The avant-garde of AltFi founders started with the benevolent aim of democratising investment.
Equity crowdfunding allowed everyday investors to back British businesses, sidestepping the often privileged nature of access to Angel networks. Peer-to-peer lenders filled a funding void left by the banks. Both were on a crusade of by the people for the people investment.
And, they’ve been hugely successful. Although it is still far from challenging the hegemony of high street banks, it’s grown at an incredible rate.
The peer-to-peer business lending market has reached over £4bn. Nearly a quarter of all equity investments last year were made through Seedrs and Crowdcube, the two largest crowdfunding platforms.
Yet in both cases, the future depends not on the retail investors - Joe Public - that made their name but on market-shaping institutional investors.
Institutional investment: the big guy in the crowd
The growing role of institutional investment in equity crowdfunding platforms is being celebrated by the industry.
Crowdcube co-founder Luke Lang wrote a column for BusinessZone last week, stressing the benefits of the involvement of VCs.
“Around 10% of all businesses funded on our platform have some form of VC, institutional or corporate investment involved at some point in their history, and that rises to 50% when it comes to growth-stage business,” he said.
Seedrs echoes the sentiment. Rich Mason, its business development director, says they’ve seen a “surge” in co-investment with institutions and later stage investors.
“2016 was also the year of co-investment, with a host of leading institutions or strategic partners investing alongside the crowd, highlighting a growing trend by VC firms to lead or support crowdfunding rounds on Seedrs,” he adds, citing Draper Esprit into Perkbox, Ascot Capital into WeSwap, and Unilever Ventures into blow among others.
This means, for example, Passion Capital invested £5m in challenger bank Monzo alongside 1,877 crowd investors, who invested £1m in just 96 seconds on Crowdcube.
And, high-growth company experts Beauhurst told BusinessZone that over 10% of campaigns across the myriad of crowdfunding platforms have institutional investors alongside the crowd last year. This refers to the number of deals that have elements of crowdfunding with separate VC investment (rather than VCs investing through the platform).
Who’s the ‘peer’ in peer-to-peer?
Institutional investment is considerably more developed in the peer-to-peer lending market. As explained by Seedrs’ Lynn:
“None of this should come as a surprise. In many ways equity crowdfunding has tracked the growth of peer-to-peer lending, but is about four to five years behind it. Where we are today is roughly where peer-to-peer lending was when institutional investors first entered that space."
Today, institutional money is crucial to many P2P platforms’ survival and shapes the type of loans that are made.
At one end of the spectrum, £4m of two-year-old lender ArchOver’s £18m book was funded by partner Hampden Group. “We realised we couldn't get it to the stage where it was truly customer ready without a larger partner,” founder Angus Dent told BusinessZone last month.
At the other end of the spectrum, 25% of Funding Circle's investment is from institutions (including the securitisation of loans). And lenders like ThinCats, the sixth largest player in the UK, are cautious and its growing impact.
“If you’re a P2P platform that’s relying on institutional money you have a few investors that are calling the shots,” says founder and chairman Kevin Caley. “They might say they want to get a minimum of 7% and decide what they will invest in.
“That’s a big problem for the ‘retail’ P2P lenders. It’s about allowing individual lenders to make the choice of who they want to lend to; there is a danger that institutional investor are going to swamp the market if we’re not careful.”
Institutional investors as a sign of proof of concept
On one front, the involvement of these funds is a huge step forward - their stringent approach can help protect investors.
ThinCats’ Caley says changes to its lending criteria due to the demands of institutional investors, cut 20-25% of loans last year.
Crowdfunding too, sees it as a legitimising force. “From a crowd investor’s perspective, investing alongside a VC has a number of benefits. VCs are naturally very selective and will usually only become involved with a handful of businesses each year,” says Lang.
What does the future hold?
Whether this is a good thing or not seems split between the two leading forces of alternative finance. On one hand, everyday investors now have access to big funding rounds like Monzo, something that would have been impossible in the past.
On the other, the future of peer-to-peer lending is less clear. Very few of these platforms make money and several have already struggled after key institutional investors pulled the plug.
Seedrs’ Mason is adamant the involvement of institutional investment won’t impact crowdfunding’s mission to democratise seed-stage investment. Arguing these funds bring extra benefits of providing follow-on capital in later rounds.
“It is a massive plus to be able to connect businesses who may have raised at seed stage with VCs and institutions as they move into Series A or B. This is simply a sign of the maturity of the sector and the huge potential for businesses of all sizes to raise from the crowd,” he says.
When posed the question, Lang made the same point about providing access to later stage VC-backed businesses:“we've democratised Series A funding rounds and beyond”.
The world of peer-to-peer lending is more cynical. Chris Hancock, CEO and founder of Crowd2fund, says the role of institutional investors has the hallmarks of the old world.
“In my opinion, it’s the old system,” he says. “It’s lending money as a bank, not using innovation to offer a better product.”
About Christopher Goodfellow
Journalist and editor with nine years' experience covering small businesses and entrepreneurship (ChrisGoodfellow.net). Follow his personal twitter account @CPGoodfellow and his events business @Box2Media. He has written for a wide range of publications in the UK, Ireland and Canada, including The Financial Times, The Guardian, The Independent and Vice magazine.