Tuesday, 6 December 2011

Internet financing sites – are they taking over?

It has been difficult to avoid the impression recently that the internet is becoming a major player in the funding of businesses. So firstly, what do I mean by internet financing sites? I am not referring to existing funders who are making more use of the internet to provide information on their products or with online applications. Rather, I am referring to those that are getting access to a new set of online investors, typically based on crowd funding. Crowd funding (as the name suggests) relies on a co-operating group of investors pooling together smaller amounts to produce the larger amount required for funding.
Crowd funding originated in the charity sector, but the model has now been adopted for both debt and equity solutions. Typically hundreds or even thousands of small investors can make investments ranging from £10 up to £1000s. The loan or equity agreement is carefully constructed so that these investors are not required to self-certificate as high net worth or sophisticated investors which would be the case for more traditional business angel investments.
So what is the practical impact on companies like yours? The first point to make is that crowd funding currently makes up only a tiny fraction of both the debt finance and the equity finance solutions available. However they do have their place in the market and can be an invaluable option in the right situation.
Pegasus work with a number of these crowd funders, but this discussion only considers two such companies, one is a company that only provides debt and the other that provides equity, who have both been successful in gaining recent exposure. The debt one appear at the top of most internet searches and the equity one has been making headlines following their recently financed £1,000,000 deal.
The debt crowd funder’s applications require a business proposal that describes the business, the purpose of the loan and an explanation of why the business is safe to make a loan to. The proposal also requires latest management accounts and at least two years filed accounts. They will undertake a credit check and rate the companies risk profile.
Pegasus has had a number of successes in raising debt through this means. A recent example is an internet retail company who raised £40,000 for development capital. They have an excellent relationship with their bank that provide a £10,000 overdraft and a £245,000 trade finance line but were not prepared to fund development capital. The terms are 36 months at 9.5% annual interest. Note the 9.5% was an aggregated rate from over 500 smaller loans which ranged from 8% to 9.9%, although this is transparent to the applicant. Interestingly there are no penalties on early repayment and there is a setup fee of 3%.
In our view Crowd Funding Equity company can also be a useful resource, but it may not be suitable for all companies. One issue relates to the amount of exposure that your business plan will receive, with applications accessible to 1,000s of potential investors. Whilst they will have signed confidentiality agreements, it is not possible to place practical controls over so many people. These investors may be competitors, or people who like your idea and want to replicate it. Inexperienced investors are also unlikely to know “the rules of the game”.

Another issue might be where companies are looking to go on to raise future rounds of funding. In this instance, some future funders and especially VCs might well be put off by a large number of perceived investors. The large number of small investors can however also be an advantage, particularly if you are seeking public exposure. One of the more notable Dragon’s Den successes such as Reggae Reggae sauce would have been an obvious contender for this approach. Also the recent £1M fund raising success by  a Group who are planning to build a new venue in Soho is an ideal candidate. It’s “bricks and mortar”, it’s not massively innovative and it can only gain from a set of enthusiastic advocates who are also stakeholders.
Like any other equity opportunity, a comprehensive business plan needs to be in place. At Pegasus we have a strong understanding of what Investors  investors will find attractive. We also know how to help a company become investment ready and the level of due diligence material that they will need to have prepared. Furthermore, we understand the nature of the shareholder agreement and can discuss implications with companies upfront.
In summary, we believe that crowd funding resources such as these two will become more significant over time, but will only be alternatives to be considered in the overall funding mix.
We are confident that we can continue to add value to the process and increase your chances of obtaining funding through these routes.
Bruce Colley: 07730 029594

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