Seedrs Crowdfunding Round Due Diligence

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Seedrs, the equity crowdfunding platform, are launching a crowdfunding campaign y’all! The campaign will open to existing investors first, then publicly ~1st October (will keep you posted). I’m an investor but I will try to be impartial from here. Please note I can’t disclose confidential information. Whilst it’s a first draft, I’m conscious it’s getting too big ( Feel free to just read the summary below), so we’ll see what happens editing wise.

N.B. I’m thinking of making a blog on this kind of stuff as I happen to enjoy it and would be better motivated to finish the posts on a blog (it’s alot of work)!! Please let me know if this sounds like something you’d follow in the comments/DM or even using my referral link (I know, sorry, you get £25 credit to invest though :stuck_out_tongue: )

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Summary

Let's hear it, then

Seedrs is an equity crowdfunding platform founded by Jeff Lynn and Carlos Silva in 2012 as an MBA project at Oxford university; it enables retail (or institutional) investors to invest in unlisted companies online. It was borneout of a lack of bank risk appetite for small business finance to after the 2008 crisis, and a pro-risk environment for retail investors stemming from low interest rates. ECF is opening up an asset class to retail investors that was previously the reserve of high net worth individuals, and finance for entrepeneurs in what is still a bias and elitist venture capital industry :+1:
Seedrs have developed a reputation as a user-friendly, ethical and transparent platform – a major USP that could see them occupy a significant share of the market. They are also strong on product innovation, having created a secondary market and fund/passive product. Fellow platform Crowdcube pose a significant competition risk. Furthermore, the terms of this round (convertible note - see “terms”) reduce upside potential of any investment, but also offer downside protection. Brexit, changes in regulation, the possibility of a market downturn and brand reputation are key risks also.

The wealth of information provided by Seedrs makes the investment opportunity particularly easy to assess, a fairly rare development in equity crowdfunding; Seedrs are close to breaking even, which is uncommon in early stage Fintechs nowadays. The market opportunity remains extremely large, with private equity being a multi-trillion pound industry.

Background

Team:

Jeff Lynn is Founder and executive chairman at Seedrs. He has a history in corporate law and is a startup-enthusiast, Seedrs being his MBA project from Oxford university. He relinquished the CEO position in 2017, he has a role as spokesperon for Seedrs and oversees product developments.

Jeff Kelisky has been CEO since 2017. He has 15 years previous experience as a CEO and has taken a business to exit and similar levels of experience within technology, having worked at Microsoft in a senior role.

Whilst they have impressive credentials, neither team members have outright experience in fintech. They are joined by COO Mark Brooker – whose experience at Betfair, but importanly as an investment banker at Morgan Stanley and Merril Lynch fills this gap somewhat. A venture capitalist or executive member in a fintech (Ex-Zopa, say) would have been nice though.


Product

Seedrs is basically a website structured like a marketplace – companies list pitches and users invest into those pitches. To keep things simple, let’s focus on if users are engaged and if it’s scalable. So they have a strong trustpilot rating of ~4.5/5, over ~700 reviews. The median average investor has just one investment although, this may be indicative of a recent influx of new users. Seedrs have a track record of product innovation, facilitating a secondary market, automated investing and an EIS fund product – this could draw in the lion’s share of retail investors. The notion that it is a scalable business is almost given considering the low cost base of a digitised business :desktop_computer: The unit economics reinforce this view (see financials). I’m pleasantly surprised at how relatively low their costs seem to be given that it operates in a regulation-sensitive space. :thinking:


Seedrs in action: EIS100 fund product


Seedrs in action: Secondary market


Seedrs in action: Investment portfolio hub


Growth:

If you invest in Seedrs, it is a capital growth play. You are not getting dividends anytime soon.You therefore might want evidence that it is high growth, and that there is opportunity for growth in future. Please see ‘financials’ section for revenue growth, which is strong. No. Of investments annualy has gronw from ~46k to ~73k, yet no. of investors has been fairly static. This may sound problematic, but Seedrs have admitted focussing on unit economics (value per capita/investor/user) and this ultimately shows a positive development (increasing deal size and investments per user)on that front.


