Freetrade Crowdfunding Round Due Diligence

No news that freetrade is crowdfunding at the moment. But just because freetrade is the bees knees (impartial from here on, promise :wink: ) doesn’t mean you shouldn’t do your due diligence when investing in them. I’ve tried to give a due diligence quick rundown, to save you making those calls/emails, looking through all those companies house filings, financials, community posts, etc. I’ve noticed some people are on the fence as to whether to invest, especially if they’ve invested before, so I thought this might be helpful. Please note I can’t disclose non public (i.e. from the pitch deck) information, so i’ve avoided explicit quotes of figures/statements. There’s more to come, especially on investment terms, please enjoy this first draft for now :crazy_face:

Full disclosure: I’m twice-fold an investor in Freetrade, but no affiliations otherwise. I’ll try my best to still be impartial about the best neobroker on the planet. Whoops, starting now.

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The Company

I’m sure I dont have to tell you, but: Freetrade is a mobile-first, zero commision brokerage, challenging the high fees and god-awful user experiences of legacy brokers. They are ultimately democratising stock market investments by reducing the barrier/costs to entry and providing a millenial-friendly platform for investing.

Team

Doddsie is ex KPMG, a chartered accountant and financial analyst. He used to audit banks and brokerages, and advised on fintech M&A. Viktor is ex-google and is FT’s marketing braun. Crucially, he has experience scaling startups (Notey, in Hong Kong, from 2015-2017). and Ian Fuller is the head of engineering, ex-snap and Amazon talent. A strong team indeed.

Product
Review

The app is well designed, boasting designers from Deliveroo; It is simple and intuitive. It’s got hella shoutouts on Trustpilot (>9/10) and the app/playstore (>4/5). Onboarding takes minutes, Orders are simple. It’s a simple 4 digit pin to login. No drama. To those that haven’t/can’t use it, here’s a screenshot from my tablet:

What I love most is app iteration is user-driven, with features priorities based on votes by the community. If you don’t like something, make your voice heard - It’s effectively made by investors, for investors.

Some criticism has come in the way of how you are automatically setup to make an instant trade, rather than a basic one, therefore charged a fee. Some have noted this is against the freetrade ethos, and constitutes a ‘dark pattern’. There has also been some criticism as to how often the app crashes, which I have experienced to a small degree.

Most criticism, though, is directed at the small range of stocks, a few hundred on the app despite the thousands in the stock universe. This is ultimately because Freetrade lists stocks via third parties. With the debut of the investment platform, these processes can then be done in-house.

Future developments

Freetrade’s product innovation has been unparalleled. Granted, the most exciting innovations are yet to be shipped. Highlights of freetrades public roadmap includes Premium accounts (Freetrade Alpha), fractional shares and SIPPs. They are set to be the first broker to offer EU fractional shares, having recently gained the necessary FCA permissions:

You might be aware these are coming up:

  • The investment platform, the magic bullet that will allow a greater rate of stock additions

*‘Portfolio insights’ is also on the horizon, a portfolio analytical hub in-app, currently being tested by willing users:
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Images taken from this freetrade users post

You’re less likely to know about these:

  • Autopilot, which will be an auto rebalancing, auto investing feature to maintain a chosen fixed allocation portfolio

And this is me speculating:

  • In the most tongue-in-cheek way, Doddsie has hinted at Monzo integration in the future. This would capitalise on monzo’s 2 million customers (at time of writing), who are known fintech adopters - this therefore makes for an efficient customer acquisition channel.
  • I expect limit orders, watchlists/virtual portfolios and after hours trading to be developed in the more distant future, given demand in the community. After hours trading I find particularly important, as it amplifies the freetrade’s democratic effect somewhat (potentially opening up investing to 9-5ers who don’t invest as a day job). .

