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Equity crowd funding, latest step in much-hyped social capital, carries risks, high failure rate

Equity crowd funding, which became legal in New Zealand this month, comes with a high risk of failure based on figures showing existing forays into social capital have a success rate of less than 50 percent, one new entrant says.

The Financial Markets Conduct Act, which came into effect on April 1, allows businesses to crowd fund by offering equity of up to $2 million without the burden and costs associated with a prospectus, effectively giving investors skin in the game rather than getting a 'reward' or making a donation. The Financial Markets Authority has received 12 expressions of interest from companies wanting to set up as equity crowd funding platforms, of which two have applied for a licence.

"The balance of probabilities sits on the side that they won't be successful and that's going to be a challenge for the companies wanting to raise money, and it's also going to be a challenge for the crowd funding platforms," said David Wallace, director with Armillary Private Capital, which has teamed with UK-based Crowdcube to apply for an equity crowd funding licence.

"There are some very real risks for a number of the crowd funding businesses themselves, whether they can build a sustainable business model - that's probably a question globally for all the crowd funding platforms, not just for New Zealand ones," Wallace told BusinessDesk.

Armillary is the operator of the Unlisted share trading platform. Partner Crowdcube of the UK began in 2011 and has raised more than 22 million pounds.

Kickstarter, the US-based crowd funder which has garnered more than US$1 billion in pledges, has a success rate of about 44 percent. Last year 3 million people pledged US$480 million, or US$1.3 million a day, on its website, according to its own data. Of 198 New Zealand-based projects listed on the site, 103 had been unsuccessful or cancelled, 24 were in the process of fundraising and 71 had secured funding, a success rate of 35 percent for kiwi projects.

"We know from experience in the UK that 25 percent of pitches that actually get to Crowdcube actually get activated on the platform, and of that about 25 percent actually get funded, so you're probably talking about 8-and-a-quarter-bit percent that actually get funded of those looking for funding," Wallace said.

Wellington-based crowd funder PledgeMe is another group planning to add equity-based crowd funding. The platform has been operating for the past two years and claims a 49 percent success rate, having raised more than $2.5 million for some 560 projects. Auckland-based Snowball Effect says it has 11 companies looking to raise funds through its platform.

The FMA says the purpose of licensing is to ensure members of the public are given all the information they're entitled to in the absence of a requirement for a prospectus.

"The real focus of licensing the intermediaries is to make sure the customer gets real clarity over what the risks are, so it's not necessarily that they're reducing the risks, but making sure that there is a transparent disclosure of the risks," said Colin Magee a senior FMA adviser. "It might be that there isn't much information, but as long as it is clear what information there is and isn't that's sort of the job of that licensed intermediary."

Equity crowd funders would typically earn their fee from a percentage of the capital raised, meaning they get nothing if the offer doesn't meet its target.

Armillary's Wallace says its platform plans to restrict who it will accept and expects to successfully raise funds for six or seven companies a year.

Auckland-based MeMini, a wearable camera developer, raised US$94,300 on Kickstarter in February, exceeding its US$50,000 goal. Co-founder Sam Lee said he will follow equity crowd funding closely, but wasn't sure if his business would use it to raise more capital.

"Reward-based crowd funding is a great way to get seed money and to validate your concept and idea without having to actually go to market with a product," Lee said.

Queenstown camera company Syrp used Kickstarter in June 2012 to raise US$636,766, surpassing its US$150,000 target, for its Genie time lapse camera. Wellington-based Loomio, the makers of an app which facilitates online decision making and is part of the Enspiral Foundation, last week raised US$124,509, surpassing their US$100,00 goal using CrowdtiltOpen, a San Francisco-based crowd fund website.


Comments and questions

So one of the UK's leading equity crowd funding platforms has raised GBP22 million over three years. That is around NZ$45m, or NZ$15m a year. Given that the UK is say 15 times the size of NZ (poulation and GDP) then we are talking about the equivalent to $1m a year in NZ.

Based on a 5% fee that is $50k a year of revenues.

Maybe NZ will do more, but this is not the case for the donation based numbers Pledgme is running at about 20% the size of kickstarter adjusted for population / economy size.

There is absolutely no way the NZ market can support 12 of these plaforms, so a number will fold. My main concern is that some will become desperate and will over hype the deals being promoted (think about the financial advisors who flogged finance company deals to its client base just to earn commissions), and they will cost investors and then the whole market will collapse - e.g. the NZ equity market post 1987 (still struggling to recover investor confidence), finance companies etc?

Agree- NZ only big enough for one or two.

Interestingly GBP650k was raise in less than 24 hours yesterday, and it was for a reward crowdfund platform.

Interesting take, Suze!

In the rewards space, a 50% success rate is actually fantastic when you look at the aggregated success rate of creative grant applications in New Zealand (21%).

In the equity space, the numbers are a bit less transparent because we don't really know the success rate of companies seeking investment. We know that $57mil was invested by VC's in 2012 to SMEs, and $33bil lent by the banks. We also know from overseas studies that up to 5 x the amount invested by VC's is invested by family and friends. So, equity crowdfunding could be a great tool for making those rounds cleaner, easier, and more transparent (using technology like it should be used).

We've heard the concern from so many people in the financial sector about '87 - but I think the real difference here is how tech is being used, and that it's companies connecting to their own crowds (family, friends, and customers), not completely unrelated investors.

How big it'll grow, no-one knows. But, personally - we're stoked with how we've done over the last 2 years with over 560 projects funded, and we know equity crowdfunding will help more kiwis fund things they care about (their companies).

You say that technology will make this different to 87, what technology? In my view crowd funding of equity is not new it is called the stock exchange the only thing that is different is that companies have a much lower hurdle to meet. Which has to increase the risk for investors.

Good luck with this but some of your comments would indicate that you do not understand this market. You may know your technology but investing is not about technology.

Hey Anon,

Any technology that adds efficiency and transparency around early stage investments, and doesn't let folk hide behind Anon when they're making comments will make it different :)

But seriously - this isn't how companies currently raise money. You're right, the barriers to entry are lower (as are the costs). But it's using technology to enable companies to go out to their own crowds in a transparent and efficient way - and allowing their crowd to ask informed questions openly during the process, so all potential investors can see.

It makes it about more than just the money, but about an engaged shareholder base that really wants to see their companies succeed - which has it's own benefits. And, if technology can make raising money and maintaining those relationships easier for young and growing companies, then we're doing a few things right. It doesn't replace the need for other avenues and tools, but it's going to educate the market on new and more interactive ways of raising funds.

If you want to chat about it more - feel free to drop me a line! Our team has significant experience in the capital markets, but it's always good to get more points of view.

I personally think it's a smart way of raising capital because the fundraising method makes investor confidence very visible (it's not an infallible guide to the merit of the investment, but not worthless either). You can readily gauge whether other people judge the investment to be sound, and if there isn't a critical mass who believe that's the case, you're no worse off. Better than taking a stab in the dark with some finance company that swallows your retirement provision, surely? And I can't seriously believe that someone would dispute the role of technology in the economy. Heard of the industrial revolution? Or the internet? Jesus wept.