Big Society Capital neglects small businesses – Could crowdfunding save them?

5th April 2012

Big Society excludes small companies

Big Society Capital, the long awaited "big society" fund to help charities and community groups has been launched. Or rather re-launched – the original announcement was last July.

The fund has £600m – with much of it "borrowed" from "dormant" bank accounts", those where there has been no activity for 15 years. Holders can reclaim their cash -often forgotten small sums. The balance will cost from a consortium of high street banks.

But while it offers a new source of funding to the voluntary sector – Big Society Capital has already made a few loans – it will do nothing to plug the financing gap between what new and small businesses need and what banks are prepared to provide.

Appeal to the crowd

One solution could be "crowdsourcing" cash, where a large number of investors respond to an online appeal, each putting small sums into the project. Last December, business secretary Vince Cable announced a business finance consultation that would include crowdfunding. 

The study is led by Tim Breedon, Legal and General chief executive and chairman of the Association of British Insurers. Most small businesses rely entirely on their banks but Cable said: "Businesses across the UK are still in many cases unhappy with the way they have been treated by banks."

Crowdfunding is more advanced in the United States where sites such as Kickstarter, IndieGoGo and RocketHub, raise small amounts of money from large pools of investors. Kickstarter alone has seen more than $125 million in pledges since its inception in April 2009, according to the New York firm's Justin Kazmark, spokesman for the New York company. One business raised almost a $1 million from more than 13,500 backers in December 2010, setting a record.

Kickstarter recently sought some $400,000 for San Francisco based game start-up Double Fine Productions. Using the power of the internet "crowd", it pitched the company to potential investors. They came up with the cash within a working day. Then over the next few weeks, a further $3m arrived. A virtually unknown firm with an unknown product now had 87,000 small investors. Kickstarter took 5% of the total as its fee. In South Africa crowdsourcing is seen as "cool"

More traditional venture capitalists caution, however, that the fund raising was for a "sexy company" in a "sexy sector" which internet-savvy investors might want a slice of. Trying the same for a high tech engineering firm or a speciality baker could be different. There is no guarantee what return, if any, investors in Double Fine will receive.

Legal constraints can impede progress

But future progress may be impeded by legalities. The US Securities and Exchange Commission may need to relax rules on these deals. And in the UK, regulators have not even started looking at crowdfunding or at peer-to-peer lending (P2P), a more organised alternative which has a substantial crossover with crowdfunding.

There are also legal as well as marketing expenses associated with large numbers of small loans and transactions. These can add substantially to financing costs.

P2P and crowdfunding may not remain, however, areas where many people with small amounts get together to finance new business. According to the Financial Times, investors with large six figure sums are moving into P2P, replacing or side-lining those with smaller amounts.

P2P sites see these big investors as a way of propelling the concept into the financial  mainstream but realise this can give a few investors powers over small companies which the recipient firms may find oppressive. It could turn what is still a cottage industry into something more substantial although at the cost of losing "innocence" (and innovation) in the same way that what was a small building 30 years ago turned into Northern Rock.

Government to inject P2P funds

In the budget, the government announced it was considering injecting some £100m into P2P. Investors have to deal with loan defaults. They can charge more for riskier projects but – and the only evidence for this is a prediction from P2P operators – the chances of individual borrowers not repaying can be anything from 0.5% to 6%. Others in this area suggest that this could be optimistic. P2P lending, whether to companies or persons, is not regulated and has no compensation scheme.

This far, Funding Circle, the largest business P2P site, claims that around 3% of its loans are either late or in default. But Funding Circle has still to reach its second birthday so there must be more chances of other firms not paying.

Ian Gurney runs comparison site P2PMoney. He told the Financial Times: "A lot of lenders are talking about the number of big participants in the market and the effect that is having on rates."

Big investors can bid for the best deals, squeezing out the smaller saver. They can  better judge risks.  And they can also undercut others because they can employ economies of scale.

Bigger participants hope P2P will become big enough for it to become an asset class. If this were to happen, it could change the costs for small and medium sized companies using more formal structures such as corporate bonds. And if enough investors were to crowdfund or use P2P, it could diminish the role f
or  investment banks and venture capital funds specialising in this area.

Seedling companies get new scheme

But there are other possibilities as well. In the budget, the government announced the Seed Enterprise Investment Scheme (SEIS) which allows investors to claim up to 78% tax relief on sums up to £100,000.

On Saturday, the start of the 2012-13 tax year, the first fund opens for business. It comes from Ascension Media Group and will focus on the UK creative industries, digital media and technology sectors. There will also be a second fund aimed at companies that are beyond the seed capital stage. This will qualify for tax relief under the enterprise investment scheme.

Ascension CEO Sanjay Wadhwani hopes interest will be boosted by "new promised initiatives for the content industries through the introduction of tax credits for companies producing drama, video games and animation from April 2013."


More from Mindful Money:

The network directed investor

Does ‘crowdfunding' stack up for investors?

Towards a language of banking

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