Achievements:

Growth

Freetrades landmark achievement is its growth. . They have reached ~40k users in well under a year, implying a weekly growth rate of 10-12% a week. By Sam Altman’s (of Y combinator fame) standards, that is beyond excellent. There is evidence of a recent tail off (see images below);

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Remember: download/user nos are vanity metrics, what matters is active users. FT’s definition of active is unknown in this case (one login? one trade? who knows)

The paid referral incentives are currently being tested, and this may well boulster growth. Even more impressive is that this growth has been organic - employing no sig. paid marketing channels as yet. One reason this works is that FT’s target demographic is relatively cheap to acquire, and will likely grow to be even more valuable customers over time (by building wealth). This has kept customer acquisition costs quite low. FT take alot of inspiration from Monzo in this regard, leveraging their engaged community to grow virally. For example, Monzo recognised crowdfunding goes beyond raising capital - it creates brand ambassadors who champion your product, effectively marketing you’re paid for! Crowdcube is currently getting 1.3m web visits per quarter. Note the spikes in google’s search engine traffic for the query ‘freetrade’, coinciding with recent crowdfunding campaigns (i’ve highlighted the May 2018 crowdfund spike, as it’s harder to see)

Challenges

Access to talent

Engineering talent: FT is an SaaS company (an app), and to build it up you need software engineers. They are the lifeblood of such a business. Unfortunately, British engineering talent is both scarce and expensive. At time of writing, there are seven open freetrade engineering positions, against a team of~20 developers. There is an increasing trend of outsourcing engineering -one of my portfolio companies (Urban Massage) did so with a 30-strong engineering team in Lithuania- though Doddsie ruled this approach out. Stock options are a great way for startups to appeal to engineers when competing with tech giants like Google and Apple, who can’t be beaten on remuneration alone. You will have indirectly suffered from this talent shortage: if a stock you wanted was unavailable in FT’s stock library, its down to the pace of development of the fabled investment platform, which in turn depends on freetrades engineering muscle.

Business model

How does a zero commision stockbroker make money?
Well, If we look at Robinhood, their US competitor - they do it largely by payment for order flow (being paid to have their users trades executed by certain institutions), which is illegal in the UK, so this model is out for FT. So FT have chosen to make money from the interest on uninvested cash (which monetises basic account users, negating a free-rider problem somewhat), ISA fees, instant trades and premium account fees (Freetrade Alpha, which is due to launch in the near future). They also charge for currency conversion, but this fee is only enough to cover the third party costs involved.

Will all this revenue yield a profit? This is a major risk/uncertainty I can’t answer. Freetrade’s tech stack ultimately means they can do things alot cheaper (e.g. onboarding, KYC checks) than legacy brokers; still, I doubt the margins will be as high as those HL or AJ Bell currently enjoy. I’ve found Freetrade’s forecasted margins quite optimistic (sorry guys!) and take it with a pinch of salt.

Why the competition might be a problem

FT have benefited from being largely uncompeted in Europe so far. Given Robinhood’s success in the US, Several startups are due to come into the foray and capture the EU market, from atleast 2019 onwards. Note I have focussed on the mobile first, zero fee stock brokers. Platforms such as trading212 and Degiro exist, and are competitors, but not as direct competition as those below I feel. Competition is understandably a primary concern amongst investors:

Robinhood, the unicorn startup that caused this whole challenger broker frenzy. They began a hiring spree in early 2019 in anticipation of a UK launch. There have been frew developments since, and I note that they have not gained regulatory permission in the UK as yet. Furthermore, although they are extremely well funded their business model is effectively illegal in the UK. Moreover, their unethical approach very much so leaves a gap in the market for an ethical neobroker such as FT.

Revolut Wealth, Revolut Bank’s answer to Freetrade/Robinhood, will be launching in the near future. An ex-FT executive team member, Andre Mohammed, was fired by Doddsie (Adam Dodds, FT CEO) and joined Revolut thereafter to help build their zero commision broker. He still owns 3.5m shares in FT…
Revolut have now tested their app with real money and have suggested a few hundred stocks on launch, so the development is very nearly complete it seems. They do not as yet have the regulatory permissions needed to be a brokerage. They’re app could be finished, with a 100k user waitlist (there isn’t one, btw), but they can’t start until they have FCA authorisation. Revolut have been dogged with bad press in light of FCA probes, etc. Their broker would likely still leave a gap in the market for the ethical, customer focussed broker like FT. Users also need a revolut account to partake, which may cause friction in acquiring customers. Lastly, they limit trades per month on basic accounts, which may further deter potential customers.

