We had a very enlightening chat with a business founder who had used Crowdcube to raise capital but had so far failed to get even close to its projections.
His explanation was honest. Simply put, it is impossible to create sensible projections. So all businesses therefore produce overly optimistic projections. Everyone knows this. Therefore everyone allows for around a 50% reduction on net revenues when they look at them. The point was also made that it's impossible for businesses to know what costs and revenues will be even 12 months out, so trying is pointless.
Added to that, he stated that the only sensible way to value new businesses was to look at further funding rounds where the value of the company will be dictated by the amount people are willing to pay for shares.
We dont agree with either.
It maybe a fact that all the projections we see on Crowdcube are hopelessly optimistic but we believe there is a positive reason for this. Its done to attract investment. If any of the investors believed that these projections were out by 50%, they wouldnt invest at the value which is set by the very same projections. We know this because if you look at the queries on valuations on Crowdcube, they are all answered by pointing directly to the figures in the projections. If everyone agrees the figures are nonsense then so is valuation. Unless investors really are fools, they would only invest at a halved valuation. Its not a conclusion you can escape - people still invest. QED they believe the projections are in the right ball park. Most of then are not on the same planet.
Regarding the company health check - we also disagree with this. How many times have we seen companies returning for second third and fourth rounds at increased valuations only for the company to go bust. There are quotable examples where the administrator's report states the company had been in trouble well before the funding rounds and yet the upward valuations indicated the opposite. These valuations are entirely subjective and investors have mixed motivations for reinvesting. Many believe that just a little more will bring about the outcome they dream of - a healthy ROI. Otherwise known as the Gamblers Curse - once on the ride it is difficult to jump off. These dreams are initiated and encouraged by founders emails to shareholders giving them often highly misleading information. These emails are not regulated and do not go via the platforms. So they are legal lies. They can get away with whatever they like and often do.
There is a fundamental problem with UKplc being littered with companies that have accessed ECf funding based on these types of projections. It encourages them to over trade in a vain attempt to meet their aspirations - taking on crippling fixed costs that will if unfunded in subsequent rounds, bring the business to its knees. As down rounds are not really the thing on ECf platforms, these next rounds simply exacerbate the problem by raising the value - thereby satisfying everyone that the business is being successful. Given a more gradual climb many of these companies could become part of a healthy UK SME structure.
All the while all of this mess creation is being paid for in part by the Goverment's S/EIS tax reliefs. What we need is a system where all directors of limited liability companies have to pass a knowledge based test or S/EIS is not available. This, backed by much more stringent assessment of the handling of the company's affairs on administration, would certainly help. After all you wouldnt want someone on the roads without a license.
It was certainly interesting and worrying in equal measure to hear this opinion from the horses mouth.