“What should I look out for when choosing an equity crowdfunding platform?” If you think the platforms are all the same you could find yourself out of luck and out of pocket a few years down the line.

[Disclaimer: I’m a co-founder of SyndicateRoom, one of the equity crowdfunding platforms covered in this article. Throughout the article care has been taken to separate my opinion from facts related to each platform. It was assumed an average investment of £2,500, roughly the average that each online investor commits per investment.]

While less savvy investors, and the media, are picking up on the fact that investing in companies through crowdfunding poses a risk which is inherent to investing in any young company, less notice has been taken of the underlying danger posed by the platforms through which the transactions are made and the deals are arranged.

The three largest equity crowdfunding platforms in the UK are Seedrs (minimum investment of £10 into very early-stage startups), Crowdcube (minimum investment of £10 into startups), and SyndicateRoom (minimum investment of £1,000 into early-stage and more established companies).

Here then, are the top 5 things an investor should look for when selecting an equity crowdfunding platform to invest through.

1) Is the platform entrepreneur-led or investor-led?

Entrepreneur-led platforms are those where entrepreneurs set the investment terms including share price and the amount of equity given away. Investor-led platforms are the ones where a lead investor negotiates more beneficial terms for investors, invest their own money and then the crowd can invest under the same terms. If you think of Dragons Den, entrepreneur-led platforms allow you to invest at the bottom of the stairs, before any negotiation. Investor-led platforms allow you to invest with the Dragons at the end of a pitch and for the amount of equity as they have negotiated for themselves.

2) Can I get diluted out?

If the shares on offer come with pre-emption rights, this means that investors have the right to ‘follow’ their money in subsequent funding rounds, protecting them from future dilution. For those of you that have watched the movie ‘The Social Network’ and wondered how Facebook managed to dilute the shareholding of Eduardo Saverin, one of the business’ founders of Facebook, from 30% to just 0.5%, this is how. Any investor without pre-emption rights could invest in the next Facebook but not see any returns. You will instead be supporting someone else to get rich whilst running the risk of being pushed aside when it really matters. All in an entirely legal process. This is how it works:

A company has 100 shares. Say that your investment bought you one share out of the 100. You own 1% of the company. Now imagine that you invested in the next Facebook and it is going to be sold for £100m next week. You get your calculator out and find out that you will get £1m, which is pretty cool. So you treat yourself to a Ferrari and a nice yacht, which you’ll pay for next week when the company gets sold and you get paid your £1m. Except that you won’t. In an entirely legal process, the entrepreneur could issue 1,000,000,000 shares the day before the company gets sold and buy them all for £1. If you don’t have pre-emption rights you cannot buy any of these shares. Now suddenly, instead of owing 1% of the company, you own 0.0000001% and will be paid £0.10 back.

So instead of being paid £1m, you are paid £0.10. All because the crowdfunding platform you invested through didn’t give you pre-emption rights.

When super-angel Jonathan Milner was asked whether he would ever invest in a good business opportunity without pre-emption rights, he categorically said no. So did business angel Graeme Porteous and a number of others. No business angel would ever accept investing without pre-emption rights, so why should the crowd get any less just because the amounts they invest are smaller?

3) What is the due diligence like?

Due diligence is a detailed investigation of a company by a potential investor, for the purpose of evaluating that company as an investment opportunity. This is an extraordinarily important part of the investment process. However, due to financial regulations and none of the platforms wanting to attract potential liabilities, the due diligence carried out tends to be hidden away and not shared with investors.

4) Direct shareholding or nominee structure?

Much has been written around this topic. There are two perspectives:

From an investors’ point of view, having a ‘middleman’ hold the shares on your and other investors’ behalf (i.e. a nominee structure) can be beneficial, as a group of small investors can act as protection from not-so honest entrepreneurs (less likely) and/or future institutional investors or venture capitalists (a lot more likely). However, most investors prefer to hold their own shares directly and be part of the shareholders’ agreement, which is the usual process for experienced investors.

From the companies’ perspective, the nominee structure makes the administration of the shareholders less cumbersome. However, there are easy ways to manage a larger number of shareholders effectively. Companies such as Inform Direct liaise with Companies House on a company’s behalf for less than £10/month, and for a similar cost there are companies that will organise updates and reports for investors.

5) Is it FCA authorised?

The way money flows internally is strictly controlled by the regulator (FCA). If a platform is not authorised by the FCA, you cannot be confident that your money is being handled correctly, or that it is safe during transaction.

I cannot stress how important investors’ protections are. You are investing your hard-earned cash and investing in companies is risky as it is. It doesn’t matter how good you are at spotting the next great opportunity; if you don’t have decent investor protections you may still lose your money . What is the point of investing in the next Facebook if you don’t profit from it? You won’t be investing; you will be giving your money away to fund someone else’s success.

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