**BUX ** are an (ex) CFD broker that are investing heavily into a zero commision stock brokerage app. They are well funded (having recently closed a ~£10m funding round and also launching in Western Europe. Definitely one to watch.

The incumbents/legacy brokers (e.g.Hargreaves Lansdown, HL) have yet to feel any competitive influence. When they do, we can app development. What they might struggle to do is compete with FT’s pricing, HL have an extremely high margin business, so there is room for price cuts, but not enough to give thins away for free. They have too much overhead and too inefficient tech stack to do this.

Why the competition might not be a problem

One absolutely beautiful fact about FT as an investment is the sector has a large barrier to entry: Regulation. For this reason, any competition cannot move as fast as it might like. This is partly why, in addition to starting over mid-development, Revolut have taken so long to develop their trading platform.

FT also have a first mover advantage in the UK/EU - basically a headstart. Right now they are the only zero commision brokerage in the UK/EU. When their arch rivals launch, FT will then be the only neo broker with 1000+ stocks, fractional shares, and ISAs. When they’re competitors have these, they’ll still be the only neobroker with SIPPs, 3000 stocks, etc. And so on. This is a powerful, but not insurmountable, advantage.

Lastly, brokers traditionally haven’t been a winner takes all market. In the UK alone, you have Hagreaves Lansdown, AJ Bell, Interactive investor, etc. This isn’t a gaurantee neobrokers will go the same way; Monopolies do exist (Google - search engines, Facebook-social networks, etc), but this is atleast somewhat reassuring.

The investment

Valuation

The price of a business is just as important as - and separate to - the underlying business itself. I cannot stress this enough. If you’d somehow bought into Monzo at early stage in 2017, on a ridiculous £10bn valuation, you’d still have made no money to this day, despite Monzo having gone from strength to strength. Conversely, as poor as the future performance of Woodford’s equity income fund might be given his current crisis, if it was valued at £1mn by the market (without changes to fundamentals), a massive discount to NAV, it is very likely to be undervalued and potentially a great investment.

Monzo was valued at £85m pre-money, with 120k users. So freetrade is in the right ball park relatively speaking. Objectively speaking, however, I still believe equities are overpiced across the board, a symptom of a pro-risk market and fintech bullishness. This is not to say Freetrade won’t give you a decent ROI, but just that it may be partially eaten up by the valuation. Early stage businesses are notoriously tricky to value given their lack of cash flow ; the key, therefore, is to make sure you are rewarded for the risk you’re taking; the valuation must imply a forecast return commensurate to the risk your taking (i.e. at the very least, better than that from blue-chip stocks). If we take a forward looking (on forecasted revenue for this year, a risky valuation method)revenue multiple, Freetrade is incredibly expensive - more so than weswap or seedrs, for example. Revenue multiples are a weak valuation metric, and Freetrade has indeed grown remarkably, but FT is an expensive business in my opinion.

Potential return/market opportunity

i’m not going to say what FT will make, but what they could make. To do that, one needs to get a feel for the size of the addressable market. So: According to the FCA, in 2015 there were 11 million retail and private investors in the UK, with a combined £1.2 trillion in AUM (i.e. invested). Whats key is that because freetrade democratises investing, they will likely expand the market, so the addressable market may well be even bigger than this. Only a small slither of the addressable market needs to be captured to provide a monstrous 30x VC-tier return,which is very good indeed.

Terms

The shares on offer are B shares, which carry no voting or pre-emption rights. Doddsie has put this down to corporate governance issues involved in too many A shares. Voting rights might seem unimportant, but they can prevent an unfair sale, for example. Remember that Andre Mohammed still has 3.5m potentially voting shares. The crowd own 52% of Freetrade, so they ought to have a bit of clout. Pre-emption rights are basically the right to invest in future rounds, preventing dilution.

