Where is the exit?
Stuart Lucas, Co-founder of the online share trading platform Asset Match provides tips on providing an exit route for crowd-funders.
More growth companies and start-ups are looking to equity, rather than bank debt, to accelerate growth. It's not just angel investors either, tapping into the crowd to source finance by entrepreneurs continues to grow. Nesta's latest report shows that alternative finance (including crowdfunding, peer to peer (P2P) lending, and other categories) has more than doubled over the past few years and stands to top £1.74 billion ($2.75 billion) by the end of 2014. With any investment source, it's never long before investors clamour to get their investment back - preferably at a profit. So how can early stage shareholders and equity crowd-funders exit their investments and when is the right time?
Providing shareholder liquidity has long been a problem for any private company. Towards to end of 2013 the Financial Conduct Authority, the UK's financial regulator, raised real concerns on this issue, specifically in relation to companies raising funds through the crowd.
When fund raising, an entrepreneur's main focus is on getting the cash the company needs to meet its strategic and operational objectives. The funds are used in any number ways – expansion plans, product development, marketing, new staff, easing cash flow and so on. The fact that the company is taking on a group of shareholders is often treated as a by-product of the immediate capital requirements. The long term thinking that is needed to plan an eventual exit or even liquidity is usually not thought through properly (or at all) and is often considered as something that can be dealt with in the future.
However thinking about providing an exit at the time that an equity funding round is taking place goes a long way to attract more serious investors and helps ease future funding requirements. After all an experienced investor's primary concern is whether they are going to get a return on their investment and when.
For this a company will usually elicit an 'event'. The two most cited events are an IPO (initial public offering) or trade sale. The commitment to these exits is largely because, for many, they are perceived as the only feasible way it can be achieved.
An IPO is certainly a liquidity event that provides an exit. However, despite the amount of press coverage a company's intention to float on the London Stock Exchange, or its junior market AIM, receives, only a tiny fraction of companies ever actually go public. The reason for this is that many businesses are simply not, or ever will be suitable. There are a number of factors that contribute to the unsuitability of a listing, such as earning patterns, whether a company has high barriers to entry, over reliance on a few customers or historical performance. Many companies are simply too small in terms of earnings or assets to make a listing worthwhile.
Going public is costly and for smaller companies it is disproportionately expensive. The average fees for listing on AIM, the London Stock Exchange's junior market and perceived final destination for many SMEs, are typically between £500,000 and £1 million. This is cash that could otherwise be returned to those early investors or reinvested in the business. Timing an IPO is also crucial. Like any market, the IPO business has its peaks and troughs. Go at the right time and an early investor could see good returns. The wrong timing can result in a company's shares being discounted, and, on occasion, to such an extent that the IPO is pulled; advisor fees however are not. Companies with a projected market capitalisation of under £25 million need to consider carefully whether an IPO and ongoing listing provides good value.
Finding the right buyer
A trade sale is a less expensive and, in the long term, a more straight-forward way to return cash to early investors. Building a business ready for sale often takes much longer than anticipated; finding a willing buyer at the right price is the next challenge. The three to five year promise can end up being five to 15 years. And ultimately all the shareholders have to be prepared to sell up.
I once found myself in this position and was locked-in a successful private business for over twelve years. The only option available was to sell my shares back to the company. However determining price was a trickier problem and with no transparent mechanism to ensure I got a fair price, I felt I just had to sit tight.
The third way
Angels and crowd-funders need to be aware that the promised event of an IPO or trade sale won't happen any time soon or even at all.
But there are still those shareholders whom, not unreasonably, have the right to an exit. With new financial technology, the long term problem of buying and selling shares, or liquidity, in private companies is possible. What is more the timing of the promised exit can be controlled and costs a fraction of listing fees.
Take BrewDog, the irreverent Aberdeen based craft brewery and a pioneer of a crowd-funded business, as an example. Since 2009 they have carried out three 'Equity for Punks' share issues, the first was at £25 per share, the most recent at £95 per share. An early commitment to shareholders to provide a liquidity event was realised in November last year over the Asset Match platform. Buyers and sellers were brought together in a five hour 'Dutch' auction where 220 investors took part. Participants were able to see the range of bids and offers which spanned from £25 to £300 and adjust their orders accordingly. In the end 118 individuals traded successfully. The smallest seller sold just one share while the largest buyer invested over £80,000. At the close shares were transacted at £125 per share giving BrewDog a paper value of just under £150 million.
The concentration of activity over a defined time ensured that there was a market to determine a fair price. Many shareholders chose not to exit while others invested more; crucially those wanting to realise their investment were offered a way out.
Promising a clean exit when an SME or start-up is looking for alternative equity investment is unrealistic. However, providing shareholder liquidity in a fair and transparent way is more than possible. To attract more investors, private companies looking to the crowd for funds can now make promises they know they can keep.