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Crowdfunding: will Central Bank oversight help or hinder sector?

Experts hope it will help Ireland catch up with UK – but the model will always be risky

Taoiseach Micheál Martin may have called time last week on most of the Republic's remaining Covid-19 restrictions. But Andy Byrne, the owner of Schoolbooks.ie, the online company that kept Irish households in supply of everything from crayons to chemistry books during lockdowns, hopes the boom the crisis delivered to his business will continue.

“Our sales jumped 68 per cent between 2019 and 2021,” said Byrne. “And while customers had more choice elsewhere last year than during the worst of the restrictions, our turnover continued to grow. We are forecasting that, with the service we provide and having a huge stock of 5,500 different items, we will see additional growth in 2022.”

No overnight success, Schoolbooks.ie has been around since 2004. However, when Byrne needed cash in 2014 to grow the business, two years after taking it over, he encountered a post-crash banking system in retrenchment mode, with little appetite for lending, especially to small businesses.

He turned to a fledgling alternative lender, called Linked Finance.

“We have raised a total of €756,000 from nine loans through Linked Finance over the past eight years, including €200,000 last September,” said Byrne. “While we deal with mainstream banks, Linked Finance is the go-to for us if we’re looking to raise money quickly.”

Set up in 2013, Linked Finance is the State’s oldest and largest player in the area of crowdfunding, a practice of financing a project or a venture by raising small amounts of money from a large number of people.

While crowdfunding goes back centuries, there are three main types in its modern online form: donation-based, debt-based, and equity-based funding. The area is generally targeted at small-time investors with limited or no investment experience.

The first recorded instance was when British rock band Marillion financed a four-week North American reunion tour in 1997 through online donations from fans. Debt-based crowdfunding – also known as peer-to-peer (P2P) lending – is said to have begun with the setting up of a lending platform called Zopa in the UK in 2005. The first known equity-based platform, where small-time funders receive shares in an enterprise, was launched two years later in Australia.

Global market

Estimates vary widely on the size of the global crowdfunding market, but UK market research firm TechNavio puts it at $120 billion (€106 billion) as of 2020 – excluding the donation market, which is more philanthropy than investing – and forecasts it will grow to $196 billion by the middle of the decade. The Irish market is estimated to be in the low hundreds of millions of euros.

Interest among retail investors has been fuelled by the fact that deposits in Irish banks are earning no interest, with savings pots of more than €1 million facing negative interest rates in many instances.

The last finance minister, Michael Noonan, began to look in 2017 at potential regulation of the industry in the Republic, three years after UK authorities started to supervise their crowdfunders.

While his successor, Paschal Donohoe, vowed in his budget speech in October 2018 to begin work on the regulation, a decision was ultimately taken to hold out for EU regulations on crowdfunding services providers (CSPs) – the intermediary between investors and project owners – in the areas of debt- and equity-based financing. Those finally came into effect last November.

Earlier this month, the Central Bank unveiled its new regime under the EU rules, requiring CSPs to be authorised from November of this year. This will leave firms subject to operational and prudential requirements as well as investor protection measures.

Will the nascent oversight of a previously unregulated sector fuel activity in it, or choke it?

For Derek Butler, a PwC-trained accountant who launched peer-to-peer lender Grid Finance in 2014, after four years working for aid agency Goal in Uganda and Haiti, regulation has come too late.

"I submitted a 22-page document to the Department of Finance five years ago under Noonan's consultation process, saying we couldn't wait around for the EU to implement rules," he said. "You need tens of thousands of [small lenders] for the business to make commercial sense, but we felt we couldn't get there without a proper regulatory regime."

Changed course

Grid Finance changed its business model in 2019 and got out of crowdfunding. It now focuses on providing short-term loans to businesses that earn money from credit card and debit card sales – an area known as merchant card financing. It raises its own funds through institutional investors.

Grid lent out about €10 million in each of the last two years. “We expect to do about €25 million this year,” Butler said. He is noncommittal about the prospects of getting back into crowdfunding now that regulation has arrived.

“We will have a look at the regulations and make a decision by the end of [March] on whether to re-enter the retail funding market,” he said.

Linked Finance chief executive Niall O’Grady reckons, however, that the timing of regulatory oversight is “perfect”.

“We’re miles behind the UK in terms of the stage of the sector here and are going to see very significant growth in peer-to-peer lending in the coming years,” he said. “This is a massive step forward.”

Some 27,500 investors have delivered over €180 million to over 3,000 business around the country since Linked Finance was set up in 2013. Last year, lending through the platform rose by 90 per cent to €36 million.

Loans issued through the firm, which are unsecured and backed by personal guarantees, carry interest rates of spanning between 6 per cent and 17.5 per cent, depending on the level of risk involved, with the average loan of a little more than €100,000 currently attracting a rate of 8.5-9 per cent.

Some 1.56 per cent of all of Linked Finance's loans have defaulted to date, according to O'Grady. By contrast, Permanent TSB, where O'Grady worked for 17 years to 2016, latterly as its commercial director, had almost 5 per cent of its mortgage book at least 90 days in arrears at the height of the financial crisis.

“Our credit assessment work is critical. You can lose credibility very quickly in this business if you don’t get that right,” he said. “Last year was a bit of a stop-start year, with the level of confidence tending to change as Covid restrictions were tightened or eased. Certain sectors that use us have actually being doing very well, such as solicitors, accountants and other professional services. Logistics companies and certain parts of the retail sector, too.”