Thanks for reading :slight_smile:

Disclaimer: This is not investment/tax/financial advice, please carry out your own due diligence and consider the risks to capital before investing in freetrade. Opinions are my own.

N.B. I welcome criticism and feedback; i’m happy to edit this post on an ongoing basis to make sure it’s as good as it can be.

21 Likes

Great write up!

What makes you think FT wont be able to match HL/AJ Bell? Once fully established I would imagine FT’s operating expenses to be lower than that of AJ Bell?

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Thanks man, I’m glad you think so :slight_smile:

It’s a great question. I want to preface anything I say with I absolutely could be wrong, it’s just my reasoned opinion.

But yeah, I don’t think FT won’t match HL per se, I absolutely think FT could become bigger than HL, but it would be a volume play, not a margin play in my view. My bad if I didn’t communicate this well enough - i’ll edit the original post to reflect this when i can.

Here’s what I mean: FT will definitely have lower operating expenses than HL, mostly by virtue of automating and digitising the business. FT just don’t make as much per customer is all. HL’s pre-tax margin is an insane ~63% today, and you’ll have to check out FTs pitch deck for their pre-tax margin forecast (can’t disclose, sadly), which I feel is still optimistic. HL are making 0.45% on million pound portfolios, and FT is making a fixed amount annually whether it’s a £1m portfolio or £1k portfolio. But that isn’t too say the business won 't succeed, I have a lot of confidence it will, but it rests on their ability to acquire a s**t ton of customers - which is looking very possible.

Here is interesting article on revenues of discount brokers, it’s a long read but can skip to conclusions at the end of the article.

Payment of for order flow is not a the big chunk of revenues if all brokerages are considered.

1 Like

Thanks for taking the time to write this post :pray:

To make this a little bit more tangible, Monzo shared a really interesting stat at their ‘Investival’ at the weekend, which some of you might have seen Adam tweet already -

Hopefully Freetrade’s crowdfunding investors will be just as keen to spread the word. It’s early days but it looks like you are so far :smile:

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49% of investors have referred at least on 1 person

I would of imagined this number to of been much higher although quite impressive when you think they had 36,006 investors in their last round alone.

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I have to say I see it from the other side - I’m surprised it’s that high. Many investors are not interested in using the product that the company they have invested in sells, they are simply looking at the likelihood of making a return on their investment. Considering the emotional attachment that also being a customer can invoke this is understandable.

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The number of referrals Monzo received - from both investors and non investors - shot up after they introduced the £5 referral bonus.

However, Monzo are very clear they would not have introduced the referral bonus at an early stage (unlike Freetrade) as a) they wanted to build the product/brand first, b) organic referrals are cheaper!

No problem! It’s taken a while, but I don’t mind, I just enjoy it! It’s a really curious thing.

I don’t think we’ll dissapoint! Already sent my link out to a couple now the scheme’s on android :robot:

Interestingly, not every monzo investor is a user: ~50% of monzo investors are/were monzo users, the other 50% might be crowdcube opportunists/investors simply looking for a ROI (Just as Warren Buffet probably doesn’t have an iphone). So its possible the 50% that didn’t refer simply had no intentions/means of doing so (even if it is ultimately to their benefit as a shareholder) - they weren’t using, or even looking to use, the app.

Quick detective work shows that Monzo have: 2m users, 40k forum users, and 12.9K topics created. Freetrade have: ~40k users, ~4k forum users and ~3k topics created. Monzo had ~1.9k Investors, Freetrade has 4000 (and counting :chart_with_upwards_trend:) at a similar stage. I wonder if , because FT’s community is more active, they might be more likely to refer?

I will say the hot coral cards were an especially creative way of doing word-of-mouth marketing. Those ‘wow, that’s a bright card’ moments are just cheap adverts for them, and i think that’s brilliant.

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Monzo were losing money on each additional customer at the time, it didn’t make sense for them to increase this loss at the time. I expect this is different for Freetrade as their revenue generating products are coming this year, so they’ll have positive unit economics…

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