#edGY: Equity crowdfunding and lessons from NZ

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BY the end of this year, Malaysia would have had its first taste of equity crowdfunding as an alternative route for businesses to raise capital. This will supplement the host of available sources of funding, such as private investors, angel investors, venture capital funds and bank borrowings.

Equity crowdfunding is relatively new to the region. Most people are familiar with reward-based crowdfunding via platforms like Kickstarter, where the crowd pledges money in return for rewards, often in the form of products.

There are also crowdfunding platforms that are entirely donation-based, where people support a project or an idea with funding because they believe in it.

But with equity crowdfunding, the crowd comes in as investors who fund a business in exchange for a stake in the company.

The promise of equity crowdfunding is that growing businesses have improved access to financing. But there’s also something for investors. Now, retail and sophisticated investors have an avenue to invest in fast-growing companies.

#edGY reached out to Josh Daniell — co-founder and head of platform at Snowball Effect (www.snowballeffect.co.nz) — for some insight into how the New Zealand-based equity crowdfunding platform that has been showcasing deals since last year is faring.

So far this year, Snowball Effect has completed two multimillion-dollar deals: Invivo Wines, an Auckland-based winemaker, raised four times its target of NZ$500,000 while Aeronavics, a Waikato-based drone maker, raised double its initial goal of NZ$750,000. Invivo sold 20% of its equity to 439 investors for NZ$2 million while Aeronavics raised NZ$1.5 million after selling 15% of its company to 213 investors.

Our Q&A with Daniell gives an idea of what companies are suitable for equity crowdfunding, how valuations should be done and how companies can harness their “crowd” of investors to help give their business a boost.

#edGY: What companies are suitable for equity crowdfunding?

Josh Daniell: Equity crowdfunding is typically better suited to raise growth capital rather than seed capital. Later-stage companies are more attractive to small, passive investors because they are more likely to have governance and other structures that give these investors comfort. They are more likely to give investors a good experience.

Companies need to be aware of the range of capital-raising options available to them. Equity crowdfunding will not always be suitable — the company may be better suited to debt, angel investors or other expansion capital solutions like joint ventures.

A suitable company will typically want to tap into one of the three key benefits of equity crowdfunding: Access to a large investor pool; brand exposure; and efficient capital-raising process.

You’ve seen the equity crowdfunding model take shape in New Zealand. What are some of the key points Malaysia can borrow, considering that we are a slightly different market?

Focus on quality over quantity. Equity crowdfunding markets will struggle if sophisticated investors are not investing. These investors will only come if the deal flow is of high quality.

Next, keep the regulatory regime light. This reduces cost and allows the platforms to respond quickly to market demands.

Platforms should focus on the investor side of the market. Equity crowdfunding will only be sustainable over the long term if investors are making returns that are commensurate with the risks.

What due diligence needs to happen before a company can be accepted on Snowball Effect?

Our vetting boils down to whether we think an offer will be successful on the platform.

A whole host of factors feeds into that judgment, including the usual things like investment readiness and valuation. But also factors that are more relevant to equity crowdfunding, such as the amount of any pre-arranged funding and the size of the audience that the offer can easily be marketed to.

Who determines the valuation of a startup?

Valuations are set by the issuing companies.

We see some tensions arising as a company works through its valuation process. First, there’s the obvious incentive for a company to value itself high so that existing shareholders retain more equity. However, there are a number of incentives for a company to set a valuation that’s perceived as fair by the market:

1. A company will face negative response from sophisticated investors if the valuation is perceived to be too high, decreasing the chance of the offer succeeding and potentially resulting in a waste of time and money for the company.

This can happen to companies of all sizes — we saw this with a company called Hirepool in New Zealand last year. The company was looking to IPO (initial public offering) but was shunned by brokers on the basis that the valuation was too high. A failed offer may be more than just a waste of time and money; it could actually damage the company’s reputation.

2. Many high-growth companies will require multiple funding rounds to achieve their desired rate of growth. Early funding rounds that are overvalued will cause disappointment to early investors and potentially alienate them from subsequent rounds.

Many startups are a bit apprehensive about equity crowdfunding. The worry is that there’ll be a need to manage a big pool of random shareholders versus getting in one or two VCs (venture capitalists) or angels that can also provide mentorship. What do you say to that?

Management of shareholders is easy with the right technology and legal structure. In New Zealand, companies can outsource management of the share registry for NZ$1,800 per annum. Shareholder communications are done electronically. If a company doesn’t want a large number of shareholders for some reason, it can use a nominee company to group the small shareholders.

Companies should be looking for more than cash from their investors. They should also be looking for the added value that will increase the worth of their business.

High-growth businesses are often looking for ‘smart money’ — cash from investors like VCs and angels who bring networks, experience and expertise. VCs or angels could well be the best option for a company, depending on its circumstances.

However, I think that ‘crowd money’ — investment through equity crowdfunding — has the same potential as smart money. Each crowd of shareholders comes with a wide range of experience and expertise.

The question is whether a company can tap into these assets. If so, it can mobilise a powerful skill base.

How is this done?

First, the company needs to understand the skills that sit in its crowd. Equity crowdfunding platforms should play a role here by collecting this information about investors and passing it through to investee companies if they have the investor’s consent.

This will allow the company to see, for example, that Mary Edwards, a new shareholder, is a digital marketing specialist and would most likely be happy to give a helping hand. Or that Tony English distributes similar products in Japan and South Korea, two of the company’s target growth markets.

Aeronavics is one of the companies that raised funds through Snowball Effect this year. It has already shown examples of this by finding a legal mentor and employee candidates among the shareholder base.

Secondly, along with experience and expertise, crowd money comes with a large network of supporters.

We typically see a jump in revenue after a successful equity crowdfunding offer. This is driven by two things: the broad public exposure of the company during the offer and the new shareholders advocating the company.

Shareholder communication has generally been seen as an obligation rather than an opportunity. But companies can get ongoing value from their network. To unlock these benefits, companies need an effective shareholder communication channel.

We’re not talking about snail mail with high-brow legal and financial information but engaging electronic information about new products, new customers and new opportunities for the company. This information will keep the business top-of-mind for shareholders and will power up the crowd.

Brewdog, a Scottish brewery, is an example of a company that has leveraged its wide shareholder base well. That’s been one of the drivers of average increase in revenue of over 160% over the last five years.

A clean tech business called CarbonScape raised funds on Snowball Effect last year and has seen a slightly different network effect. It was receiving sporadic interest from potential investors, collaborators and customers. The public offer turned this into a steady stream, particularly from offshore markets. CarbonScape is currently in commercial discussions with parties in the UK, China, Norway and Australia.

In short, when a company is looking at equity crowdfunding, it is looking for more than cash. It is looking for the marketing benefits of a public offer. It wants to harness the network effects of a wide support base.

There’s real value on the table for companies that do it well.


This article first appeared in #edGY, The Edge Malaysia Weekly, on June 8 - 14, 2015. Read more here