‘Very tentative’

While new applications from businesses involved in tourism and hospitality dried up in recent years, Linked Finance is currently seeing “a very tentative move back into the market by some of these now”, he said.

The EU rules governing the Central Bank regime distinguish between sophisticated and non-sophisticated investors, and have different levels safeguards applicable to each of those categories. They introduce requirements in relation to “cooling off”, or reflection, periods of four days for a non-sophisticated investor to back out of a project. They also spell out the types of information that investors need to be provided with, including a key investment information sheet (KIIS).

The harmonised rules at EU level, following years of divergence among individual member states on how to handle the sector, will also allow for CSPs to passport their services across the union.

The EU has permitted national authorities to set marketing requirements that will apply to each member state to ensure that advertisements are clear, fair, accurate and not misleading.

The Central Bank of Ireland has decided, following a period of consultation last year, that all CSPs must have a prominent warning message on all advertisements that investment in crowdfunding projects entail risks, including the risk of partial or entire loss of the money invested; and that any investment is not covered by a deposit guarantee scheme or by an investor compensation scheme.

Property Bridges, a property construction lending platform, said this week that regulation has widened the sector's appeal among investors and financial advisers, as the company completed what it claims to be the largest ever Irish P2P crowdfunding exercise. This raised over €1 million to help finance the development of 96 homes in the village of Kilmeadan, Co Waterford – with investors offered an interest rate of 7 per cent per annum over two years.

Chris Burge, co-founder and chief executive of Spark Crowdfunding, the only equity crowdfunding platform based in the Republic, has also welcomed the new oversight system, saying: "Anything that increases protection for investors and improves the integrity of the market is to be welcomed."

In 2021, crowdfunding through Spark raised €7 million for Irish start-up companies, with the average investor committing €2,600, he said.

E-scooter start-up

Investment analyst-turned-entrepreneur Charlie Gleeson turned to Spark in 2021 to raise almost €562,000 for his e-scooter start-up, Zipp Mobility. It was part of a wider €1.3 million funding round that also secured €500,000 from two prominent angel investors, including tech investor Barry Maloney of Balderton Capital, and a further €250,000 from Enterprise Ireland.

Zipp Mobility, whose original backers include former Ireland rugby international Brian O'Driscoll, currently has "thousands" of rental e-scooters on the streets in cities across the UK and Poland and expects to launch services in the Republic later this year, subject to the passing of new traffic laws currently going through the Oireachtas, Gleeson said.

The crowdfunding route had two advantages for the company, he said. The Spark process lasted less than three months, whereas a so-called series A venture capital funding round can take six to nine months. “Also, we like the idea of customers owning a piece of Zipp as well.”

“The Spark process was pretty straight forward. We pitched to their management team and once they were familiar with the concept and believed it was an investible business that their community would like, they came up with an investment term sheet – after going toe to toe with us on each individual item,” he said. “Spark fought for the best possible deal for investors. It wasn’t as though we chose the valuation.”

Graham Byrne, chief executive of P2P lender Flender, which has issued €32 million since it was set up in 2018, has also welcomed the new regime.

“It’s an important starting point. As the market grows, the regulatory environment will probably expand as well. But it should be a gradual process, otherwise it will stifle the growth of the industry, which is an important alternative source of funding for businesses,” he said.

In the UK, the world’s first P2P lending platform, Zoba, revealed last month that it had had enough of dealing with the growing costs of evolving crowdfunding regulation, and the fact that customer trust in the sector has been eroded “by a small number of businesses whose approach led to material losses for retail investors”.

In future, the company will focus on being the type of lender it had long pitched itself as an alternative to: a bank.

Crowdfunding hits, misses and scams

Companies such as Peloton, the maker of expensive hi-tech exercise bikes, and brash Scottish craft beer giant BrewDog probably wouldn't exist today were it not for the backing of crowdfunders.

Few, however, have delivered the eye-watering returns – on paper, at least – being enjoyed by early small-time backers of Revolut, the international payments company that has more than 1.5 million customers in Ireland alone. Revolut raised just over £1 million (€1.2 million) from 433 investors via equity-based crowdfunding platform Crowdcube in July 2016, a year after being founded.

Crowdcube said last July, as the still loss-making Revolut was valued at $33 billion (€29 billion) in its latest funding round, that those who invested during the first crowdfunding campaign have made 600 times their initial investment, with 100 of them having become millionaires as a result.

Investors who put a combined £5 million between 2015 and 2017 into FormFormForm, the London-based maker of mouldable glue product Sugru, in another Crowdcube equity crowdfunding exercise have had less to cheer about.

The company, co-founded by Irish inventor Jane Ní Dhulchaointigh, ended up being taken over in 2018 after overstretching itself financially, in a rescue purchase by German adhesive specialist Tesa. The £7.6 million deal resulted in original backers losing up to 90 per cent of their money.

And then there have been outright swindles. One of the most infamous cases was that of Silicon Valley businessman Jeff Batio, who used US crowdfunding website Indiegogo. com between 2014 and 2016 to raise $700,000 – and $5 million elsewhere – by fraudulently promoting a three-in-one laptop, smart phone and tablet device called Dragonfly Futurefon that never came to fruition.

He was found guilty in 2019 in an Illinois court of six counts of mail fraud and six counts of wire fraud, and sentenced last November to eight years in prison.

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