For the uninitiated, this is the world of crowdfunding. This evocative but vague term covers three broad business models. The first is fundraising for charitable or cultural causes; if there is any expectation of return, it is not financial. The second is peer-to-peer lending, as popularised by Zopa and Funding Circle: investors lend money at fixed rates of interest. But I'm writing about the third and least known form of crowdfunding, which involves buying equity stakes in start-ups.
There are two main internet platforms, Crowdcube and Seedrs, which are both growing exponentially. These act like stockbrokers, vetting ideas - Crowdcube co-founder Luke Lang says three in four applications are rejected - and then promote the chosen few on their websites. If these prove a hit with investors, the platforms take a cut of the funds raised (Seedrs also charges investors a share of gains).
One company currently on the Crowdcube platform is SuperJam, a maker of "no added sugar" jam that sells through Waitrose. It set out to sell a 10 per cent stake in the business for £250,000 - valuing the company at £2.5m - but the fundraising is already oversubscribed, with £279,150 pledged by investors at the time of writing. The money will fund a packaging refresh and promotional push. The pitch on Crowdcube's website describes the "boom in home baking" - presumably inspired by the Great British Bake Off - and the growing popularity of "natural" products. SuperJam wants to stake out a high-end position in this market, as Innocent has for juices and Tyrrell's for crisps.
Consumer goods companies such as SuperJam feature heavily on both platforms, as do retailers and restaurant or café chains. Seedrs offers people the "opportunity to invest in businesses they feel a connection with", explains chief executive Jeff Lynn. The other over-represented sector is technology, particularly for Seedrs, which is based in Shoreditch, London's tech hub.
The crowdfunding revolution raises some interesting questions for stockpickers. Most obviously, how is investing in a company through Crowdcube or Seedrs different from investing on the stock exchange?
Very different, stresses Mr Lynn. He warns against the "doll's house fallacy" - that start-ups are simply scaled-down versions of bigger companies. "You don't want to invest in start-ups that will make you a bit of money, because a bit of money will never compensate you for the risk. You want companies that, if they don't change the world, can at least change their market niche." The practical implication of this insight is that diversification is even more important than usual. "You're investing for the one-in-five chance of success - and in fact really for the one-in-100 chance that the company really will take over the world."
But these probabilities remain a matter of guess-work. Crowdcube only started operating in 2011, Seedrs a year later. They do not yet have the track records to show either the average returns on offer, or the risk as measured by the failure rate. The only real guide to the sector is an academic study tracking the period from the late 1990s to the late 2000s. It found that UK start-ups delivered annual returns of 22 per cent, without much correlation to the economic cycle. Crucially, however, almost all the returns came from one in 10 stocks.
Another difference between investing on the stock exchange and through a crowdfunding platform is liquidity. Shares in companies such as SuperJam are unlisted, so there's no easy way to get your money back. If the venture does not turn out as planned, you'll almost certainly lose everything. Even if it does turn out well, you will not be able to dictate when the investment is realised.
But perhaps the more interesting question raised by crowdfunding is existential: just how fun should investing be? The wonder of these platforms is how they take finance back to its roots, connecting savers with companies that want to invest. They are the ultimate example of the seductive trend towards disintermediation - the cutting out of middle-men. Without middle-men, however, the risk is that finance becomes a media circus, with money flowing to the most charismatic entrepreneurs and consumer-friendly business ideas rather than the most economically useful or financially promising ones. Take it from a journalist: beware a good story.
