There has been one positive outcome of the shortfall of bank lending to SMEs: it has paved the way for crowdfunding to flourish
It can’t have escaped many people’s attention that crowdfunding has revolutionised the way we view funding projects and new ideas. But with consumer, reward-driven solutions like Kickstarter dominating mainstream conversation, it’s sometimes easy to forget that crowdfunding has also entirely reformed the worlds of equity and debt funding.
The increased interest in the crowdfunding model was a by-product of the recession. “There are five main high street banks and they account for about 90% of all lending,” says David de Koning, head of communications at the peer-to-peer lending solution Funding Circle.
Whilst this doesn’t pose much of an issue when the economy is healthy and confidence is high, when these few institutions are hit by turmoil it quickly brings lending to a grinding halt. “Additionally, as a result of greater regulation, they had to hold more capital, which essentially makes it far less attractive to lend to businesses.”
The slowdown in lending can’t just be placed at the doors of the big banks. Other traditional mainstays that businesses have relied on to get off the ground have also found themselves unable to lend a hand. “Traditional business angels have been more reticent to part with their cash as their investments remained tied up so there has been fewer exits, which is how an angel would typically get liquidity,” comments Luke Lang, marketing director and co-founder of equity crowdfunder Crowdcube. “And grant funding has obviously been reduced by the government as well, so that has affected a number of businesses.”
It is hardly surprising then that some people started to look at different methods trying to get money moving again. “A new approach was needed,” Lang says. “A democratised version of angel investing was required to enable more people to access investment opportunities.” Thus the idea of crowdfunding was sown.
Essentially, the beauty of crowdfunding’s emergence onto the market was that it was just bringing together two parties that were, at the time, poorly served by what was on offer.
“What we realised when the business launched was actually you have this incredible group of hardworking, fascinating businesses looking for capital and on the other side you’ve got millions of people who are earning next to nothing in their savings accounts,” says de Koning. “Surely there was a way of bringing these two disaffected groups together?”
And as a technique, crowdfunding hasn’t just addressed a need, but actively improved on the existing services. “We haven’t created a project which is that different from what a bank loan is but what we’ve done is make it much better,” de Koning explains. Rather than a decision taking weeks, lending decisions can take place in under a day – case study Trovus received funding in just one hour. “That’s really appealed to business owners as they’re using a product now that’s better suited to their needs,” de Koning adds.
But it isn’t just enterprises looking for funding that stand to benefit. Crowdfunding has also made the process of lending and investing much more egalitarian and significantly lowered the barrier to entry. Lang comments: “It’s transformed angel investing in the UK and has proven to be a catalyst for the birth of a new breed of angel investor, what we’ve dubbed the ‘armchair Dragon’.”
There has been a huge shift in terms of public attitudes toward earlier stage businesses and investment, partly in the wake of shows like Dragons’ Den. “The idea that you can become your own angel is proving to be appealing for a lot of people,” says Lang. But one element that may have previously barred individuals from getting involved was the amount of money one would have to invest to be a part of a traditional angel network. “Traditionally, you’d need to have £20,000; that would be the smallest investment realistically that you would make,” he comments. “Our average amount is around £2,800 so it’s much more accessible.”
Additionally, the fact that individuals can opt for lower individual investments in each project means that they are more in a position to spread their funds across multiple projects, somewhat mitigating some of the risks involved in a relatively high risk field. “If you have one business that fails then hopefully you’ve got two or three others that are looking positive and looking like they’re going to deliver a return in the next year or two,” Lang says. “That’s really important.”
But, obviously, the proof of the pudding is in the eating. Crowdfunding’s success can only really be measured against the degree it has helped to get money moving. “They’re still fairly nascent industries,” says de Koning. “We’ll probably push through £200m lend in the next six months or so, which is fantastic for us but we probably represent less then 3.1% of the whole small business lending industry.”
However, one thing is clear; whilst crowdfunding is still establishing it’s foothold in the lending landscape, it has certainly broadened the options of the entrepreneurial community and this even in itself is an admirable achievement. “I certainly think if you are a younger business now, getting started, you’re probably not thinking ‘the only place I can go to for lending are banks’,” concludes de Koning. “So the opportunities are great.”
The crowd in action
Caspar Craven, co-founder and director of customer intelligence consultancy Trovus, is no stranger to raising funds via more traditional routes. “I was an investment banker for five years,” he explains. “I specialised in raising funds for other people. A lot of private equity funding, a lot of bank funding, deals anywhere from £1m - £20m; that was the area I used to work in.”
Having ruled out equity routes because of his desire to avoid diluting ownership, when Craven was seeking funds for Trovus he approached the high street banks. “I went and spoke to our bank about getting bank financing,” he says. “Even getting an overdraft had very high fees and I would have had to give my kidneys away to do it.”
After advice from a few individuals, one of whom was a finance director that had previously raised money from the peer-to-peer lender, Craven decided to apply for debt-finance through Funding Circle. “We put our profile together on the website and literally we raised all the money within an hour,” he recalls. “Compared to other funding things I’ve been in, it was the most painless funding I’ve been through.”
And this has had a very palpable impact upon the business in the three months since their successful funding pitch. “Our profits so far this year have really soared as has our revenue, which is in no small part due to the investments we’ve been making, freeing us up to make more investment decisions,” says Craven. Given the fact that the funding has enabled them to so effectively capitalise on business opportunities, Craven confirms he is already considering a second round to enable the enterprise to secure further growth.
Obviously for firms like Trovus, crowdfunding is radically shaking up the way funding is viewed. “Fundamentally, they’re disruptive business models; they’re challenging the banks where there’s a lot of process and fear,” Craven comments. Because the lending confidence amongst crowdfunders seems to be much higher and the process is much more immediate than the lengthy application periods at the banks, he feels it’s an excellent option for start-ups. “If anyone’s looking at funding it’s an absolute no-brainer.”