Crowdfunding giving young companies a leg up
10 February, 2015
What is crowdfunding and what is all the fuss about?
Crowd funding operates by many people (i.e. the crowd) putting in small amounts of money to support either a project or company usually by way of a website platform.
There are actually three types of crowdfunding:
- Social crowdfunding: this is for projects where financial supporters receive rewards or simply make a donation.
- Debt crowdfunding (also known as peer-to-peer lending): where funds are raised for a business or individual and investors who lend the money receive interest on their loans.
- Equity crowdfunding: which is what we're talking about tonight, where funds are raised for a business and investors receive shares in the company.
All three types of crowdfunding are really starting to take off. Some listeners may have read about a New Zealand brewing company called Yeastie Boys that raised $500,000 within half an hour of the offer opening when the target was only $350.000. I saw one estimate today that over $9 billion was raised worldwide in crowdfunding in 2014. So it's growing quickly and undoubtedly here to stay.
What are the upsides and downsides of equity crowdfunding in New Zealand?
The upside for potential equity investors is that they can invest relatively small amounts of money in young companies that one day may very well grow into a large company — essentially they are getting in on the ground floor.
The upside for companies is that this they can potentially get financing that may not otherwise be available to them i.e. from traditional sources like banks.
The downsides are considerable for potential investors. It is a fact of life that many new, small companies fail and so investors should only invest money that they can afford to lose. Also, there is currently no secondary market for crowdfunding company shares, so investors need to be investing for the long term — they may not be able to sell their shares when they need or want to.
The downside for a company looking to raise funds is that this type of funding is not cheap — crowdfunding platforms typically charge over 6% of the funds raised as a fee.
What safe guards are there for investors who are looking to invest through one of these equity crowdfunding platforms?
The Financial Markets Authority (the FMA) has been proactive in this area and currently licensed four companies to provide crowdfunding services in New Zealand and other licenses will undoubtedly follow. These equity crowdfunding providers are listed on the FMA website.
Licensed crowdfunding providers have been checked by the FMA to ensure they follow rules around helping investors get information with share buying decisions and have systems in place to handle disputes and complaints at no cost to the investor.
Another safeguard is that the most a potential crowdfunding company can raise money in any 12 month period is $2m. This prevents a crowdfunding company continually coming back for more money and diluting existing shareholders.
Whilst these safeguards are useful, this does not mean that equity crowdfunding is not without risk. Just to re-iterate, potential investors should only invest money they can afford to lose and that they must have a long term time horizon.
Right — well they're not liquid, are they?
No and that's an issue — having said that, there are moves afoot to try and create a platform. There was news over the weekend that there are various players trying to position themselves to do that and that would certainly help this sector.
So in summary, what do you think of the equity crowdfunding initiative?
I think that in many ways, it is the way of the future. This is essentially a new form of funding for young companies who may not otherwise get the funding through traditional avenues.
We are hopeful that it will be a great breeding ground for companies who will ultimately become big enough to list on the NZX and grow into truly great New Zealand companies in the future.