Crowdfunding is one way businesses raise money without the need for bank loans or private equity firms.
Table of contents
The idea extends to raising money for charities and individuals through online platforms.
Some big brands launched with crowdfunding campaigns, such as beer maker Brewdog, Oculus – now part of Facebook’s Meta – and challenger bank Monzo.
The principle is simple. Businesses invite large numbers of investors to pledge small amounts in return for shares, perks or even a heartfelt thank you.
Crowdfunding is a good way for businesses to let people know they need money for a project.
Crowdfunding Options
Investors can choose from three types of crowdfunding:
- Equity crowdfunding – If you fancy a turn in one of the chairs on BBC TV’s Dragons’ Den, take a look at crowdfunding by swapping your money for shares in the company. How this works depends on the deal, so ensure you read the prospectus and scout the company.
- Loan-based crowdfunding – You can lend money directly to businesses via peer-2-peer platforms online. Rates of return are usually a lot better than any bank will offer, and the platform checks out the borrower’s financial status for you.
- Rewards crowdfunding – This option is for charitable investors and can appeal to vanity. Instead of shares or loan repayments, investors pick up recognition or rewards for staking their cash to a project. For instance, authors might offer a signed first edition of their book or give you a mention among the dedications.
Although rewards crowdfunding is just for that warm feeling helping someone gives, the other two choices offer serious returns. Just don’t forget you may have to kiss a lot of frogs before finding your princess – or her unicorn.
To crowdfund a business investment, go to an online platform like Seedrs or Indiegogo for equity stakes. Funding Circle and CrowdSpace are starting points for P2P lending, while Just Giving or GoFundme publicise donation projects.
Crowdfunding And SEIS
SEIS is the UK’s Seed Enterprise Investment Scheme. SEIS is one of the best tax incentives for business angels anywhere in the world.
Crowdfunding companies can seek SEIS pre-approval from HM Revenue & Customs to join SEIS.
SEIS offers investors:
- 50 per cent income tax reduction on investments up to £100,000, which means anyone investing £100,000 in a SEIS project can expect up to a £50,000 income tax refund
- No capital gains tax on rises in share prices
- Loss relief should the company go to the wall
SEIS comes with other benefits, like inheritance tax relief once shares are held for two years. Similar tax benefits are available to investors with more than £100,000 to sink into a project through the Enterprise Investment Scheme (EIS).
Crowdfunding Risks
Financial risk goes with the territory in crowdfunding. The businesses are start-ups often with no trading history but a lot of optimism.
Crowdfunding is not regulated in the same way as saving with a bank or investing through a financial, so you could lose all your money if the company fails to take off.
The UK Financial Conduct Authority regulates crowdfunding and demands platforms should keep investor cash in separate client accounts to minimise losses.
Other issues include a limited market for trading crowdfunded shares as they are generally with unlisted companies and not on the stock markets.
Don’t only check out the companies on a platform – in the past, some platforms have gone bust holding investor cash as well, so include them in your due diligence.
Investing In A Crowdfunding Project
More than 250 crowdfunding sites are active in the UK. Many platforms offer niche investments – Seedrs focuses on start-ups, while Kickstarter is home to art projects.
Here’s how to invest in crowdfunding step-by-step:
- Narrow down the type of investment you want to make.
- Decide which business or project you want to back with your cash and check if you can take advantage of any SEIS or EIS tax breaks.
- You can never carry out enough due diligence, so ask for all the information the project can offer and then scour the internet for reviews and data about similar businesses. Clarify timelines, the amount you are expected to provide and the terms and conditions of the deal. Don’t forget you must hold SEIS and EIS shares for 36 months to qualify for the best tax breaks.
- Take independent advice about the investments and the potential advantages and pitfalls.
- Make your investment pledge on the crowdfunding platform promoting the opportunity and wait to see if other investors will pitch in to reach the funding goal.
- Once the funding target is passed, the money is transferred to the crowdfunding business, and the project starts. If the amount raised fails to meet the target, the project halts and the money is returned to the donors.
Another investment option is by specialist funds.
Rather than direct crowdfunding, investors can opt to back a fund with equity shares across several diversified projects.
The advantage of investing via a fund is someone else carries out the due diligence, investment risk reduces as crowdfunding can take place directly or across more than one platform. The downside is fund managers and administrators will grab fees to pay for their services.
Crowdfunding By Numbers
Although crowdfunding is a recognised and trusted way of raising money for business, here are some of the stats that underpin the opportunity as a worthwhile investment:
Equity crowdfunding raised more than £332 million across 433 projects in 2020.
P2P business lending reached £1.2 billion – a significant fall of 35 per cent compared to funding levels in 2019 – the fall is mainly blamed on the coronavirus pandemic
All You Need To Know About Crowdfunding FAQ
Why do businesses crowdfund?
Crowdfunding is a forum for businesses with little or no trading history that would otherwise have difficulties in raising money from more traditional routes, like the banks.
A crowdfunding platform allows a business to pitch directly to potential investors who might not be reached through normal investment channels.
Equity crowdfunding is often the preferred option because the business has no capital or interest repayments against shares.
Have any big businesses successfully crowdfunded?
Yes. The list is pretty long, but Brewdog, the craft beer maker, has raised more than £145 million from crowdfunding in the UK. Monzo, the online bank, raised £20 million before being bought out for £85 million, while fitness firm Peloton started as a crowdfunded business in 2013.
How much is a crowdfunded investment?
There’s no maximum or minimum crowdfunding investment, although platforms and projects will set limits. However, if the project has a SEIS pre-approval, the full investment each financial year is £100,000.
Are crowdfunding platforms safe for investors?
The risks are high because the businesses looking for funding have no trading histories. As a result, investors can lose all their money.
Dealing with a platform is straightforward – if you register and pledge cash to a project, your money is ring-fenced until the project meets its target and the money switches to the fundraiser. Should the project fail to reach the target, the platform returns the money to investors.
Where can I find out more about crowdfunding?
Most platforms publish extensive guidance, but the most useful independent advice comes from an IFA who specialises in investment with broad experience in crowdfunding and P2P lending.
Related Information
Below is a list of related articles you may find of interest.
