John Mulheron warns that following the “crowd” is an investment into the unknown

Since it’s explosion around five years ago, the ‘alternative funding market sector’ has grown to around £3.2 billion in value, but there is still little protection for amateur investors looking to take a punt on a fledgling start-up.

Between 2011 and 2013, 367 businesses have secured funding, however, a fifth of those have ceased trading with investors seeing their ‘hard earned’ disappearing down the plug hole.

Exciting new business

Whether the growth has been fuelled by non-existent interest rates, clamp downs by successive chancellors on the buy-to-let industry, or that it gives someone a feeling that they can directly make a difference to an exciting new business, any hard evidence is purely anecdotal and largely personal.

There are also attractive tax breaks if you’re investing in certain sectors through the Enterprise Investment Scheme which can be tempting. But are such risks out-weighed by the chance to own a piece of the next tech unicorn?

To date, I am only aware of two companies that have returned a profit to its ‘crowd’. One is the E-Car club, which secured investment back in 2013 and was subsequently acquired by Europcar in 2015 with backers receive two and half times their investment.

Whilst there are going to be other success stories, the cold reality is only 45% of start-ups make it past the fifth birthday and this should ring alarm bells for anyone looking make a few quid. The trouble is, there is very little research an amateur investor can gather.

The diligence and rigour banks or corporate funders go through before committing is pretty tough. We have a range of tools at hand to evaluate risk and spend time looking at business plans, the wider market place and take a view on the ability of the board of directors to deliver. Whereas the man on the street often decides by little more than a gut feeling!

Many of these start-ups won’t have audited accounts to view or even a robust business plan and forecasts to analyse.

Challenger bank – no licence

Yes, the idea or business concept may be exciting on paper, but can that idea be fully commercialised? The challenger bank Monzo raised £1 million in just 96 seconds without having succeeded in actually having a banking licence. Does that seem sensible to you?

Often the ‘crowd’ backs a business because of its ethical stance. Whilst this is very noble, it’s nothing more than a warm and fuzzy reason to invest.

There are three principal types of crowdfunding. From a simple ‘donation’ to a community cause or project where generating a return isn’t the end game to funding debt, which is ‘peer to peer’ lending where you’ll receive payments against the interest. The last one is equity funding, where you’ll receive a share or small stake in the business. Essentially, it’s a ‘pop up’ stock-market!

On the flip side, why has it become attractive for start-ups to side step the more traditional methods of raising capital?

In today’s financial industry there has never been so many ways to kick start a business and we’ve also seen a growth in angel investing, where entrepreneurs provide funding and mentoring to business creators. This can be really attractive, especially if you’ve got the ideas, but neither the skills, personality or little black book of contacts that can immediately open doors.

A large part of the problem for micro entity businesses getting going has been due to the major high street banks.

Mountains of cheap cash

We have commented a number of times in this blog about how various funding schemes or initiatives haven’t been fully delivered on with banks preferring to keep the mountains of cheap cash offered up by (Chancellor of the Exchequer) Mark Carney on their own balance sheets for self-gain.

RBS, one of guiltiest parties has regularly been accused of pulling funding from SME’s, putting many in grave financial danger or worse still, letting them go to the wall.

Research by insurer RSA cites around 80% of businesses fail due to cash flow which, in many cases with proper planning can be avoided. Using a professional corporate funder, solutions such as debtor financing or confidential invoice discounting can make a difference.

Unfortunately, you won’t get that sort of advice from several thousand crowd investors.

It’s time we looked at these failure rates for start-ups. The UK is one of the most attractive countries in the world to take a seed of an idea and turn it into a reality. With Brexit, we have an opportunity to rid these businesses of the mountains of red tape that burden our ambition. Our tax laws run to thousands of pages and directors – often wearing several ‘hats’ – are bogged down with planning, health and safety, employment laws…..the list goes on.

Clearly the world of crowdfunding is of direct competition to independent asset funders like ourselves and it’s healthy to have a wide range of options available. In some cases, it works and but it’s vital to look at all the risks associated before committing. Plus, as any financial advisor will tell you, investments need to take a long term view. If it were that easy to double or treble your money, we’d all be stinking rich.

Perhaps the biggest reason for rise in alternative finance is simply sticks two fingers up at the banks. And that erosion of their market share is purely of their own making. Will they learn? Probably not!

John Mulheron is managing director of CMF Capital www.cmfcapital.co.uk