The two largest crowdfunding platforms (Crowdcube and Seedrs) have announced their intention to launch secondary markets for investors. This begs the question why investors would be interested in secondary shares at all? The answer is simple – that although investing in early stage business always carries risk, a secondary share offer generally means that some of that risk has been reduced. From a company’s point of view surely it is better to have a new and interested investor on the register than one that doesn’t want to be there at all.
Unlike quoted companies, early stage businesses have a number of factors to consider when creating a secondary market, not least how you determine price in an essentially illiquid stock and is it just supply and demand that should determine that price? Early businesses often need to raise follow on rounds of capital, and secondary shares trading at a discount to a primary offer can be very damaging to a business when it is at a critical stage of growth.
This is a challenge that is facing all crowdfunding platforms and different approaches are being taken. At Crowdcube, we started by offering existing investors the opportunity to sell at the same time as follow on rounds and therefore the price is set for all to see and depending on demand investors would either get new or old shares. More recently we have expanded beta testing an open market with a cohort of investors. In the case of Seedrs they have begun by creating regular trading windows and setting share price themselves (at the moment only existing shareholders in a business can add to their holding).
Common with other fintech businesses it appears that we are both taking an iterative approach to find the best solution that will maintain the interests of all stakeholders. What is certain is that there is demand from buyers and sellers for greater liquidity: early investors can benefit from multiple returns without waiting for the company to complete a trade sale of IPO and buyers can still benefit from backing a company when it is still young.
There will be some hurdles along the way not least that many private companies’ Articles of Association prevent shares from being freely traded, largely to protect founders and larger shareholders. In many cases, these will need to be altered and agreed to by a majority number of shareholders.
The opening of secondary trading in the crowdfunding market will no doubt be a game changer for the crowdfunding industry. All platforms are aware that, for the industry to mature, they need to do more than help businesses raise capital alone and move towards a small business investment eco-system that allows capital to be recycled which will allow them to continue to offer new opportunities for investors. Alongside this early stage business will have behave more like public companies in order to maintain interest which in turn will make sure they are better prepared for any sale or if they decide to IPO. Either way, investors are likely to benefit.