The concept of crowdfunding has grown rapidly in popularity in recent years. Often promoted across social media, it brings many small investors together to finance business or other ventures. It originally mainly financed causes that people believed in, but for which they didn’t necessarily expect to receive a financial reward.
The first example of online crowdfunding apparently took place in 1997 when Scottish rock band Marillion asked US fans to help finance a tour to accompany the release of its seventh album. The band was no longer at the peak of its popularity, but its US fanbase displayed their desire to see their heroes live by raising the $60,000 required.
Increasingly, however, crowdfunding is being used by businesses to raise money from investors who do expect some form of pay-out.
This takes two main forms: equity and debt crowdfunding.
In a sense, this method of crowdfunding allows individuals to become very small-scale private equity investors.
The former gives investors a share of a business or project. If successful, the value of this share goes up; if not it goes down – sometimes to zero. In a sense, this method of crowdfunding allows individuals to become very small-scale private equity investors.
Debt crowdfunding involves lending. In theory, lenders receive their money back with interest. This allows businesses to borrow money while bypassing banks.
I have always been somewhat sceptical about the concept of both equity and debt crowdfunding. I felt that with equity crowdfunding, valuations generally looked steep and regulation looked rather loose compared to that which governed listed companies. In the case of debt crowdfunding, I felt that if debt offered equity-type returns it probably carried equity-type risk. My fear was that fools and their money were being easily parted.
However, last year I attended a small conference on the subject organised by the CFA Society of the UK. The conference covered crowdfunded equity and debt, and the platforms which have sprung up to facilitate such transactions. The presenters covered all of these areas and the audience was a mixture of professional investors (some of whom were also crowdfunding) and a broader group of investors who were also crowdfunding in addition to their “day jobs”.
The professional investors tended to share my scepticism. However, that evening we were firmly put in our place by the crowdfunders. The gist of their arguments was “How dare you accuse us of foolishness and not understanding what we are invested in”.
We heard explanations of biotech investments, which wouldn’t have led me to invest, but which demonstrated a thorough understanding of the risks. We heard one investor (talking about the same biotech investment) who viewed the small amount he was investing as broadly like a charitable donation. His perspective was that if the company was successful it would benefit humanity…and on top of that, he would make money. We heard of investors in football clubs who invested out of a sense of loyalty and a desire to be a part of the club that they loved. Financial reward was low on their list of priorities. We heard of small rock bands crowdfunding - with fans getting their name mentioned on the album sleeve. Again, there was little expectation of financial reward - but what price immortality and the ability to listen to an album from the band you love that might not otherwise have come to fruition? There were many lessons learned that night by the intelligentsia of the investment community.
However, one of the other cause celebres that night was BrewDog. The craft brewer, founded in 2007 in Fraserburgh, north of Aberdeen, is notorious for its provocative marketing strategy. One notable example was the launch of its “Tactical Nuclear Penguin” beer, at the time the strongest in the world at 32 per cent proof. (It also made a low alcohol beer which it named “Nanny State”.
BrewDog has been a big user of crowdfunding - issuing various tranches of “equity for punks”, as the company’s founders described the new shares. There was much talk that night of the stratospheric valuations that were implied by the prices of this equity – figures that bore little relation to the valuations of comparable quoted companies. The implication, of course, was that gullible investors were merely buying the “story” without regard to the risks – or indeed the underlying profitability – of the company. Again, the debate focused on “other” reasons to invest, with some participants attempting to find brewing transactions globally that could justify the lofty valuation implied by the “punk” equity issues.
Well… at the start of the month justification for the valuation arrived in the form of a bid by US private equity firm TSG Consumer Partners, for 22% of the company. TSG has invested £100 million in new BrewDog equity, also buying £113 million of its existing equity. This gives the company an implied enterprise value (of the company’s equity and debt) of £1 billion. That’s a figure sufficiently hefty to silence the valuation sceptics who attended last year’s conference. It represents a significant (albeit, in many cases, implied) return for those early “punk” investors. Good for them that they may have proved the sceptics wrong. To put this in some context, investors who bought one £230 share in the first crowdfunding round are now sitting on a shareholding worth £6590 – a return of 2765% since 2010.
Good for BrewDog also - it is an innovative and well-run company with – importantly – at its heart a good product. It does not take too huge a leap of imagination to see how new capital might allow it to replicate its early success on a more global stage.
However, the “punk investors” have also had a lesson in equity dilution, or the reduction in the existing shareholders’ ownership of their company. The issue document makes the deal subject to the “disapplication of pre-emption rights in relation to the allotment and issue of new shares”, or the removal of their right as shareholders to vote against dilution of interests. Minority shareholders must just put up with this. The founders assure them that this is OK. I hope that they are right.
TSG also get to buy new preference shares. In the event of a liquidation, return of capital or a sale of the business, these shares stand to receive a return of 18% per annum or the rate of return that ordinary shareholders get – whichever is higher. Certainly, good equity, if you can get it. Shareholder rights are important and valuable – one gives them away at your peril. How important they are in this case – and how valuable – will undoubtedly be tested in the years ahead.
So what are the lessons to be learnt?
In BrewDog’s case, we have seen a company go from a garage start-up to a billion pound enterprise. There are few companies that will ever achieve this. But when they do it is great to see. Compromises have perhaps had to be made en-route – the two founders’ stance that they will never sell out to a “monolithic purveyor of industrial beer” may be tested when a monolithic supplier of industrial beer inevitably approaches TSG. But that’s for the future. For now, the founders remain in control (or at least in the majority) and can continue to pursue their dream.
Is this the “right” valuation for the company? It is certainly a real price, where some of the shares can trade. The price rise comes against a background of a frothy private equity market, one where cash is burning holes in many participants’ pockets. Whether this marks a peak, or the start of the next successful phase, time will tell.
While a measure of scepticism is always a good trait in an investor, in this case it seems the crowdfunders may not have been as naïve as was initially suspected.
And one final thought. Alternatives to the exchanges run by the be-suited elite as a means for new companies to raise equity and debt may be no bad thing.
So cheers to BrewDog – and to all their intrepid shareholders.