Will the alternative finance ISA be a game-changer for crowdfunding?

In November, HM Treasury made two very important announcements which have the potential to totally transform the crowdfunding market.

Firstly, it confirmed it had widened the range of investments which qualify for inclusion in the soon-to-be-launched Innovative Finance ISA by allowing debt-based crowdfunding within the new savings vehicle.

It also launched a consultation on whether to allow equity-based crowdfunding to receive the same treatment, a move which – if enacted – would provide consumers with even more choice when it comes to their investments.

The potential flows into the sector as a result of the changes above cannot be overstated. If even a fraction of the £483bn* held in ISAs in the UK switches into crowdfunding it could be a game-changer for the market, and while there will always be challenges ahead, the direction of travel from the Government is clearly supportive.

When you consider interest rates are at rock bottom and unlikely to climb anywhere near the levels seen prior to the financial crisis in the foreseeable future, crowdfunding investments offering far higher yields should continue to grow in popularity.

So far, so good. We have a sector being made much more appealing to savers by removing tax implications, potential returns which are far higher than rates available on deposit, and the all-important feel-good factor which peer-to-peer lending offers.

The potential flows into the sector as a result of the changes above cannot be overstated.

The fact investors can now effectively sidestep the banks, by far the most maligned of all the financial institutions, and lend to each other directly is a huge plus. Indeed, we expect crowdfunding will take more and more market share off the financial powerhouses of this world over time.

However, there remain many risks. Most obvious in the near term is the fact crowdfunding is a very immature market.

It has not gone through a complete market cycle, having only existed in the very unusual world we currently find ourselves in of record low interest rates and Government intervention, and how it copes with rising rates will be of paramount importance.

Many crowdfunded investments will also fail. These failures are as inevitable as another bank being fined for mis-selling, and without the safety net of the Financial Services Compensation Scheme, if a well-known brand does go pop it will be keenly felt.

Pie-in-the-sky valuations for new businesses need to be brought back down to earth with a bump, transparency needs to improve, and some guiding principles need to be put forward by the crowdfunders collectively.

Finally, there is the double-edged sword of customer loyalty to contend with. Having spent the past few years working in this space raising over £100m via successful mini-bond launches for companies including John Lewis, The Jockey Club and Lancashire County Cricket Club, we know anecdotally that many savers will happily sacrifice a few per cent in interest if they are helping to create something (such as the development of Cheltenham Racecourse, for example) for a business they are emotionally attached to.

A number of crowdfunded or peer-to-peer projects rely on this tie-in from investors to offset the risks, or the low rate of return being offered.

As a die-hard Evertonian, I understand this only too well. I would happily do my bit to support my club via a mini-bond or some such investment, with the interest I received of secondary importance behind my desire to help my football team.

Clearly, this is an incredibly powerful tool for businesses with strong brands and loyal shoppers to utilise. But if a particularly high-profile company’s mini-bond failed it would be nothing short of a disaster for the whole sector, potentially tarnishing it in the same way the PPI scandal (and numerous others) has the banks.

The only way forward, and to counter the almost inevitable challenges highlighted, is for the sector to tighten itself up.

Pie-in-the-sky valuations for new businesses need to be brought back down to earth with a bump, transparency needs to improve, and some guiding principles need to be put forward by the crowdfunders collectively.

Some are already making in-roads on this front and hopefully others will follow suit, because only by doing everything in their power to ensure customers are getting a fair deal can the sector realise its potential.

With these changes to the ISA regime, the Government is doing its part to help crowdfunding. The crowdfunders must now follow suit and help themselves.

If you’re interested in finding out more about MRM’s involvement in alternative finance, email me at richard.wheat@mrm-london.com.

 

*Statistics from HMRC, as at end of 2014/15, published in August 2015.

https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/4