Posted on 7th April, 2016
Posted on 7th April, 2016
by James Codling
Co-Founder & MD
The importance of aligning interests with carry
The phrase “crowdfunding grows up” is one that is increasingly coming into conversations throughout the industry. Crowdfunding grew 191% in 2015, representing £245m of investment in to UK businesses and this trend is set to continue. By some studies, equity crowdfunding now represents c. 16% of all seed and venture-stage equity investment in the UK.
However, it’s important not to confuse the exponential growth of the market with taking a more mature approach to the way a crowdfunding platform runs its business.
I’ve mentioned in my previous blog that, as the market evolves and becomes more mainstream, there is a need for crowdfunding platforms to shift their focus away from raising as much money as possible through their platforms and instead move towards providing a demonstrable return to investors. In its simplest terms, it means we need to see some exits and that the companies that have raised funds need to grow and position themselves to be attractive to a potential purchaser.
Platforms must develop their business models to enable them to achieve this goal and I am a firm believer that the most effective way to do this is through an alignment of interest model between the platforms and their investors. This is the model that has long been used by the Venture Capital and Private Equity community, who, according to BVCA statistics, have consistently outperformed the public markets over by 3-5 per cent.
It encourages the right sort of behaviours and the philosophy is a simple one, pick the best deals (back winners), diversify (don’t put all your eggs in one basket), look after your investors’ interests post-fundraise (you’re their eyes and ears) and keep them regularly updated on how their portfolio is performing (transparency leads to trust).
The most important aspect of this relationship is carry, the profit share a manager will take if, after all their hard effort, they manage to deliver a return to their investors.
To contextualise this, imagine you have worked in the property market for a number of years and have a deep level of knowledge on the industry. You’ve been approached by someone from outside the UK who has investment capital but little knowledge of our market and they’re looking for you to help them purchase a property in London.
They’ve heard that it is an attractive place to invest, want a quick deal so they don’t miss out and are prepared to pay you, the broker, a deal to secure a property on their behalf. As compensation for your time they will give you 5% of its value on completion.
The more mercenary amongst us may look for a property that is highly priced and in an area that has already ‘come up’ in order to maximise the fee we’ll make and not worry about what happens when the buyer sells further down the line.
Now imagine the deal is that they have heard that the London property market is an attractive place to invest but they appreciate that it’s not their skill set and want to find someone with in depth knowledge. They approach you as they want to find the right property with long term capital gain potential. They also want to make sure that the property is looked after and cared for so that when they come to sell in five years they can maximise their profit.
They have asked you to be their partner in sourcing the property and looking after it, after all they’re a long way away. In return, they have agreed to give you 20 per cent of the profit they make on the house.
This is a big incentive for you. You’re likely to undertake a lot of research to identify the next area that will experience a property boom, look at the potential for structural and cosmetic updates to increase the property’s value and once it has been purchased, ensure that it is kept in good running order so as to maximise your return. It’s not a case of taking the money and running.
This latter, long-term partnership, is essentially the approach we take with our fundraises. Just like the banking industry matured to introduce bonus caps that ensured fund managers and big banks weren’t taking excessive risks to make a quick buck, making sure that our interests are aligned with our investors drives our behaviour as a business in a way that benefits all parties.
We have real skin in the game and that’s why we have a strict criteria that all our fundraising businesses must achieve before we present them on our platform. You can learn more about the opportunities currently raising through VentureFounders here.