Small Talk: Is crowdfunding good? Depends which government arm you ask

Is equity-based crowdfunding an accident waiting to happen or a valuable new source of growth capital for fledgling businesses? It appears that one arm of government tends towards the former view while officials down the corridor take the latter approach.

In the negative camp sits the Financial Conduct Authority (FCA), the chief City regulator, which last year took on formal responsibility for regulating crowdfunding platforms – both sites where investors lend money to companies looking for finance and those where their money gets them an equity stake in the business.

While the FCA appears to feel relatively comfortable with the concept of loan-based crowdfunding, it is much more wary of the equity-based platforms. It has previously insisted that these sites are only suitable for the most sophisticated investors and warned that “it is very likely you will lose all your money”. Last week, the regulator returned to the fray, warning that some equity-based platforms were misleading investors about their chances of making a return.

Meanwhile, the FCA’s colleagues at the Treasury are apparently far less anxious. They continue to offer investors incredibly generous tax breaks for putting their money into small businesses raising equity on crowdfunding platforms. The seed enterprise investment scheme (SEIS) is not specifically aimed at the crowdfunding sector, but almost every business raising equity from crowdfunding qualifies for inclusion – and the valuable incentives on offer add significantly to the allure for investors.

The fact that these two public bodies are not singing from the same songsheet is easily explained. The Treasury is desperate to stimulate investment in small businesses, particularly given the reluctance of the banks to provide capital. The FCA’s primary duty is investor protection: while it doesn’t want to strangle financial innovation at birth, its priority is to prevent another damaging mis-selling scandal in the financial services sector.

Nevertheless, investors need to hear a consistent message. When the Government grants tax breaks to a particular type of investment, the implicit message is that it is safe for investors to proceed – indeed, the credibility that tax incentives provide can be just as valuable as the financial benefit they offer. If this credibility is then undermined by regulators, investors don’t know where they stand.

The truth about equity based crowdfunding is that no one should invest money they can’t afford to lose. Some platforms mitigate the risks more effectively than others – they’re more discerning about which businesses they allow to pitch for funds, for example, or they work with businesses that are much further on in their development than the riskiest start-ups. Nevertheless, investors who put money into illiquid assets where there is no timetable for even a provisional return of their cash should not be surprised to lose the lot.

Equally, any crowdfunding platform that doesn’t make equity investors aware of these risks is acting irresponsibly. As the facilitating party in the investment process, the platform is obliged to ensure both sides of the transaction are well informed about the risk and reward profile of the deals in which they’re engaging. Regulators are right to seek to ensure that is happening.

The appeal of equity-based crowdfunding is, in the end, twofold. Some investors genuinely like the idea of supporting growing businesses. And all investors hope that the companies they back will turn out to be big winners – one huge payday for the crowd might more than compensate for a series of disappointments.

This is an immature industry that has so far raised only tens of millions of pounds from investors. It needs to be given a chance to develop, with platforms working together through bodies such as the UK Crowdfunding Association to introduce common standards and values. Regulatory scrutiny will be important in that process, but let’s not be draconian.

Where platforms have been upfront about the risk of equity-based crowdfunding, investors who lose money can’t complain they weren’t warned.

Small businesses could be among the biggest losers if plans to change the legal aid laws go ahead, insolvency professionals are warning. R3, the trade body for the sector, opposes proposals to stop making legal aid available for firms involved in insolvency litigation – it warns the reform will cost £160m a year.

Ministers want to get the cost of legal aid down, but its proposals would prevent those without the means to finance legal action themselves from seeking redress in insolvency cases. That has alarmed MPs, with figures including the shadow Justice minister, Andy Slaughter, signing an Early Day Motion that calls on the Government to reconsider the changes, which are due to come into effect in April.

“If the Government presses on, bad behaviour by directors will be harder to reverse and up to £160m of creditors’ money will stay in the wrong hands every year,” argues Giles Frampton, the president of R3.

Biotech companies have in recent years found the UK markets difficult to tap for funding, with US investors tending to show more enthusiasm for them. However, the appetite for biotech appears to be increasing, following a stellar year in 2014 for returns from healthcare companies.

One company hoping to embrace the UK’s newfound enthusiasm for the sector is Motif Bio, a US firm with interesting antibiotics in development. It intends to raise up to £16m in a flotation on the Alternative Investment Market, ahead of plans to get its most advanced drug into final-stage trials during the second half of the year.

Motif Bio will have been buoyed by Friday’s announcement by the leading fund manager Neil Woodford that he is to launch a investment company specialising in unlisted and small company biotech businesses. He has been a cheerleader for biotech firms in recent years.

“I launched my vintage furniture restoration business in 2012. It was a complete change for me – although I’d been running my own business providing administration services, this was completely different.

“The business began as a hobby, really – I found a couple of bits of old furniture which I restored for fun and then was able to sell them; I reinvested the profits, and it all began from there.

“By 2014, I realised that my hobbyist business had turned into something much bigger than expected, and that it was more profitable than the admin company, so I made it my full-time venture. It also fits in around my young son much better, because I can work at any time of the day or night, depending on when I need to.

“Sales grew by more than 500 per cent last year and although it’s just me at Florrie + Bill, I work with other small businesses to fulfil orders. I use a local firm of upholsterers, here in Leicestershire, to do some of the work; I source all the business and strip down the furniture and they finish the work to my designs.

“Working this way enables me to be very flexible as business comes in – plus I’ve been able to increase my capacity.

“I work for individual clients but also with several firms of interior decorators, who use my pieces in projects such as apartment developments.

“By 2016 I hope to be in a position to open a workshop to increase capacity still further, and I’m thinking about taking on an apprentice. The business has developed much more quickly than I anticipated.”

@davidprosserind