Wednesday, 11 March 2015

A very poor investment

Do the math.

Platforms helpfully recommend investors should spread their risk over say 10 pitches. So lets see how Joe gets on.

He invests £1000 in ten ECF pitches. Each pitch for sake of ease is offering 20% of the company for £100,000. So Joe now owns 0.2% of the post money operation, valued as it was at £500,000. These are class B shares with no preemption or voting rights.

Over the next 5 years, 5 of these companies close down. On closure they owed an average of £40,000 to o/s creditors and £100,000 to investors each. They lay off an average of 3 staff each.

2 of the companies trundle along never quite reaching their projected goals and make no return in terms of dividend.                               

2 of the companies burn through their cash and have to raise more, diluting Joe's holding by a quarter - leaving him with 0.05%. (ECF advocates would point out here that the company valuation would have increased which nullifies the dilution. However the evidence of second and third raises on sites like Crowdcube is that they are forced by poor sales and the new valuations in no way compensate for the diluting effect.)  One sells out for £1m in year 5 - giving Joe £500.

The final company out of the ten, makes progress and sells out for 6 times its pre money valuation ie £3m. Joe receives £6,000.

Of these ten companies, the five that went bust were all start ups and had SEIS relief at 50%. Of the other five, 2 were eligible for EIS at 30% and 3 received no tax incentives. So of the total £10,000 principle, Joe manged to claw back £2,500 from SEIS and £600 from EIS. He therefore invested a total of £10,000 less £3,100 or £6,900.

Joe received a total back of £6,500. So has made a loss of £400 (ignoring lost opportunity costs) when you take into account the tax rebates. He is still the owner of shares in 3 of the companies but is locked in as there is no market for them. Even if a market did exist why would anyone buy shares in a company that makes money for its founders and staff only. The chances of seeing any return from these are negligible.

The loss to HMRC is 5 companies bust at a 50% rebate each on £100,000 or £250,000 and loss to o/s creditors is £200,000. In reality a large slug of this would be owed to HMRC in vat, NICs etc. This HMRC loss is in effect a loss of taxpayers money.

In this example we have used data collected from ECF platforms since 2011 - mainly from Crowdcube. No single company on any ECF platform in the UK has yet returned a single penny to investors and we feel that the chances of having two investments that sell and make money, as in this example, is very slim. So you could argue that the example is over optimistic.

So who has benefited?  Platforms like Crowdcube make very loud claims about the number of jobs they create etc. They do not mention on their platforms any of the companies that have gone bust or why they did so. They also never mention the wasted SEIS and EIS money that these companies have used and the lost money owed to o/s creditors - with all the implications that this can have for those companies. They do not list the redundancies. Certainly Joe has not benefitted.

The only beneficiary of this whole process is the ECF platform, which takes a ~5% commission on the £1m raised or £50,000.

So given the above why are so many people pouring millions into ECF. Could it be the Game Show, ''Dragons Den'' promotions that the ECF platforms seem so keen on? Well that and pure stupidity. Cut out the SEIS and EIS reliefs and this would all stop. Maybe then we could take a serious look at how or if this type of SME funding might work for the benefit of all of us. As it stands at the moment we are just building debt and failing businesses.

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