Seedrs’ 2018 in review

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Courtesy of Beauhurst; Crowdfunding as a sector has been static in growth in the UK recently, perhaps indicating a saturated market? The need to expand abroad is clear

With European expansion planned, the opportunity for growth is large. The european venture capital industry is worth ~£60bn in Assets under management.
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Source: Mckinsey and Company, via consultancy.co.uk

So growth and growth opportunity? Check. :white_check_mark:

Notable Risks

Whilst there are many risks when investing in a startup (illiquidity, lack of dividends, total capital loss, etc), I have highlighted some risks and challenges unique and/or especially important to Seedrs at this stage of their company’s journey.


Brexit risk:

Brexit is a key risk going forward for Seedrs. Around 85% of seedrs’ businesses are UK-based, if the UK economy were to suffer as a result of brexit, the resultant market downturn (startups are closely tied to the GDP) would spell trouble. Seedrs have offices in Portugal, Germany and the Netherlands, which may mitigate or enhance brexit risk depending on your view. An EU-wide policy due to pass in 2020 is primed to harmonise ECF laws (See “regulatory risk” section) across europe - Seedrs have sought to position the business to capitalise on the opportunity.

An obvious means of mitigating this risk would be to diversify the geographies in which they operate to those unaffected by Brexit. Although acquisitions and partnershipsin the US have proved non starters, expansion in Europe is key to Seedrs scaling going forwards. Interestingly, Seedrs took part in a government-led fintech partnership with Hong Kong recently, indicating Seedrs’ appetite for global dominance. Muahaha.


Regulatory/Policy risk:

The famously innovative FCA have created a regulatory climate in which ECF can thrive in the UK. At the moment , some KYC/AML checks, risk questionaire/warnings and you’re good to invest. The UK government has also been supportive of ECF with tax incentives like (S)EIS, etc). Globally, restrictive policy/regulation has inhibited the growth/adoption of ECF - only Israel and the baltic states come close.

Whilst the likelihood ECF being made illegal in the UK/EU is remote, any negative development of any significance occuring in policy or regulation (restrictions to EIS, regulatory crackdown, etc) in this space will have a negative impact on Seedrs. This is a key risk going forwards. This has been the case recently in the P2P lending sector.

Alot of Seedrs’ value going forwards will be from opportunities capitalised on across Europe. The EU are soon to be enforcing legislation that will and, importantly, allow “passporting” - harmonizing rules across Europes. This is a positive development. For Seedrs, although it might enable competition from European platforms that were previously unable to compete/scale.

[EU legislation due to be enforced has proposed many interesting rules :
  • propsectus threshold of ~£7m – a ~£100-500k document detailing financials must be issued to raise more than £7m on a platform. Companies will may not want to pay this, nor disclose their business financials

  • all raises must have a key investor information sheet, that includes project information (incl. Financial information for past three years), risk factors, terms, investor rights, fees/legal redress, etc.

  • Platforms must disclose the default rate of their portfolio companies from atleast the past 2 years

  • Platforms must adopt an ‘alignment of interest’ policy, which may comprise a carry fee or ‘skin in the game’

  • due diligence comprising background checks (history of fraud/insolvency, etc) and ensuring founders are not in high-risk countries must be carried out on each project

  • ICOs do not fall under this regulation (thank god)

  • A yet-to-be-determined fee will be payable to the body that regulates platforms; ultimately a compliance cost.


Market risk:

In a downturn or bear market, investors have traditionally fled risky asset classes in favour of less risky ones. There are some indicators, such as yield curve inversion, that a market correction is due.

A mass exodus of investors would leave ECF platforms without completed deals, and therefore revenue. Seedrs’ business model/carry fee (see “business model” section) means that revenue is partially tied to the performance of their portfolio companies. There is an argument that ECF platforms might see increased volume in a downturn as companies seek out more accessible forms of finance, offering lower valuations to incentivise investors.


