Fundraising can be a daunting task – especially for young peer-to-peer lending platforms. Michael Lloyd explores the barriers to entry for start-up and scale-up P2Ps…
Raising money for a new business is never easy – just ask any of the hundreds of entrepreneurs who have faced down the venture capitalists of Dragon’s Den.
Most peer-to-peer lending platforms will understand the pressure, risk, and excitement of a showdown with the dragons, because they’ve had to go through this process themselves, in one form or another.
There are myriad ways to access equity funding, so how do nascent platforms secure the backing they need to enter the P2P space?
According to Robert Pasco, chief operating officer at soon-to-launch P2P platform Plend, it’s all about perseverance.
“Everyone says you have to kiss a lot of frogs and get a lot of ‘no’s, and that’s definitely true,” says Pasco.
“We’ve applied for everything, we’ve been to talk to pitch events and angel groups.
“The ones that become a ‘yes’ are those we have not given up working on, giving updates. The best experience is talking to someone, not asking for fundraising and building a rapport.”
As Pasco suggests, there are plenty of avenues for P2P platforms to seek funds, even if the outcome is not guaranteed. Funding can come from family and friends, from institutional investors, venture capitalists, or via crowdfunding.
P2P platforms have collectively raised more than £17m through crowdfunding platforms such as Crowdcube and Seedrs. But despite sharing a ‘people-powered’ ethos, these crowdfunding platforms come with their own challenges.
“Crowdcube and Seedrs are some of the hardest money to earn, so much effort is required to make your profile look attractive, a ton of money is needed first and a strong marketing campaign to get as much user base converted to investors as possible,” says Pasco.
“It can be quite an expensive form of funding.”
Equity crowdfunding platforms usually require businesses to have secured a substantial lead investment before they will let their crowdfunding campaign go live.
Sources have told Peer2Peer Finance News that this lead investment requirement can be as high as 30 to 80 per cent of the fundraising target, which significantly raises the barrier to entry for new P2P platforms.
However, both Seedrs and Crowdcube say that there is no set figure for pre-campaign fundraising, as it is measured on a case-by-case basis.
“There is no set number, but we advise investee businesses to be able to generate some momentum before publicly launching their campaign, whether that’s through a lead investor or their own community,” says Debra Burns, compliance director at Seedrs.
Similarly, a Crowdcube spokesperson says that the platform has no set thresholds and it really comes down to a discussion between the campaign manager and the entrepreneur.
“It’s very hard to put an exact figure on the lead investment, it really does depend on the type of business, sector, size of its community etc,” the spokesperson says.
“There are no rules around it, it is down to the discretion of the campaign manager on the amount of lead investment that is required, and it really depends on the size of the business and its community.
“If we don’t feel that a business has a reasonable amount of lead investment, then we wouldn’t advise a company to launch. Some businesses don’t come with any, most recently Curve, Secret Cinema and Taster.”
Stuart Law, chief executive of Assetz Capital, says that lead investment is used on these platforms as an extra layer of due diligence.
“If a company can’t bring substantial investment from people that understand it, such as close contacts like friends and family, why on earth should a single investor on Seedrs or Crowdcube believe it and back it?” he says.
“If you haven’t raised a significant amount of money from people close to you before going live your company probably isn’t worth investing in. That’s the reality of it.”
Despite these challenges, both Crowdcube and Seedrs have reported significant growth in investments and have hosted an array of successful P2P campaigns.
Seedrs achieved record levels of fundraising and investing last year, funding 265 deals in total and seeing £293m invested in campaigns, while Crowdcube witnessed a 24 per cent increase in new investors across 2020.
P2P platforms believe that equity crowdfunding is well suited for their fundraising activities due to the notable similarities between the two business models. Furthermore, the platforms which have been able to meet the lead investment thresholds have typically managed to meet – or overshoot – their fundraising targets.
“It’s the same as reaching out to the crowd and getting funding from them, there are some similarities,” says Filip Karadaghi, managing director of LandlordInvest.
