Crowdfunding and the third age of finance: Why banks are now seriously taking note

Crowdfunding has titillated a lot of people. 

 

Armchair investors can pile into funding rounds alongside VCs, lending to or taking stakes in promising businesses. People can raise money for unwell relatives and community projects nearby – or across the globe. And SMEs turned away by banks can borrow from the crowd, issue equity, or auction their invoices. 

 

I spoke to Dr David Brown, a business angel and consultant who has over three decades of experience in the pharmaceutical and biotech industries in both research and senior executive roles, having worked at Pfizer, Zeneca, GlaxoWellcome and Hoffman La-Roche, to find out why he’s turned to crowdfunding – both as an expert, and an investor. 

 

 

I am an angel investor, and also a stock market and property investor. A couple of years ago I was doing some consulting on the Third Industrial Revolution. We know about the first; the second saw a new form of energy – oil – replace coal, electricity bring about the advent of the telephone (a new form of communication), and the limited liability corporation was the financial breakthrough after the stock market. The third revolution is where we are now. The internet is the new form of communication. The new energy source seems to be solar power, but I was struggling to work out what the new financial system was. 

 

I had been talking it through at Cambridge’s business school when I met Goncalo de Vasconcelos, the co-founder of Syndicate Room, the crowdfunding platform. It’s less advanced, but internet-driven breakthroughs like crowdfunding and peer-to-peer finance are fast becoming key parts of the new financial system. Within a few months, I was investing my money via Syndicate Room.

 

But do you think crowdfunding is sufficiently revolutionary? Some people would argue that it’s just a modern iteration of what’s gone before – a stock market online. 

 

Actually modern crowdfunding is very new. And it’s the transformational level of access provided by the internet which makes it so. In principle, it allows anyone around the globe to participate in the funding industry, whether lending or taking equity, and with scales ranging from £10 to £10m. And the whole process is very easy. People can access data on companies and make comparisons very quickly. The speed and scale is unprecedented. 

 

There was a crowdfunding conference in Chicago last year. During a panel discussion, someone made the point that, if the world’s high net worths alone were to put just 1-2 per cent of their wealth into crowdfunding, that would be 10 times more than all the venture capital available at the moment. And that’s before the crowd comes in. Crowdfunding will overtake venture capital in scale.

 

The internet has changed everything. If you look at what’s happening with Google, Facebook and Apple, there’s a real chance that they’re going to compete with or even replace the banking system. They are registered as banks. Facebook has 1bn customers; these companies have almost zero infrastructure. Apple has got billions of dollars just sitting there, whereas a number of the banks are effectively bust. My feeling is that the internet platform companies are going to start lending very soon. And if they also do something with blockchain, it’ll transform the financial system in ways people haven’t even conceived of. 

 

Goldman has already developed a platform, UBS has a blockchain laboratory, and there’s talk of a highstreet bank here in the UK showing serious interest in crowdfunding. Is it closer than we think?

 

It’s a lot closer than I thought. A year ago, I would’ve said five to 10 years; now, I’d say five months. People realise that blockchain is a very significant idea. The level of security is very different to the current financial system. The big guys are experimenting very seriously now. 

 

 

Again, it’s changing very fast. A year ago, we had many people saying crowdfunding wouldn’t be applicable to biotech – it’d be too risky. Today, it is becoming commonplace for money to be raised by crowdfunding for startup biotech firms. And the UK is leading the way. Syndicate Room alone has raised about 40 per cent of crowdfunded biotech raises in Europe. 

 

It’ll split into three areas. The first will be totally for-profit equity crowdfunding. That’s no different from the current model. And that’s fine; it’s needed. Investors just need to remember to balance their portfolio – you need at least ten companies in a portfolio. 

 

Second will be the non-profit approach. I’ve been involved in Antibiotic Research UK, a charity which is kickstarting new antibiotic development. At the moment, we’ve gone for funding only from high net worths, but crowdfunding offers huge scope beyond what we’ve already seen for fundraising for nonprofits. And we’ll also see sick people donating money so that, rather than receive equity, they can be involved in trials. That’s the third area. 

 

It will be a learning curve for crowd investors. There will be losses and people will have to learn about the risks as we go along. But that will be offset by the fact that people really care about health. We all have sick relatives, people we know who are poorly. People will turn to crowdfunding to support the research that’ll keep us well.

 

 

I would actually like to see the regulatory authorities get tougher in cases where crowdfunding platforms offer models that are disadvantageous for investors. The fear is that certain platforms will be unscrupulous and will damage the whole industry. There has already been criticism of some practices, and that could well make it harder for those that are doing it right. 

 

Aside from that, I also think the US has got to get its regulation together sooner rather than later. We’ve actually been quite lucky here in the UK in terms of government attitudes, but it won’t be long until the EU will start to take an interest. The preference would be for the EU to leave the industry alone, of course – it’d be a really bad idea if it did otherwise. We need a Darwinian process to see what works. 

 

 

Crowdfunders must approach it as they would any investment portfolio, knowing there will be losers as well as winners. So they need several investments, at least 10, I would say, of roughly equal size to spread their risk. Ask if the invested money is of a suitable size relative to your total investments. My view is that investment in high-risk startups should  account for less than 10 per cent of your total investment portfolio. 

 

Do you understand the business? What is the track record of the lead angel investor? Do you understand how you might make money – what is the exit strategy? Are you happy with the company’s financial plan?

 

Investors should also consider how many more rounds of funding may be required – it may be worth keeping some powder dry. To prevent dilution, they may need to exercise their full pre-emption rights, which could mean doubling up at each round. Then they need to ask: can an angel plus the crowd take the company the whole way?