June 9, 2014 12:13 am

Crowdfunding gives entrepreneurs cheaper and faster finance

Rather than going cap in hand to a banker, those with a fledgling business can resort to crowdfunding – going straight to investors – and customers – for the money, often at cheaper rates.

Sites such as Seedrs in the UK and Lending Club in the US bring lenders and borrowers together, while others facilitate early business equity investment.

Steve Case, founder of AOL, and chairman of the Case Foundation, believes it can create “Silicon Valleys everywhere” by enabling entrepreneurs anywhere to access funding.

The amount lent by such peer-to-peer sites was almost $3bn in 2013, up from around $100m in 2007. The estimated number of sites has grown from 1,100 to 2,700 in the last year.

While the US and UK, as well as some other northern European countries, have been the fastest to adopt crowdfunding, it originated in Australia.

Since it was set up in 2006, the Australian Small Scale Offerings Board (see illustration) has raised A$138m (US$128m) for more than 200 businesses. It will provide up to $5m per transaction but all companies seeking finance must have their books reviewed by a qualified accountant.

While the internet has enabled transactions, it is only one of the drivers of this rapid growth, says Richard Swart, director of research on crowdfunding at the University of Berkeley, California.

Prof Swart says the financial crisis was the biggest cause. Banks were restricting lending just as people became accustomed to online financial transactions.

“Access to bank lending for small businesses collapsed around the world. There also seems to be a general distrust among the millennial generation of anything institutional. They trust the power of other humans to make decisions.”

A slew of TV programmes featuring angel investors such as Dragons’ Den and Shark Tank have also helped to demystify entrepreneurship and give younger people new role models.

Finally, there was an older generation who suffered the loss of a job and a sharp reduction in their stock market-linked savings plans. People over 50 are the fastest-growing age group starting businesses in many developed countries.

“A lot of the growth is not driven by innovation but necessity,” says Prof Swart.

Venture capital firms are investing hundreds of millions as they see the potential to build fast-growing, high margin global businesses.

More countries are permitting crowdfunding and enabling cross-border business.

Canada, New Zealand and France have all revised laws this year to facilitate it. Korea saw $150m in lending last year.

Even the US is also lagging behind, with more onerous restrictions on business fundraising via crowdfunding than on stock exchanges.

Many regulators are searching for a way to protect consumers from failures. The industry is young and there have been a few high-profile failures but most sites offer no protection against default.

Many platforms run secondary markets but others do not, leaving investors with a stake in the business they are unable to sell for several years.

If regulators forced the new platforms to operate the same risk controls as banks it could eradicate some of their competitive edge.

Nevertheless, the efficiency of the software-driven websites, issuing consumer loans within minutes and business ones within days, means banks are as likely to join forces with sites rather than compete.

Prof Swart says the typical SME loan was processed for around 40 per cent of the cost of a bank loan.

The biggest bar to growth remains ignorance. Nicola Horlick, a former fund manager for Morgan Grenfell who earned the nickname “Supermum” for combining life in the City with six children, in May launched Money & Co, a crowdfunding business, in the UK.

Money & Co commissioned a survey that claimed UK SMEs had an annual unmet need for finance of £4.3bn. The study, conducted by research agency Populus, asked senior management at 300 SMEs about their last loan application, comparing it with the average sum awarded. The difference, extrapolated across the UK’s 404,175 SMEs, was £4.3bn.

While half of respondents agreed that bank bureaucracy was a deterrent when applying for a loan, 72 per cent would still approach one first for a business loan.

Only 4 per cent would consider crowdfunding as an initial means to secure finance, while 5 per cent would first approach an angel investor and 11 per cent would try government funds.

But while crowdfunding still only accounts for around 1 per cent of global start-up funding, there may, however, be wisdom in crowds. Prof Swart says that preliminary data suggests that companies with such funding do better than others. Around 70 per cent of firms were still in business after five years, reversing the usual statistic that 70 per cent fail in five years.

“We need more data to know for sure, but it seems like crowds select better businesses,” he says.

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