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Buying Shares in P2P Website Assetz Capital

Assetz Capital is a large P2P lending company offering secured business loans, and it has a good record when it comes to bad debts.

Now, Assetz Capital is looking for investors to buy shares in itself through Seedrs, a website that enables you to buy shares in start-ups.

The bare bones of Assetz Capital's pitch

Assetz Capital is clearly a popular investment. In Seedrs' “Trending” section, it appears first on the list.

The P2P lending company is looking for £2 million of funding and it has already been offered 80% (£1.6 million) of that, with just under 50 days still to go. It might extend this to £4 million.

In its pitch to investors, Assetz Capital says it has matched £60 million of loans between borrowers and lenders last year and expects to match £300 million in 2015.

It also claims to be in the “top four” P2P lending companies. I'm not sure how it measures this, because by monthly loan volumes I don't think that's correct. But all the P2P lending companies seem to make grand claims about how they're bigger and better than the rest. That's marketing for you.

Buying shares in start-ups vs peer-to-peer lending

I won't repeat any more of the details of the investment opportunity here, because you can see them on Seedrs if you want.

And I'm not going to evaluate this specific start-up investing opportunity, because 4thWay is about helping you lend your money better through peer-to-peer lending, not evaluating whether to buy shares in a single start-up.

However, I want to write a little about buying shares in start-ups in general. The reason being that it helps you, as someone who is investing (or lending) your savings, to have a rounded understanding of how different types of investments compare to P2P lending and to each other.

Get a wet handkerchief…

…Because you'll need to mop your forehead clean a few times if you want to buy shares in a start-up.

Just one of the reasons for that is that buying shares in start-ups requires you to do a few convoluted, highly hypothetical sums to estimate what proportion of the business you'll own at the end and at what price.

(You also have to figure out if that price is fair, which isn't so much maths as a lot of guesswork, skill and experience. I'm not even going to try to write about that here!)

In the easiest case – and Assetz Capital is not the easiest case – the first step will be a simple piece of arithmetic. If the company is seeking investment of £150,000 in return for 10% of the company then it is claiming to be worth £1,500,000 in total. And if you invest £1,500 you'll own 0.1% of the company.*

At least for the time being.

Because then you need to look into what might happen to your share of the company in future. This can be quite complicated and based on the agreed structure of the deal with you, the founders and other, potentially even earlier, shareholders. Plus it will depend on management's current plans and future decisions regarding raising even more money.

For example, will future shareholders be allowed to dilute your holding, and by how much?

You might own £1,000-worth of shares valued at 0.1% of the company today, and the whole company might be valued at £1 million, but if the company then prints additional shares and sells them all for £1 million to new shareholders at the same price as you, you and the other existing shareholders will see the value of your stake cut.

You still own the same number of shares, but now you just own 0.05% of the company. Your ownership has been halved. So, if the company is sold for £50 million, you'll just get £25,000 instead of the £50,000 you were expecting.

Your share of the company might be reduced several times if there are even more funding rounds. And there usually are.

This isn't necessarily bad; more investors joining later on should hopefully mean the business is heading in the right direction and the extra money could lead to more profits to share between you, more growth and higher chances of success, which could compensate for your dilution.

But dilution is a complication in establishing the ultimate price you'll pay and one that I think is ignored by most investors. Yet dilution for early investors can be huge.

It can get even more convoluted

Assetz Capital makes it even more complicated by selling you convertible notes instead of straightforward shares. Apparently these are a popular way to fund start-ups.

I've been investing for nearly 20 years, but, since I've not invested in start-ups, I didn't even know what “convertible notes” were until today.

It turns out they're distinctly different to other convertible investments I know of. I don't like other convertible investments but, as for these convertible notes, I don't think I like them any better.

Let's say you invest £2,000 in Assetz Capital through Seedrs in the form of these convertible notes. To begin with, the P2P lending company will take your cash and start spending it, but it won't even tell you what proportion of the business you're going to own.

You read that right. You pay them money and they don't tell you what you're going to get in return.

Your £2,000 will “convert” into shares in Assetz Capital whenever it goes for, and gets, another round of investors to invest an additional £1 million or more.

At this point, the new investors will get shares, and so now will you. Only you'll get them at a 10% to 20% discount compared to the newer investors. This means if they get 100 shares for £2,000, you'll get between 111 and 125 shares for the same price.

