Lang, cofounder of Crowdcube, told BI earlier this year that his platform has a team of 6 in-house analysts who "benchmark valuations against industry standards and... offer guidance to try and rein them in or increase them when they’re not high enough."
But if businesses are too highly valued when they crowdfund, future fundraising or IPOs could see the business take a write-down on their valuation or just a small rise in its valuation. In these cases, investors who cash out wouldn't make much money and could even stand to lose it.
Smith didn't single out any specific platforms but said of the industry: "That doesn’t sit well with me, that because they don’t know as much you can charge them more. That does need to be looked at because you don’t want the whole market to be ruined."
Despite these reservations, Smith says crowdfunding is a "brilliant" innovation. "If you’re a startup, where did you go 5 years ago?" she says. "You might use a credit card, you might go to the bank for an overdraft but that’s not happening anymore. It’s actually filling a real gap."
finnCap is the biggest broker to companies on London's growth stock market AIM and is one of the top 5 stockbrokers for the London Stock Exchange.
finnCap invested in crowdfunding platform PrimaryBid in May. The platform aims to offer retail investors access to stock market flotations and secondary fundraisings on public markets using the technology of crowdfunding.
Numis, another City of London stockbroker, has also made a bet on the crowdfunding market, investing £6 million in Crowdcube last year.
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