“And you expect equity crowdfunding platforms to understand what P2P is, better than venture capital or angel investors.”
Fundraising P2P platforms have another challenge to contend with – the ongoing issue of changing regulations.
Platforms selling equity investments to private investors who aren’t being advised need to ensure that those sales are appropriate.
Firstly, the investor has to certify that they fit in one of three categories: restricted, sophisticated or high net worth.
Then they have to be assessed by the platform to ensure that they understand the risks of the investments in question. Typically, this is done through testing their knowledge of the risks of the investment such as liquidity, diversification and dilution.
Read more: Seedrs surpasses £1bn in total investments
“Far more concerning for equity fundraising would be where the Financial Conduct Authority (FCA) wants to take the rules later on this year,” says Gillian Roche-Sanders, partner at Adempi Associates.
“Changes are afoot that mean the platforms wouldn’t be able to rely on investors self-certifying. The FCA wants platforms to police the public.
“That means if someone certifies as high net worth because they have read the statement and believe they meet the criteria, the FCA still wants the platforms to find a way to prove that they have the wealth required.
“For online businesses, that’s going to be incredibly tricky. How do you check someone has a level of income or net assets in a cost-effective way and at scale, when people’s situations will all be so different?
“There are so many less onerous ways to achieve the same aim, that I really hope the regulator listens to the industry and finds a way to make their new regime for high-risk investments work for online and non-advisory businesses.”
One P2P platform head says that the regulatory obstacle is only becoming worse due to the FCA’s ongoing scrutiny of financial promotions.
“Why is there not an ability to do crowdfunding in a low-cost way?” the platform head says.
“The regulatory compliance for each financial promotion requires thousands of pounds of work, to approve a campaign is thousands of man hours and someone who’s FCA approved for financial promotions has to sign it off.
“Regulation is a huge hurdle for fundraising – whilst it’s being made easier in the EU and US, it’s being made more difficult in the UK.”
Assetz Capital’s Law says that the FCA should not change the current rules but should continue to increase its supervision.
“There’s definitely movement in wondering about whether to make it much harder to promote a specific investment to the public,” he says.
“It would be a bad idea to change it. They should exercise control over the operations they already have. They’re out on a supervision mission to check people are complying with the regulations.”
Platform owners need to be incredibly careful not to be exposed to regulatory risk when pitching to people, including family and friends, who are best to speak to on a one-to-one basis.
Seedrs and Crowdcube offer regulatory cover to platforms, which can reduce this regulatory risk while pitching for equity investments.
“One of the reasons Seedrs and Crowdcube are successful is they do it in the legal way, you can introduce investors to an approved financial promotion from Seedrs,” Law says.
“The regulation is intentionally a minefield. Everything is illegal until proven otherwise.
“Raising equity privately by default is illegal. You can put a ton of work in and pay some lawyers or go to Seedrs and Crowdcube to find the narrow legal path.
“Some people have tried to do it themselves and ended up in hot water. Many self-issued promotions by companies ended up being case studies of fraud or people losing money.”
The regulatory repercussions of improper fundraising seem truly frightening and may put off some from fundraising in this space, creating yet another barrier to entry for the UK P2P sector.
However, the environment for raising funds is not in its worst state and there are signs of improvement.
According to the British Business Bank, investment in UK deep tech companies has continued to grow rapidly over the past five years, rising by 291 per cent to £2.3bn in 2020. Meanwhile, equity investment in smaller businesses reached £4.5bn in the first quarter of this year – the highest amount ever recorded in a single quarter.
Furthermore, the board of Zopa backer Augmentum Fintech is currently seeking permission to change the company’s investment policy to allow it to invest up to one per cent of its net asset value in fintech seed-stage investments.
Fundraising is changing, and as the pandemic finally draws to a close, more and more investors appear to be waking up to the benefits of backing alternative lenders.
Forget the Dragons, instead watch this space.