If Assetz Capital doesn't go for another round of funding, but it sells the company or lists on the stock market, your share will be based on the sale or stock price. So, if the stock market later values the company at £50 million then your reward will be perhaps £2,500-worth of shares (that's your £2,000 investment plus a 20% discount) and you will own 0.00005% of the business.

For the record, Assetz Capital is looking to get another round of funding and then it wants to list on the stock market. If Assetz Capital carries through its plan, your share allocation will be determined before it becomes publicly listed on the stock market.

Buying shares at an unknown price

Leaving Assetz Capital and just talking generally again, there are two big things I don't like about these convertible notes. I'm not sure which one bothers me the most:

1) You're relying on the next investors to be great at valuing this investment and, especially, not being naive. If they get a bad deal, you could too – even with your discount.

2) Each week that goes by after you have invested and before the next funding round, the risk rises that you'll end up with a bad deal. And that's even if the next investors got a great price for themselves.

Point two requires some explanation.

If you invest in an established, successful, robust company on the stock market, like MasterCard or eBay, you have a huge amount of information about it that helps you to value it more accurately and more easily.

This extra information makes it much less risky investing in the company. You generally have to pay a high price for shares in such great businesses, because investors are willing to pay more, and accept lower returns, for safer investments.

Even mediocre businesses on the stock market (that's most of them) command far higher prices because they provide relatively more certainty than start-ups.

With start-ups, you have considerably less information about the business and where it's going to be in five to ten years. This means that, to compensate for the additional risks, you should get a far better price than someone investing in a long-established company with a long, public record.

A start-up investor in eBay should have got, I don't know, maybe 500-1,000 times more shares for her money than an investor who bought shares in the company years after it was listed on the stock market. That early investor should own far more of the business for the same amount of money because she took much greater risks.

Getting back to my point 2, if you invest in a start-up through convertible notes and the next funding round comes in a year or two, the later investors will have much more information about the progress of the company. So they might be willing to accept fewer shares for the money they invest than you should have done.

And you will now be tied to this lower price. Yes, you'll get a 10% to 20% discount, but will that be enough to make the price fair? You won't even be able to guess the answer until it happens to you.

I can't imagine investing in anything without knowing the price I'm paying, but that's what a convertible note is asking you to do.

The convertible note discount reminds me of clothes shop sales: “Sale: 50% off!” they say. But 50% off what? The price could be anything, and it could therefore be too high.

Only at least a shop will tell you the actual price it wants you to pay straight away, so you have a chance to avoid a bad deal.

Back to Assetz Capital again

There are special rules capping the amount you have to pay for your Assetz Capital shares once they're converted if the company is valued very highly by later investors. That might help protect you from getting a poor deal.

If you read Assetz Capital's pitch as a real start-up share investor should (i.e. with a much finer toothcomb than I did for this article) you might find other protections are offered to you on price – or you might see more potential booby traps. That's for you to ascertain.

Buying shares in start-ups

It's a shame that many people lump P2P lending and buying shares in start-ups altogether like they're in any way similar.

In terms of where the risk level is centred, you almost cannot get further apart. P2P lending averages at the low-risk end whereas buying shares in start-ups is about as risky as any legitimate investment can be.

For decades I've been reading that just 10% of businesses survive the first year or so. I don't know if it's true, but assuming a low success rate seems sensible to me.

What I do know as a long-term investor is that the vast majority of companies that do manage to survive passed the start-up stage are mediocre. And mediocre businesses are usually poor investments.

If I was a start-up investor…

As far as I know, crowdfunding websites do not generally do the same level of checking on businesses that professional venture capital firms do and I believe most venture capitalists have poor or mediocre records anyway, due to the difficulty of picking real winners at an early stage.

That said, you can get a much bigger share of a company pie if you invest earlier. This suggests that if you spread your money across a great many companies you could have a much better chance of coming out with positive returns.

My research I did a few years ago (just an afternoon's work, nothing special) found that it might be sufficient, on average, for start-up investors to spread their money between at least 200 start-ups. However, due to the huge variation in returns and the short history to crowdfunding start-ups, I would aim for hundreds more than that to lower my chances of being on the unlucky side of average.

If I was to buy shares in start-ups, I'd also put no more than 10% of my money into them. It's just too darn risky.

*In contrast, £1,500 invested in British Gas owner Centrica would make you a part owner with ownership of 0.00000012% of the company. Centrica is currently valued at nearly £13 billion by stock market investors.

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