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Avoiding the crowded trade

Stephen Wilmot

Avoiding the crowded trade

Equity crowd funding is very exciting, but could easily turn into a media circus that ends up burning investors' fingers. That was the conclusion of an article I wrote in November after talking to the bosses of the two largest portals, Crowdcube and Seedrs. For those who share my concerns - but still want to invest in start-ups - a third player, Syndicate Room, may offer a solution.

All three companies run websites that match investors with entrepreneurs who need equity capital: that is what makes them equity crowd funders. All three pay themselves by charging companies a cut of funds raised (though Seedrs also charges investors a cut of investment gains). All three are authorised by the FCA, which guarantees that investors' money is being handled correctly and that research on investments is accurate - or entitles you to compensation if it is not.

But there are also slight differences between the platforms that show up the specific risks associated with this seductively direct approach to investing in companies. Anyone interested in crowd funding needs to pay very close attention, because apparently technical details can mean the difference between a good and a bad investment. Some are the kind of details stock investors don't typically have to worry about, because stock investing - unlike crowd funding - has decades of crises, experience and regulation behind it.

First, investments through Seedrs and Syndicate Room invariably come with pre-emption and voting rights. Those through Crowdcube may for larger amounts, but in most cases do not. CHOC+, the first investment currently available on its website, is a typical example. If you invest £5,000 or more in this "new, truly innovative chocolate brand" you receive 'A' shares; otherwise you receive 'B' shares with no voting or pre-emption rights. Co-founder Luke Lang says the average investment amount on Crowdcube is about £3,000, so we can assume most investors will receive 'B' shares if the fund-raising is successful.

What this means in practice is that CHOC+ can issue new shares to an important investor, such as a venture capitalist, without consulting or giving investment rights to existing B-shareholders. The risk - and it's a major one - is that investors find their stakes heavily diluted, potentially to the point where they are next to worthless. There is an oft-cited example of this problem in the film The Social Network: Facebook edged co-founder Eduardo Saverin out of its management team and down its share register in 2004-05 by issuing him shares without pre-emption rights.

Second, Crowdcube and Syndicate Room offer investors direct ownership of shares, whereas Seedrs amalgamates shares into a nominee holding. Investors who buy listed stocks through private-client stockbrokers will be familiar with the benefits and drawbacks of this approach. The key benefit is that amalgamation reduces costs, for the company, for the broker and hence for the investor. The drawback is that investors have a beneficial interest in a company rather than a direct stake. If something goes wrong, they will have to defend their financial interest through Seedrs, as the nominee shareholder, rather than as owners in their own right.

That said, there is a counter-argument here: that the nominee structure automatically gives investors a unified voice in any disagreement with a company's management. Of course, the test of such arguments will be practice. Equity crowd-funding is still too young to have thrown up problems highlighting where the risks really lie.

Finally, Syndicate Room, which was set up in late 2013, differs from its slightly older peers in offering deals negotiated by lead investors - typically wealthy entrepreneurs turned venture capitalist. These so-called 'angel' investors bring companies to Syndicate Room, and then - crucially - negotiate a single buy-in price for both themselves and other investors on the platform. This effectively gives retail investors the chance to free-ride on the expertise and negotiating skills of an experienced investor, who is often a specialist in a given field.

One result is that the companies listed on Syndicate Room don't have the same strong bias towards consumer industries as those on Crowdcube or Seedrs. Of six investments currently listed on Syndicate Room, only two have a strong consumer focus. The others are the kind of hard-to-grasp businesses you often find on Aim: a technology for testing foods for a certain toxin, an e-commerce distribution platform, an LED-light therapy for skin problems and a brand of carbon-composite wheels.

This takes some of the fun out of equity crowd-funding: it's less Dragon's Den and more, well, Investors Chronicle. And having 'angels' on board is obviously no guarantee of riches. But if you worry that fun isn't necessarily good for your wallet, and that investment probably shouldn't be like internet shopping, Syndicate Room is probably the platform for you.

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