Platform Business Models
Pedro Madeira 01-Apr-2016
This piece provides a context for InvestingZone
In a recent blog we said equity crowdfunding platforms were joining forces more and more, in a variety of ways, with established players within the ecosystem. But could the platforms have more ambitious aims in the background?
How the platforms currently make money
As you would expect, enabling investors to buy shares in fast-growing private companies is still the bread and butter of equity crowdfunding platforms. They mostly make money in three ways:
- –they can charge the company a percentage of the amount raised;
- –they can charge the investor a percentage of the amount invested;
- –they can charge the investor a "carry", i.e. a percentage of the money raised through a successful sale of the share.
Almost all UK equity crowdfunding platforms apply the first charge, and a few (such as Seedrs) also apply the third charge. The second charge is less frequent (CoInvestor combines the second and third charges).
Beyond a transactional business model
You may have noticed, as I did, that this business model is purely transactional: platforms charge companies and/or investors for a service, and need to keep them coming back for more so they can charge them for more services.
That made me wonder whether the platforms would be keen to partly replicate the way Nutmeg, Betterment and Wealthfront (and the like) work. All of these promise to enable you to manage all of your investments in one place. Or, rather, they promise to enable you to answer a few questions about yourself and your financial aims and then sit back with a Martini while their algorithms slave away on your behalf.
Curious to find out, I asked the representatives of the equity crowdfunding platforms present at the British Private Investor Summit. The other representatives said some people wanted control, others wanted convenience. In other words: it sounded like they would be pretty happy to look after your wallet if given the chance.
The pitch to potential investors would probably go along these lines: "We can give you access to investment opportunities into private companies. As Marc Andreessen recently pointed out, value creation has mostly gone from the public to the private markets – these days, by the time companies do an IPO, there is far less room for their value to grow than in the 80s and early 90s. Accessing private investment opportunities is the hard part, and we do it well. Alongside that we can also give you access to debt products and shares in listed companies, which tons of traditional money managers can do as well. Giving us your money for us to manage is just a no-brainer."
Certainly a persuasive line of argument.
Laying the groundwork
Arguably preparations are underway for this shift to start happening. Many platforms (such as SyndicateRoom and Seedrs) use a nominee structure. This means the shares you buy through the platforms belong to the platforms – you are the beneficial, but not the legal, owner. This does not per se make Seedrs or SyndicateRoom fund managers, but you can certainly see how with a nominee structure the natural next step is for you to not bother with making the investments yourself – the platforms can do that for you.
And, indeed, that is what Seedrs has been experimenting with (perhaps other platforms are too – but not that I know of). Seedrs has had a few "fund" campaigns. Some campaigns enabled investors to put their money into a pool, from which a third party would make investments; others enabled investors to put their money into a pool and then decide how to distribute their money across a range of companies.
These were individual campaigns – blink and you miss them. It's quite possible platforms will start to offer options similar to these in a more structured, ongoing way to their investors. Maybe this was a first step in that direction.
If platforms did choose to offer fund management-like services to enable investors to pour money into private companies, it is hard to believe they would stop there given their progressive expansion to other asset classes, such as mini-bonds and shares in listed companies.
From a business perspective, it makes complete sense for the platforms to target a slice of the asset management pie.
According to Beauhurst data, just shy of £5b in equity investment went into private UK companies in 2015. Even if all of that had been crowdfunded by the same equity crowdfunding platform at, say, a 7% commission, that would bring in around £350m. By no means a paltry sum, but quite far from the revenue ultimately expected of a potential unicorn.
According to The Investment Association, UK institutional assets add up to £4.34t, and UK retail assets add up to £1.06t.
Presuming a platform managed all retail assets, charging in the region of 0.01% (a standard fee for passive funds), that would mean a revenue of £1b. Even capturing only 50% of the market would bring in £500m. And this is presuming platforms wouldn't try to extend their tentacles to institutional assets, which is debatable.
Better revenue, better valuation?
Having a captive audience and targeting a potentially larger market aren't the only advantages of going down the paths discussed above.
A common way of valuing a post-revenue company is to agree it is worth a multiple (say 5, 10 or 20 times) its revenues. What multiple investors will accept partly depends on the stability of the revenue:.
Revenue multiples for equity crowdfunding platforms are unknown. But it's likelier that if platforms had a stabler source of revenue their investors (i.e. those that have invested into the platforms, rather than through them) might be more inclined to offer a better revenue multiple.
Bigger market, stabler revenues and (potentially) better valuations –
many good reasons for equity crowdfunding platforms to mutate into fund managers.