To Crowdfund or Seek Private Equity? That is the Question
Raising finance is challenging for any start-up. Despite the fact that the digital age has made the process easier than ever, there is not a one-size-fits-all solution and it’s important to look at which fundraising strategy might be best for you. Here we put the microscope on two options, angel investment and crowdfunding, to help you decide if either (or both) are right for your business.
What is the difference between an angel and a crowd investor?
Angel investors are classified as ‘high net worths’ (those with more than £250,000 in the bank or an income of over £100,000) or ‘sophisticated investors’, meaning that they’re experts in the investing process. Typical ‘crowd’ investors are designated as ‘restricted’; they are advised to invest no more than 10% of their net assets – excluding property and pension – into unlisted shares. They tend to be less experienced in investing and to put in much smaller amounts.
How much do angels invest compared to the crowd?
An angel is unlikely to invest anything below £10,000. In most cases they have some expertise within your sector, meaning that down the line, they can provide support and mentorship. Crowdfunding tends to attract unaccredited investors and can start with a pledge of as low as £10 – chances are, you won’t interact with them again beyond an automated thank-you.
Typical Share Class
Angels want ordinary shares with certain entitlements: pre-emption rights that grant existing shareholders first refusal when a company is issuing new shares, tag along rights that ensure when a majority shareholder sells their stake, the minority shareholder has the right to join the transaction and sell their minority stake in the company at the same time and voting rights. Crowd investors tend to receive B shares, which entitles them to participate equally in dividends and, if the company is wound up, share in the proceeds of the company’s assets after all the debts have been paid. These don’t bring the same rights as ordinary shares.
EIS Tax Relief
EIS was introduced in 1994 as an incentive to invest in UK start-ups and provides a tax-efficient way to invest in small companies. It is aimed at the wealthier, sophisticated investors who can invest up to £1,000,000 in any tax year and receive 30% tax relief. This is less appealing to the crowd investor, as their investments are much smaller and are usually a fan or a customer of the business they’re backing.
An angel takes due diligence seriously. They’ll spend an average of one to five days reviewing an investment and chances are, if you’ve got a secret, they’ll find it. Crowd investors tend to make a spur of the moment decision and any due diligence –is likely to be minimal.
With angels it’s simple – they invest directly and will hold shares in the company. Crowd investors are a combination of the two – they’ll invest directly or occasionally via a nominee structure.
Angels will have significant input on the terms of the investment and there are a number of key legal norms in this process, from the Term Sheet to a Shareholder Agreement. Quite simply, when a founder is raising private equity, legal advice and guidance is essential. Traditional crowdfunding sites tend to retain control over the proceedings, leaving neither the scaleup or the investor much leeway. In other words, the terms are dictated by the platform and that’s about it.
Involvement and guidance
An angel investor – as described above – will likely be more involved in your business than a crowd investor, such as taking the role of a Non-Executive Director. NEDs are responsible for keeping the executive directors and the entire board accountable. These directors can do this by helping with – and managing – a company’s strategy, performance and risk from an objective standpoint unrelated to the intimacy of day-to-day operations. A start-up who is not looking for such hands-on support, might be better off seeking investors through a crowd who won’t be so involved in the direction the business chooses to take.
You can learn more about angels through the UK Business Angels Association (UKBAA) and crowdfunding through the UK Crowdfunding Association (UKCFA).
Should you look for angel investors or crowdfund?
The crowd is a great way to fund your raise if you have a high-loyalty brand. If you are solving a problem or offering a service people are passionate about, you can gain a lot of momentum quickly. Crowdfunding is based on quantity, so you will have a high number of investors putting in smaller sums. It can be 100% of your raise or a way to supplement your capital raised from funds, angels, grants etc. And while crowd investors will be your cheerleaders, they won’t expect to get involved in your business.
Angels on the other hand, typically have more experience in business and with early-stage scaleups. Yes, they will invest more, but their money is harder to extract and their due diligence is thorough. They will scrutinise your plans and forecasts, expect to meet your management team to test the chemistry and – in many cases – will want to be involved in your business in advisory or NED roles. For those looking for a leg up with sound advice and contacts, angels can be a real asset. Tight-knit investors are also more likely to provide follow-on investment. As businesses typically do 4-5 raises before they reach maturity, this can be very important.
So, in the great debate of angels versus the crowd, there is no right answer. It comes down to what the business needs and these days, many find that a combination of the two is the best way forward.
You can read up on our options here, to give yourself the best chance of reaching your fundraising goal.