Crowd funding: a realistic alternative to bank lending?

Access to bank credit remains restricted for most start-ups and small firms. With conditions unlikely to improve in the short term, where else can you turn? Crowd funding is one solution, but is it a viable option for small firms?

Recent research highlighted that while one fifth of small firms approached their bank for credit last year, just a third were successful. The Bank of England has also stated that restricted bank credit is pushing some small firms to look for new solutions to boost their working capital. Crowd funding is one alternative that is providing finance to a small, but growing number of businesses.

Standing out from the crowd

Crowd funding allows individual investors to pool their money together, usually online, to support a business or project. Typically, people can invest as little as £10 in return for a small stake, other monetary reward or perk.

UK crowd funding providers aimed at small firms include companies such as Funding Circle, which bypasses the banks and provides loans of up to £75,000 through a network of private investors; and Crowdcube, which offers investment in return for an equity stake. Funding Circle was launched in August last year, and has so far made approximately 165 loans totalling £5.5 million. Crowdcube has 15 small firms registered on its site so far, alongside 2,500 registered investors.

Clearly, crowd funding is still in its early days. Few small businesses have obtained finance using it to date, compared to the £16.8 billion that UK banks lent to small firms in the first quarter of 2011. Time will tell if it’s to become a serious alternative to a bank loan.

“The downside for business owners with companies such as Crowdcube is that they have to give up a stake in their firm,” says Forum of Private Business senior policy adviser Phil McCabe. “But next to not being able to get the growth finance they need, there are few disadvantages to using reputable alternative funding platforms.

“There is a growing appetite among small firms for alternative funding models,” he adds.

So how does Crowdcube work?

“Banks aren’t lending at the moment and angel networks are reticent to part with their money, so Crowdcube was developed to provide an alternative to entrepreneurs in the UK,” says Crowdcube co-founder Luke Lang.

“Banks are starting to refer customers to us now. Some business owners have been turned down for a traditional bank loan and their bank has suggested they try us instead.

“For too long, entrepreneurs with good ideas have had to go cap in hand to wealthy individuals. We wanted to enable anyone above 18 in the UK to invest in businesses.

“There are two main reasons why people would invest on Crowdcube. Firstly, return on investment, and secondly we think that people will want to engage on a higher level with a business they particularly like. Also, businesses can offer ‘rewards’ to investors — such as free samples or discounted products. These are designed to act as an additional incentive and give a sense of return faster for more modest investors.

“Businesses from all sectors can pitch for investment. We give those with a good business plan and financial forecasts an opportunity to showcase their investment opportunity to a broader range of investors and take control of their fundraising. Crowdcube also provides start-ups with a method of formalising investment from friends and family.

“Start-ups and small firms seeking investment decide what stake they want to give away and the size of investment they’re after. The minimum amount individuals can invest in businesses on the site is £10, but there is no upper limit. We operate a policy of all or nothing funding, so if you’re after £20k to start your business and you only attract £2k, you don’t get the funding. You have to hit the target. We only make money when businesses hit their targets — at which point we charge a 5 per cent success fee.

“Crowdcube is a private platform and details of investment pitches are only revealed to members. However, as it’s free to become a member we advise that entrepreneurs take all the usual precautions to protect their IP [intellectual property]. If you are not protected thoroughly and you cannot communicate the essence of your business without giving away your IP, then we may not be right for you.” 

Bodycare products retailer Bubble & Balm founder Sue Acton has become the first business owner on Crowdcube to secure their target investment.

The small-business view

“Hats off to any start-up that can get a bank loan at the moment. My bank told me they needed to see a couple of years of profitable trading — something that few start-ups can show,” says bodycare products retailer Bubble & Balm founder Sue Acton.

“I went to the bank armed with contracts and orders to supply big retailers thinking I would be able to get a loan — silly me,” she laughs.

“Good businesses are always going to get in front of investors. But a lot of the investment agencies have high upfront costs, and many small firms don’t have that money. There aren’t any upfront fees with Crowdcube.

“I first heard about Crowdcube on Twitter. I’d seen Kickstarter in the US and other crowd funding providers in the UK, but these organisations were straightforward lenders or only dealt with not-for-profit enterprises.

“I need the investment to help the business grow, but also the more you expand the more of a cashflow challenge there is. The downside of supplying the bigger players like supermarkets is the extended credit terms. You can have a six-month cashflow exposure. I use factoring, and it’s a reasonable solution, but it doesn’t solve the whole problem. I also want to expand the range of products we offer, revamp the website, and to have the option to take on staff — at that the moment it’s just me.

“To pitch on a crowd funding site, you need to do about the same amount of work to create a profile as you would applying for a bank loan. The advantage to this type of application is that you are pitching to a very wide audience. Anyone who joins Crowdcube can read it, free.

“If someone is thinking about just investing £20, they don’t to have to read pages of documents. Generally, the higher-value investors will contact me directly or want a meeting ― as business angels would. I’ve received investments from £10 to £7,500 so far.

“I don’t see any of the cash until I reach my target. The standard Crowdcube terms keep your pitch live for six months, so you have that long to reach your target. Our pitch is due to close onsite at the end of July. Some investors wait until the final days or to see we have reached a certain investment level from others before committing, so we expect a lot of last-minute activity.

“Crowd funding has pledged £54k so far to my business. The target is £75k for a 15 per cent stake. I’m very optimistic we’ll hit it.”

Note: Since this interview, Sue has now hit her target investment.

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