Crowdfunding: is private equity better accessed through other channels?
Crowdfunding has become very popular in Britain. However, the risks are high and data on the sector is hard to find.
A compelling story, a slick presentation and the seductive allure of tax breaks can make crowdfunding hard to resist. What better way to start investing than to allocate your money to something that conforms to your identity, has ambitions to offer societal benefits, or is in a business area that you know well?
In just a few short years, crowdfunding has entered the mainstream with start-up and early-stage companies, from furniture makers to insurance businesses, looking to raise their profile and expand operations.
Platforms such as Seedrs and Crowdcube are at the forefront of a whole host of operators that make Enterprise Investment Scheme (EIS) and Seed Enterprise Investment Scheme (SEIS) investments accessible for the retail investor. The latter now has more than 750,000 registered users, that have collectively invested almost £700 million into 883 successful raises.
Does crowdfunding offer good returns?
Finding out how successful these investments have been, is rather harder to assess. A two year old Crowdcube article listed nine positive exits, with another ten that gave an equal or lower return than the original investment.
It would be unfair to suggest that this leaves more than 860 (97%) unaccounted for, as many of the raises have been completed since the article was written, but information is certainly hard to come by.
Across the Atlantic, data from the US shows the survival rates for start-ups follows quite a predictable curve over time. Around 40% of companies fail after four years, increasing to 60% by year eight and 65% by year ten.
Assuming survival rates are not too dissimilar in Britain, it neatly illustrates that for every Revolut or Brewdog, there will be large numbers of disappointments along the way. Therefore, investment diversification is very important, more so than investing in the public equity markets which has more mature business with track records of profitability.
Private Equity returns are widely dispersed
The long-term returns of private equity (PE) indices and relative disappointment of listed equities (for example the FTSE 100) have driven more investors to make allocations to unlisted investments. Nevertheless recent academic research, such as that undertaken by Nicolas Rabener, suggests that as the majority of PE investments are made in smaller companies, it would be fairer to compare returns to listed small cap investments, which in fact have a much more similar return profile over time.
PE investing is a very different style of investing compared to conventional investment management. As Portfolio Manager of IG Smart Portfolios, we deliberately try and avoid having excess exposure to individual companies, by owning broadly diversified exchange traded funds (ETFs) that offer low-cost market access. Other firms invest in a similar way, meaning that industry returns can look quite similar over time, with fees being hugely important.
PE sits at the other end of the spectrum. Most firms will manage very concentrated portfolios in just a handful of underlying companies.
This means that dispersion of returns is very wide, making the difference in performance between a strongly performing and badly performing fund very significant. In the image below this ranges from a top quartile 16.1% internal rate of return (IRR) over ten years to -3.7% in the third quartile – a near 20% annualised difference.
If picking a strongly performing fund manager is important, having the foresight to allocate your investments to a top performing PE fund is even more so.
As evidence shows that even the professionals can struggle to make returns, this casts some doubt on the ability of crowdfunding platforms to source persistently attractive ideas at valuations that will make their investors money.
Indeed, analysis of these opportunities is made doubly difficult when occasionally a slick presentation and video is not accompanied with any supporting financial data or projections, investors are effectively in the dark.
Types of Private Equity
Crowdfunding tends to sit at the very bottom of the size range, but PE investing ranges all the way from the smallest companies right up to the Ubers of this world, the mega caps, and it is estimated that more than $2tn of ‘dry powder’ – money raised but not deployed – is still to be allocated to investments.
PE firms can offer venture capital to start-ups, growth capital to mature businesses to enable them to expand, mezzanine financing that might convert debt to equity, or participate in large leveraged buyouts (LBO) that take a publicly listed company private.
How to invest in private equity
While PE is a difficult asset class to master, there are still ways for smaller investors to get access to it without using crowdfunding platforms.
The recent travails of Neil Woodford’s Equity Income fund, which breached its 10% allocation limit to unlisted investments, have highlighted the risks of the sector.
Listed investments (particularly those listed on Alternative Investment Market (AIM) or in certain emerging markets (EMs)) can be illiquid, but private equity investments are considerably more so – most PE funds will have long investment periods and very slow realisation periods that require ‘liquidity events.’ This could include an initial public offering (IPO), trade sale, or sale to another PE fund - in short, getting access to your money depends on the prevailing investment climate and is not under your control.
While Neil Woodford is suffering from a slew of negative press, the irony is that many of his fund’s illiquid investments are in fact available for investment through the Woodford Patient Capital Trust (WPCT).
At the time of writing, it is a member of the FTSE 250, and has ample liquidity for investors. The share price has significantly corrected from 80p to below 60p, due to bad news, but investors that want to sell out now can, while those who are willing to ride out the storm can either hold onto their investments or add to them at lower prices.
Investment trusts offer easy access to private equity
WPCT is just one of many listed vehicles that offer access to PE.
The Association of Investment Companies has a number of listed private equity companies as members, with offerings from firms such as Standard Life, 3i, HarbourVest and Apax.
If you’re looking to diversify away from equities, listed investment trusts offer a myriad of sub-asset classes, from commercial property to specialist debt, to aircraft leasing funds. These are all investments that private equity firms may consider, but in their listed form investors get the benefit of daily liquidity, pricing from multiple market makers and stronger regulation.
Start investing today
Whichever investment route you choose, opening an account is the best way to start and explore a platform. You can do so quickly and easily with IG, with just two steps.
- Open a share dealing account. You can open an account with IG quickly and easily.
- Place your first trade. Choose how many shares you want to buy, or the value you wish to invest, and get invested in seconds.