The internet bubble that peaked two decades ago, as 1999 became 2000, has a lot to answer for. Dragon’s Den, for a start. This show, which has been through 16 series and 17 dragons to date, is based on a Japanese TV format, The Tigers of Money, with its roots in the internet boom years. Aired in Japan from 2001 to 2004, it was subsequently sold to producers around the world, reaching the UK in 2005 and going on to spawn local versions in around 30 countries.
The fascination with start-ups and multimillionaire entrepreneurs that took hold during the late 90s internet bubble, when vast paper fortunes were made and lost overnight, has embedded itself deeply in our popular culture. When the world’s first equity crowdfunding website, Crowdcube, launched on 15 February 2011, its British co-founders, Darren Westlake and Luke Lang, declared, “Instead of competing for limited business angel or venture capital funding, start-ups can use Crowdcube as a platform to connect with a nation of ‘armchair dragons’.” Crucially, the entrepreneurs vowed that anyone would be able to invest in start-ups with as little as £10.
Eight years on from its emergence, equity crowdfunding has attracted hundreds of thousands of private investors and hundreds of millions of pounds of equity to back early-stage, extremely high-risk ventures. There have so far been very few standout successes and numerous flops and failures – exactly as you would expect in what is undoubtedly the riskiest area of equity investment.
Many critics argue, with considerable justification, that making it easy for anyone who fancies it to put small sums into a start-up business is a recipe for losses and disappointment. They are right. Trying to pick the winners from a menu of start-up pitches on a website is closer to punting on the horses than it is to investment.
But what about those – admittedly the minority – who want to invest in start-ups as a broad asset class, rather than trying to pick individual winners? Online equity crowdfunding websites make that possible, because they allow us to divide our money between scores or hundreds of pitches, committing as little as a few pounds to each. That was never possible before these sites came along. Instead, an angel investor would have had to put at least £10,000 into each venture: building a well-diversified portfolio of start-ups required six-figure sums.
Picking the winners from a menu of start-up pitches is closer to punting on the horses than to investment
However, while making it possible to invest in start-ups as an asset class, the crowdfunding websites do not make it easy. This is why I’ve been watching developments at a couple of the main equity crowdfunding websites with some interest. Over the past year or two, both SyndicateRoom and Seedrs have opened funds that allow investors to put their money into a single vehicle (with Enterprise Investment Scheme tax relief) that automatically spreads it across a large group of start-ups pitching for funding on their websites. The idea is to produce a well-diversified portfolio (100 businesses in the case of Seedrs, around 30 with SyndicateRoom) that gives decent odds of a positive return. While SyndicateRoom’s fund is aimed at wealthy individuals able to subscribe a minimum of £10,000, investors can put as little as £1,000 into the Seedrs fund.
The key to both funds is obviously diversification – for all practical purposes, the start-up investor’s only true friend. High minimum investment thresholds are not the only reason diversification in start-ups has been hard to achieve historically. Another is that the specialist funds previously on offer had very concentrated portfolios, often containing fewer than ten companies. At that level, the benefits of diversification are limited.
The arrival of funds with much broader early-stage portfolios is a step forward. However, important questions remain. Are the charges reasonable? How diversified are they in practice? A fund that contains ten aspiring boutique spirit brands, for example, will be less diversified than its investors might suppose. To be more sceptical still, might managers of the equity crowdfunding website relax their criteria for accepting start-up pitches, telling themselves that diversification alone will be enough to protect their investors’ interests?
The best answer I can give is that I hope not. With funds like these we are seeing the start of something new: start-ups are becoming a properly investable asset class, rather than a collection of betting slips. The investors who use these funds won’t make ten times their money, but they can hope to make a positive, uncorrelated return by adding some venture capital-type risk to a more conventional portfolio.
Sadly, for most, that will prove far too dull a proposition – human nature being what it is, we will prefer to continue investing as though we were on Dragon’s Den. But if, instead, we put most of our stake on the sort of each-way bets these funds offer, the odd 100/1 shot wouldn’t hurt.
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This article first appears in the July 2019 print edition of The Review. All members, excluding student members, are eligible to receive the quarterly print edition of the magazine. Members can opt in to receive the print edition by logging in to MyCISI, clicking on My account, then clicking the Communications tab and selecting ‘Yes’.
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