All businesses are moving towards an exit – but the speed at which they move varies hugely. Because of this, whether you’re dipping a toe into investing for the first time or are an old hand at the process, crowdfunding returns can be a little confusing. This is particularly the case with private companies, which tend to be more reserved about business information, investments and strategic transactions than their public counterparts. While high risk, investment can also be high reward, but your returns will vary enormously depending on everything from the stage at which you backed the business to the company valuation.
The most well-known way of making money from your investment is by selling your shares for more than you paid for them. You can receive a return on your investment if the company you have invested in makes an ‘exit’ in the future, including a trade sale, IPO or share buyback. These will vary for each company, so be sure to look at the exit strategy on their pitch page.
When can I expect a return?
Investing in startups and early-stage businesses is a long-term proposition and timelines do vary. At Crowdcube, we are seeing returns from businesses that raised in 2015/16 but there were far fewer businesses on the platform then than there are now. However, despite the relative infancy of the crowdfunding industry, Crowdcube has already delivered millions in financial returns to thousands of investors from businesses that have funded on the platform.
Another thing to consider is that there are a lot of losses in this asset class (which is why a diversified portfolio is so vital – more on that later). Despite this, over 85% of Crowdcube’s funded businesses are trading; this compares favourably to a report by the Office of National Statistics, which found that 50% of all new UK businesses fail after three years.
There are several typical paths to exit: an IPO or a direct listing on a stock market – going public; a sale – whether that's a trade sale, a strategic acquisition, or being bought by a private equity firm, and other M&A structures. We run through all of these below, in addition to explaining some of the ways you can realise value and access liquidity before a company exists.
A paper profit is when shares in a business are worth more now than they were when you bought them. This happens when there is a rise in valuation, causing your investment to increase in value. How does a valuation increase for private companies? Well, when a company is going through a fundraising round, the founders will set out the case for a particular valuation. The lead investor (whether a VC, angel investor or angel syndicate) will test that valuation in their financial due diligence, and will ultimately agree whether or not they are prepared to invest at that level.
A number of businesses who have raised with Crowdcube have seen paper profits. Take eco-technology company Cornish Lithium, for example; they were valued at £20 million during their first crowdfunding round in 2019, while now they are valued at £80 million. If you have invested in the initial round, your shares would have quadrupled in value.
There are also those companies which raised their first round on the platform and then a future round via VC. This was the case with internet service provider Wildanet, which had a £50 million investment from private equity after their initial crowdfunding round.
The most famous example of paper profit might be fintech company Revolut, which boasts a $33 billion valuation (as of July 2021) but is yet to translate its rapid growth into profitability.
Paper profit is complicated by the fact that we don’t often know the current valuation of a business (as it is constantly shifting due to new funding rounds) and therefore the most up-to-date value of the shares, especially when the company hasn’t raised capital over the last few years. While you won’t see paper profit showing up immediately in your bank account, it is a good indicator of returns post-exit.
Initial Public Offering (IPO)
You might have heard the term ‘going public’ but what does it actually mean and why might a company do it?
Going public is when a private company becomes a publicly-traded and owned entity. Companies want to go public for different reasons, depending on their circumstances, but most are looking to raise capital to fund expansion, pay debts, attract and retain talent, or monetise assets. It can also help a company to boost their general reputation and gain prestige.
A direct listing is a process by which a company can go public by selling existing shares instead of offering new ones. In a direct listing, employees and investors sell their shares directly to the public, whereas in an IPO, a company sells part of the company by issuing new stocks.
A Sale (or Merger & Acquisition)
Mergers and acquisitions (M&A) is a general term that refers to the activity of buying and selling companies and businesses or consolidating businesses of comparable sizes. While often used interchangeably, the two terms refer to different things: a merger is the combination of two firms, which subsequently form a new legal entity under the banner of one corporate name; while in an acquisition, one company purchases another outright.
If a company you invested in is bought in a private transaction, what happens to shares depends on the type of sale. If it is a cash-for-stock acquisition, then the buyer will pay you cash to buy your shares, and you will no longer be a shareholder.
In a share-for-share acquisition or merger, the buyer will offer you new shares in the acquiring company in exchange for your shares, so that you become a shareholder either in the larger company or in the new, combined business. You might also be offered a mixture of cash and shares.
After being acquired by JP Morgan Chase earlier this year, investment platform Nutmeg became the largest amount returned to investors following a raise with Crowdcube. The company raised just shy of £4 million in 2019 and in only two years has doubled their customer base to 140,000, while its assets under management have jumped from £1.7bn to £3.5bn, giving Crowdcube investors a healthy 2.3x return. It is important to emphasise, however, that this is a handsome return in only two years and that Nutmeg was already a later stage business when they crowdfunded. Getting in on a business in its earlier stages of growth could result in larger returns down the line.
