Appealing to the masses

There have been several notable successful stories when it comes to operators’ use of crowdfunding to push them to the next level in their growth plans. BrewDog is the obvious example. It has just launched the latest round in its Equity for Punks raise – its sixth in nine years – and is seeking an additional £7m with a stretch goal of £50m. But they are not the only ones seeing success from appealing to the masses.

Grind has completed a third successful Crowdcube round of £3.5m, after successfully raising £2.1m in 2017 within five days of the campaign going live, while Chilango has just smashed the target for its Burrito Bond II. 

However, alongside the successes, crowdfunding has also hit the headlines for the wrong reasons. This weekend saw the latest crowdfunding darling to falter – with Hop Stuff Brewery, which has raised £1.5m through Crowdcube – revealed to have been served with a winding-up order over unpaid debt.

It follows the dramatic collapse of the Burning Night Group earlier this year, which went into administration with £7.5m it had raised through Crowdstacker.

Despite the risks involved, the appetite for crowdfunding as a revenue raising tool shows no sign of slowing down, according to Barry E James, founder of The Crowdfunding Centre, whose business has tracked more than half a million crowdfunds from end-to-end over the past five years.

“Where once it was considered esoteric, now it’s pretty normal and well accepted – we get referrals from mainstream advisors quite often now,” he explains. “It’s branched into new areas. Over the last couple of years, we’ve seen huge crowdfunding flows from ICOs, which are a form of crowdfunding, and have raised billions. While that’s died off a good bit this year, the more traditional forms of crowdfunding continue to grow steadily.”

AlixPartners also believe there is a still a place for crowdfunding, but that it’s not for everyone. “It is a viable form of funding but in general this is for very early stage companies that otherwise might not be able to obtain funding at all, as they haven’t been trading long enough or are too small or too early stage for more professional investors. It can replace the traditional need for funding from friends and family,” says Craig Rachel, senior vice president - corporate finance, AlixPartners.

The funding need is also driven by the weak banking market. Lack of debt funding has created a potential need for crowdfunding from slightly larger operations, where traditionally you would have used debt to part fund expansion, adds Paul Hemming, senior advisor at AlixPartners.

What makes crowdfunding more deliverable in this day and age is the fact companies have a better social media presence, says Rachel. “You have a lot of companies that are developing real brand loyalty with customers,” he explains. “Companies that do particularly well are those who have a very clear brand identity and social media presence, so consumers feel they can identify with them. Those are the ones that have the potential to generate significant interest whilst fund raising.” BrewDog is a case in point, he says.

“BrewDog are masters of relationship marketing,” says James. “They put themselves out there to really relate to their customers. They’ve got a certain style, a panache that cuts through and makes them interesting. They’re nothing if not memorable. And they make sure that when you buy in it’s into a gift that keeps on giving – they know how to treat their investors and their customers.”

While the early stages of BrewDog’s Equity for Punks crowdfunding campaign may have tempted casual investors, or fans of the brand, with discounts of their beer, its latest campaign is offering to make one lucky investor a “BrewDog millionaire” by giving away £1m worth of unlisted shares.

Hemming adds: “The initial BrewDog fundraisings were treated like buying a discount card by the small investors, as the shares entitled owners to discounts on future purchases. Others such as Chilango’s Burrito Bond have taken the same approach, but none has been as successful as BrewDog. Crowdfunding has been at the heart of BrewDog from the start because they didn’t want to go down the route of institutional equity.”

Whilst it is difficult to place a value on a very young businesses, if you look at the valuations placed on most sector crowdfunding processes, they are significantly above the level that a professional investor would have placed on the business, says Hemming.

“If someone is putting in hundreds of thousands of pounds then the valuation will certainly come under a lot of scrutiny,” says Rachel. “But the typical crowdfund investor is putting in relatively small amounts of capital on the off chance it may be successful – it’s a bit like a bet – and they tend to ignore the valuation metrics. Adds Hemming: “Crowdfunding in the sector is filling a gap in the market and allows entrepreneurs the chance to follow their dreams. The risk is that start-ups are, by their nature, high-risk situations so a proportion of them will inevitably fail.”

Rob Murray Brown, founder of equity crowdfunding consultants ECF Solutions, says he frequently hears from disgruntled people who’ve invested in businesses that may have never had a “hope of success”.

“One element we have identified which no-one really reports on is the very high rate of zombie companies,” he says. “Once funded a company can stay open for ages without doing much – i.e. not trading as projected but not closed. And very little information is given to shareholders. Investors need to be aware that some companies are using equity crowdfunding as a last-ditch attempt to carry on,” he insists.

“They don’t sell it like that – hence the information asymmetry. Platforms don’t care as they only get their commission if a company raises the full amount or more. And they do need their commission as they are all making large losses,” he adds.

So, what’s the answer? Murray Brown argues that crowdfunding platforms must become “selective and diligent” and at least take some liability for “catastrophic failures”. The Government, he adds, could help by using SEIS and EIS to control this.

He warns that the future of equity crowdfunding will only continue to be successful if things change. “Eventually investors will dry up if they don’t see some success. Even with BrewDog, success is only on paper,” he says.

While most companies on crowdfunding platforms are trying to raise capital to open their second or perhaps third site, when operators need to start raising multiple millions of pounds, the sort of money you need to do a roll out, then you need more than individual investors putting in a couple of hundred quid each. For most this means turning to more traditional funding lines, with BrewDog being the standout exception, says Hemming.

“Most of them have to move to some sort of professional investor, maybe a Venture Capital Trust (VCT) or mainstream private equity to get the right level of investment. Professional investors will drive structure into the business through experienced management and more comprehensive reporting requirements. For most this is a beneficial step, but it can be a hard adjustment for some entrepreneurs” he says. “Most people would say that it’s an important step in growing a business, but others like BrewDog want to do it their own way. The question for owners to ask themselves is - what do you really require as a business in the cold light of day to be as successful as you can be?”. That will determine the best route for you, he says.

Further down the line Rachel says he can see VCTs potentially underwriting crowdfunding platforms to a certain extent as the platform continues to become more mainstream, although these professional investors are likely to want to invest at valuations that are less racy and more closely aligned to the market.

In terms of the UK restaurant market, private equity is understandably cautious given Brexit and weak consumer confidence. “They are currently more focused on less volatile sectors, whilst they wait for the opportunity to buy for value at the bottom of the market. If they get the timing right they will make lots of money as the market comes back, but they won’t rush into it,” adds Hemming. “I think everyone was holding on for Brexit to see what that meant, so the delay doesn’t help. Whilst the restaurant market is tough, private equity funds are still active and interested in the pubs and bars market, where the sector is deemed less saturated and in growth.”