Reputation risk:

If a crowdfunding platform suffers a high profile scandal, distrust in that platform could lead to a mass outflow of investors, with the resulting lack of deals crippling the business. Notable causes of such a scandal might be a cybersecurity incident or a fraud case. Let’s use fraud as an example. Much like over the counter (OTC) securities, companies raising on ECF companies are not subject to the same regulation or transparency as companies on a large stock exchange. Couple this with retail investors and poor platform vetting, you have a recipe for fraud. The resultant distrust from a high profile fraud case could cause an investor revolt that would lead to reduced demand and ultimately ECF platform failure. Theranos, a now disgraced unicorn, swindled millions from venture capitalists on the basis of a fake miracle blood test. So yeah, trust could be instrumental to Success. Seedrs would seem to have lower reputational risk than Crowdcube.

“Brand is shorthand for Trust” – Viktor Nebehaj, CMO @ Freetrade

There is a possibility the allure of making a ridiculous amount of money in a ridiculous amount of time eclipses the aversion to this risk, and investors will nonetheless continue to invest, as has been the case with fraud in the cryptocurrency space.


Competition:

Most competing platforms (e.g. Ourcrowd, Syndicateroom or Funderbeam) haven’t reached critical mass, or operate a subtly different market niche (e.g. Ourcrowd is limited to HNWIs , leaving the retail market wide untouched). Seedrs’ arch rival, and arguably only direct competitor is the fellow UK platform C rowdcube:

Crowdcube is possibly the largest ECF platform in Europe, with market leaidng positions in the UK and Spain, stemming from a first mover advantage. Entrepeneurs will tend to opt to raise with the largest platform, due to a bias known as preferential attachment . A bias that has a strong propensity to not only persist but to widen.

Crowdcube have a strong partnership network also, leveraging these partners to attract investors and investees alike. For example, a partnership with US platform Seedinvest has led to American startups listed on Crowdcube (no other UK platform has managed to do this), a key point of difference for Crowdcube. This is effectively US expansion by proxy. Also, Crowdcube are funded by EU VC heavyweights Balderton capital, whose network was likely key in Crowdcube securing Nutmeg (a Balderton investee) to the platform. Crowdcube have received similar capital injections to Seedrs thus far, if not a bit more. Interestingly, VC Draper Esprit have invested in both Crowdcube and Seedrs, perhaps this conflict of interest explaining why Seedrs aren’t raising from Draper Esprit in this bridge round.

Unlike Seedrs, Crowdcube have branded theselves to entrepeneurs as a means of creating brand ambassadors , creating a use case for crowdfunding with high-profile, later stage companies who are already well funded. For instance: Chip investors are 4x more likely to refer users. This could continue to see Crowdcube obtain the lion’s share of companies; UK consumer fintech has been Crowdcube’s highest indexing sector, amounting to £71m in 2019 thus far.

Convtroversy around their due diligence, transparency and investor protections (e.g. as with Emoov and Sugru) have tainted Crowdcube’s brand image. This is likely to have led to Investor churn . Whilst some shares lack favourable terms such as voting or pre-emption, Crowdcube sometimes offer very attractive terms, offering liquidation preferences (which can’t be EIS eligible), etc. Seedrs typically offer ordinary shares (which are EIS eligible) and seek to secure reasonable investor protections on virtually all raises. Compared to Seedrs, Crowdcube’s investor fees (1.5% upfront) are cheaper in the event the underlying investment/portfolio does well, if you ignore the return enhancing effect investor protections might have. No Investor fees are charged if a company defaults on Seedrs. Crowdcube have been known to undercut Seedrs’ raise fees, which may have helped in Crowdcube sometimes stealing Seedrs clients as a result (e.g. Wisealpha, NextUp, etc). Seedrs have managed to poach back however (Notably with Revolut, but also with Much better adventures, Kokoon and others).

Crowdcube have also suffered engineering issues that may have deterred investors and entrepeneurs from using their platform: Monzo ran their own crowdfunding in-house for the most part, after a poor user experience at their prior round with Crowdcube. Crowdcube have since invested in their engineering department, hiring a new CTO and other talent.

Seedrs’ success hinges on their ability to outcompete Crowdcube, as well as whether ECF is a winner takes all market , a phenomenon that traditionally takes effect at a later stage.