Another notable example is meal delivery service Mindful Chef, which was acquired by Nestlé in 2020. Shareholders who backed Mindful Chef in 2017 saw an impressive 3.5x return on their investment after the sale.
A Secondary Share Sale
A successful exit for investors doesn’t only mean a blockbuster IPO or acquisition. Many European business leaders are choosing to stay private for longer but they still want to reward early investors and key personnel. This is where a secondary share sale can come into play.
A secondary sale is the sale by an existing stockholder of shares in a private company to a third party, unrelated to any acquisition of the company. When a lot of secondary sales happen together as part of the same transaction, it is sometimes referred to as a liquidity round.
Freetrade is a notable example of the returns you can access via a secondary share sale. Powered by Cubex, 1,063 shareholders in fintech platform Freetrade sold £5.8 million of shares in 2021, celebrating a 47x return on their investment. Six shareholders became millionaires as the company valuation skyrocketed from £2 million to £265 million!
Businesses paying dividends
Selling your shares is not the only way to get a return on your investment. As a shareholder, you might also benefit from a business paying dividends. A dividend is the distribution of a percentage of a company's earnings to a class of its shareholders, either in the form of cash or as additional stock.
A number of businesses on the Crowdcube platform have shared any annual profits by making dividend payments to their shareholders; these include the likes of fea, Parcel2Go, Foxize, EFS and Beara Beara. However, be aware that this is quite rare and typically only occurs with either very established, profitable businesses, or listed companies.
Where a limited company has several shareholders with various amounts of money invested, they often allocate different types of shares with different ownership, conditions and rights. Investors on Crowdcube will be offered Ordinary Shares with pre-emption and voting rights: you can read more about this in our Q&A here.
Shares are diluted when a company issues new shares, reducing the ownership percentage of existing ones (unless an existing investor buys or receives more shares to maintain their holding). For example, if two people own 50 shares each in a company (each holding 50% of the issued share capital), and the company issues/sells 50 new shares, their holding would be diluted down to 33.3%.
However, dilution isn’t necessarily a bad thing. If the company is growing and its valuation increasing, then while your overall ownership of the company might have been diluted, the value of your investment may have increased. In the above example, if the value of the 50 shares originally was £50 (i.e. £1 per share) and at the new investment round, the company issues 50 new shares at £10 per share, then the value of the 50 shares will have gone up from £50 to £500.
However, Crowdcube seeks to protect investors from dilution by including pre-emption rights in the shares that are offered on the platform by raising companies. When a new issue of shares occurs and a pre-emption opportunity arises, Crowdcube seeks to give investors the opportunity to participate - either to maintain their existing % holding or to oversubscribe and acquire more shares in the company, if other investors don’t take up their pre-emption rights. You can learn more about pre-emption rounds here.
Keep it diverse
As with all investing, particularly in seed or early-stage businesses, it is important to diversify your portfolio by making a range of investments with different risks, across sectors and stages. Most businesses fail, so the idea behind early-stage investing is that a few long-term winners have the potential to make up for losses, and more. With that in mind, it is best to invest small-to-medium sized amounts in lots of businesses rather than hedging your bets with large amounts on just a few.
Have realistic expectations – but prepare to be surprised. When distribution company ZigZag Global was acquired by Global Blue, their investors made a whopping 38x return on their investment that they made into the company back in 2015! Now that’s playing the long game.
However, it’s good to have a few potentially less lucrative but lower risk companies in your portfolio, so that you hopefully see some more modest returns in shorter time frames (e.g. 2x - 5x), alongside the longer term high-risk investments. That’s why we are so proud of the diversity of companies that are available for investment on Crowdcube: as well as later stage companies such as Nutmeg, Curve and carwow, where you get to invest alongside later stage venture capital funds, we also offer access to much earlier stage businesses who are at seed stage or seeking their first VC investment, which might have a longer lead time to exit.
Routes to access liquidity are evolving all the time. Direct listings (Spotify and Slack famously went through direct listings in 2018 and 2019 respectively); secondary markets; and the advent of regional stock markets are all more recent developments. It's an exciting and unprecedented time to be a retail investor getting in at the early stages!
Risks to be aware of
As with all investments there is a risk that you will not receive any return on your capital and the business could go on to fail. Or alternatively you could receive less than the amount you invested originally . Although there have been exits through the Crowdcube platform the past performance of these companies is not a reliable indicator of future returns. Remember, only invest what you can afford to lose.