Cf Series 1: Big and small funders learning to play together

Crowdfunding and P2P lending have been much touted as a way for individuals and businesses to raise funds by attracting small amounts from a relatively large number of individuals. But there is also a growing trend of big traditional investors finding ways of working with ‘the crowd’ of small funders and the projects and businesses funded through these online finance models. Across the different crowdfunding and P2P lending models, there are emerging examples of bigger institutional funders like banks and venture capitalists engaging with these new entrants. In the long term we are likely to see more of this activity as platforms, traditional funders and the crowd attempt to find new ways of working together.

Online platforms channeling investment from institutional investors

While the original aim of alternative finance platforms was to facilitate investment from ordinary people looking to back a project or invest in a business for a return, larger institutional funders are beginning to put significant capital through alternative finance sites.

When one talks of crowdfunding, the typical perception is of thousands of unsophisticated investors contributing £10 or £50 to a firm in exchange for very small chunks of equity. But this is rarely what we see in practice. As equity-based crowdfunding platforms have expanded (an average growth of 410% from 2012 – 2014), and have attracted an increasing number of interesting investment opportunities, traditional investors have begun to look to them for opportunities. Nesta’s 2014 study of alternative finance in the UK, revealed that 38% of investor survey respondents from equity-based crowdfunding sites identified themselves as being either sophisticated investors or high net worth individuals.

While much of this participation is ad hoc, some platforms have sought to formalise the relationship between traditional larger investors and the smaller, often inexperienced investors. One of these is The Syndicate Room. Here, ‘the crowd’ can  invest (with the caveat that the minimum retail investment is £1000) alongside active business angels, provided that a lead angel investor is investing at least 25% of the overall amount. Crowd-investors then get the benefit of investing on the same terms as the professional investor, so in effect, when they look after their own interest in the company they look after the crowd investors too.

Institutional lenders getting involved in the peer to peer lending market

It is not only the equity-based model that has attracted the attention of traditional financial institutions. The UK P2P lending market is funneling around £1.3 billion to UK individuals and businesses in 2014, an amount equivalent to around 2.4% of bank lending to SMEs. Unsurprisingly, then, banks and other large financial institutions are exploring how they can get involved, primarily through lending through the platforms.

This trend is quite advanced in the US, where an analysis of the two biggest P2P lending platforms, LendingClub and Prosper, found that over 60% of loans were “snapped up by asset managers, banks, hedge funds, insurance companies, pension funds and other institutions”.

This is also becoming a feature of the UK market. One example is the New York-based KLS Diversified Asset Management agreeing with the P2P business lending platform Funding Circle to invest £132 million in loans to UK small businesses via the platform. Another is Metro Bank announcing in early 2015 that it will begin lending through the P2P lending platform Zopa.

It is not just big financial institutions getting involved. More recent developments have seen big tech companies with large SME customer bases partnering with P2P platforms. One example here is Chinese e-commerce platform Alibaba partnering with UK and US P2P lending platforms.

Matching funds from large charities with crowd contributions

Beyond the private sector, large charitable organisations are also beginning to use crowdfunding campaigns. Here, their aim seems to be to test demand and partly-fund bigger projects, by agreeing to match funds raised from the crowd with grants or investment.

One example is Creative England, a not-for-profit organisation with a focus on nurturing the country’s games, TV, film and digital media industries. They partnered with the crowdfunding platform Crowdfunder to develop a programme to get more women involved in coding. The campaign, Queen of Code, sought to address the fact that, according to the campaign, up to 49% of people using video games are women but only an estimated 12% of developers are women. Creative England committed to topping up each of the first three projects that successfully raised funding from the crowd via Crowdfunder with an additional £5,000.

Government using alternative finance to supporting businesses through partnering with citizens

Governments, too, are also beginning to explore the opportunities of P2P lending and crowdfunding. In Newcastle, the city council has teamed up with the P2P lending platform Funding Circle, to set up a scheme where the city as part of its Local Business Lending Partnership, which aims to stimulate local economic growth. The city council will lend £100,000 directly to businesses based in Newcastle, viathe Funding Circle platform.

Another example is the Danish central government, which is pioneering how crowdfunding can be used to support startups. As part of the scheme,companies who have raised approximately £50.000 (500.000 danish kroner) through a reward-based platform of their own choosing, can seek a match funding grant of between £50,000 and £146,000.

Crowdfunding also presents an opportunity for government to leverage more funds for public services and experiment with how this can impact on how public funds are spent. This is explored further in the next blog.

Institutional funders and online finance platforms complimenting each other

We’ve described above how institutional funders are looking to invest through platforms. In addition, we are also seeing examples of them using crowdfunding models to find new investment opportunities or create a more flexible offer to their customers.

One of the biggest strengths of rewards-based crowdfunding campaigns is that they are can provide proof of concept and build a product fanbase before committing large amounts of investment. This has turned Kickstarter, Indiegogo and other rewards-based platforms “into the venture capitalist’s best friend”, as they provide a free process for identifying potentially good investment opportunities. One famous example of this is Facebook’s controversial $2 Billion acquisition of Kickstarter success Oculus Rift. However, it has become a popular way for many firms to identify acquisition targets and  investment opportunities, especially for smaller and less high profile projects. Looking at 443 hardware projects that had raised over $100,000 on the Kickstarter or Indiegogo platforms CB Insights found that 9.5% of the hardware projects had gone on to raise Venture Capital, receiving $321 million in total VC financing after their crowdfunding campaigns.

Banks are also looking to see how  alternative finance platforms can complement their activities. One emerging trend is referral arrangements for unsuccessful loan applicants, from banks to the platforms. Two examples of this are Santander’s referral partnership with Funding Circle and RBS’s similar partnership with both Funding Circle and Assetz Capital.

We note that the UK Government has recently legislated that all large banks will have to direct unsuccessful loan applications towards alternative lenders. This is expected to be rolled out in 2016, and so we expect to see a significant increase in this trend.

What could the future look like?

As described above, this is an area of rapid development, with institutional investors already playing a very active role within the different crowdfunding models. Looking forward we predict institutional money playing an increasing role in both P2P lending and crowdfunding.

However, questions remains: what exactly are the benefits for institutional investors of engaging with the alternative finance market compared to more traditional methods of investment? What does it mean for the ‘crowd’ of small lenders and investors? Is alternative finance a democratisation of finance or will the ‘crowd’ be squeezed out of promising deals?

We see several potential future scenarios:

  • Small lenders and investors will get crowded out of many P2P lending platforms, with some platforms and projects limiting the participation of institutional investors to prevent individuals from getting crowded out.
  • Banks and other financial institutions will set up, or acquire existing, P2P lending platforms
  • Venture capital firms will set up formal partnerships with crowdfunding sites and some will be setup to invest exclusively in crowdfunding successes
  • Large charities and foundations will put 50% of their grant funding through match funding programmes

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