Under the hood


Financials:

Seedrs have been beyond transparent with their financials, this may well be the richest financial information i’ve seen in a crowdfund. The numbers are audited by KPMG, so reliable. Whilst seedrs carry fee model means they have money sitting unrealised “carry pool”, Anyway, keeping things simple - you want to know how much money a startup is making (losing, usually), how much they have

Here’s a nifty chart I ‘borrowed’ from some dude’s Linkedin (thanks my guy, i’d link you but i’m cautious you might prefer the privacy):

I will also draw your attention to this:
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Seedrs is therefore on a trajectory towards profitability. You should expect them to become strategically loss making in any event to invest for growth, but atleast they will have proven their business model unlike some. I’m looking at you, Uber. :oncoming_taxi:

At end of financial year 2018, Seedrs had £6.3mn in the bank. Given their burn rate and revenue trajectory, they will have roughly two year’s runway (time till they run out of cash) after they finish the current £5mn round. The larger a startups runway is, the less risky it is – most startups that crowdfund don’t have anywhere two years of runway. Seedrs has debt, a little under £1mn of it is due financial year 2019- companies house accounts dont seem to clarify to whome this debt is owed. Note also tjat interest paying convertibles may be payable if institutional investors are in this round. Seedrs have sufficient capital to pay off this debt, it would seem. Seedrs have been quite capital efficient indeed, they have gotten quite far with their last capital injection of ~£6m in 2017.


Business model:

Raise fees: Seedrs charge 6% of funds raised on the platform on succesful campaigns. A further 0.5% payment processing fee and afixed £2.5k completion fee is also payable on completion. No fee is applicable on failed campaigns. Please note that to incentivise larger companies to raise, these fees are sometimes reduced. Furthermore, Seedrs offer to market/promote the campaign for an undisclosed (perhaps as it’s discretionary) fee. As Seedrs tend to know their dealflow well in advance, this is a fairly predictable revenue stream, unlike their carry fee below.

Investor fees: Seedrs charge no upfront fees, instead charging what is known amongst venture capitalists as a “carry fee”. This is a share of on any profits that investors make. Seedrs’ carry is 7.5%, so 7.5% of any realised (be it via an IPO/trade sale, or a sale on the Seedrs secondary market)return an investor makes is taken by Seedrs This means that Seedrs make money only when investors/users do, aligning the interest of both parties and enhancing Seedrs’ ethical offering. They make no revenue from investors in the event of an investee company failure, meaning this revenue stream is tied to their portfolio performance or the volatile capital markets. The carry fee makes for an interesting comparison to Crowdcube’s upfront 1.5% fee.


Terms:

Valuation: As Seedrs are raising via convertible (See “terms” section), they have not set a valuation for this round; this is not a ‘priced round’. Seedrs has in the past gone for a 20x revenue multiple. By comparison, Crowdcube’s last revenue multiple was 13x. Given it’s not entirely relevant to this raise, i’ll leave talk on valuation at that.

As this is a convertible note round (see “terms”), you will not immediately receive shares for your investment. Rather, you receive an instrument that converts or is “triggered” to shares in the future, at a discount (which is set in advance) to the going price . In other words, the businesshas not been valued for this round; it is not a priced round. Normally, a convertible pays interest until it converts, however this would render it ineligible for EIS, so Seedrs structure convertibles as not paying interest.

Why would a business do this?
The main reason is that Companies can raise money without undertaking a valuation exercise. The most notable use case is if a company needs to raise money in anticipation of a large/institutional raise: commiting to a valuation whilst negotiations with institutional investors are ongoing may negatively impact those discussions. A convertible means these discussions can continue without influence, enabling entrepeneurs to negotiate a more attractive valuation. Convertible notes reduce downside risk relative to shares, but take away the upside potential also.

So let’s dive into the parts of a convertible:

  1. The discount: The discount at which shares are issued. e.g. If you invested £100 in a convertible with a 30% discount and the going share price after the convertible triggers is £10, you would get ~14.8 shares because you are effectively paying £7 for £10 shares.
  2. The valuation cap: The effective value of any shares issued via the convertible will never exceed the share price implied by this valuation cap. E.g. If a company is valued at £50mn upon trigerring, but the valuation cap is £20mn, you will get shares at a price that reflects a £20m valuation rather than the current £50mn valuation .
  3. Longstop date. If the convertible hasn’t been triggered by this date, it is triggered anyway. Pay close attention to what happens if the convertible isn’t triggered by the longstop – sometimes clauses allow companes to choose (okay, negotiate) the share price…! Most longstop dates are one year, the sooner the better typically.
  4. Convertibles can be EIS eligible because of the way Seedrs structures them.

What is fascinating is that after this round closes, you will still be able to buy shares in Seedrs on Seedrs’ secondary market. Because of the way their secondary market works, these shares are still going for the 2017 price. As Seedrs have grown considerably since then, these shares are arguably considerably undervalued, and may well be better value than the convertible note in this round. Please also note: buyers suffer from significant information asymmetry here (no access to shareholder information before buying), these shares are not EIS eligible and these shares are known to be snatched up in the blink of an eye.


Investor relations:

Seedrs’ updates may be sparse (yearly, at present) but they are informative – more so than virtually all of my other portfolio investments. The financial statements are audited by KPMG, and Seedrs are open and transparent as to their business plan going forwards. The founder and executive chairman Jeff Lynn is proactive in the shareholder forum, despite how busy he must be. The shareholder forum is a useful resource, with many professional angel investors chiming in as to happenings on the platform, as well as the wider industry.

Miscellaneous

Risk disclaimer

This is not financial/investment advice, and opinions are my own. PLEASE consider the risks before investing - see crowdcube’s risk disclaimer for more details. The main risks are capital loss, lack of rarity of dividends, illiquidity and dilution. Be prepared for fraud - fraud is a very material risk, and is worth mentioning as people are especially averse to this risk (misleading of investors to some degree is more common than you think, but a full blown Theranos may happen in this space someday)

The worrying strategies of most investors

Most, not all, investors understand the risks inherent here, but in my opinion few truly appreciate the magnitude of these risks. Yes, you would expect to receive a greater return for taking on the increased risk of start-ups relative to large cap stocks, etc but this is not guaranteed. Increased risk only increases the range of possible outcomes (more risk = worse losses OR higher gains). I’ll shut up and let this chart from Howard Marks do the talking:

Perhaps the most crucial thing to consider is that should you invest in Seedrs, that investment should be one of many in a portfolio of startups,which should ideally be a small portion of your wider portfolio in less risky, more liquid assets. The science says a minimum of 28 diversified (don’t be that guy that is all in on 7 challenger bank startups in the UK) startups should do the trick. You should expect the majority of your startups to fail, with the hope being that the outlier “home runs” recoup your losses and then some. The median average investor in seedrs has made one investment… Here is why you must diversify:

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IRR = internal rate of return

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Hey :slight_smile: there’s no date for a public launch yet :c - all they’ve said is they are opening the round beginning of Octoberish and the public launch will be sometime after, I’ll reflect the original post to make this clearer.

Also, don’t worry, i’ll keep chuck a cheeky reply on here as soon as it launches. :+1:

So, are you thinking of investing? What do you make of them and their terms? :slight_smile:

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I’m a big fan of seedrs, the lively discussions on seedrs forum as well as other on businesses’ forum. On Crowdcube it is lacking. Even crowdcube team is not using their own pitch page to communicate with the investors…

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As I promised, here is an update on when the campaign opens: it opens on 3rd October, apparently closing on the 7th. If existing shareholders leave enough room, the round will open up to the public around this time.

Pre-register here to be kept informed.

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The Seedrs campaign is private live.

As it’s private, you might not be able to have access yet unless you are a current shareholder. It will launch to the public/wider Seedrs user base on October 7th. Feel free to DM me if you’re a bit impatient for the terms :slight_smile:

Interestingly, Seedrs are not charging fees to investors for their raise!

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Maybe they really need the money.

Seedrs raises for their own platform have always been fee exempt, both the initial fee which is charged to the business raising and the carry charged to investors on exit.

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