Financial watchdogs are warning crowdfunding investors that putting money in to start up businesses is risky and that they could lose all their cash if a firm fails.
The Financial Services Authority (FSA) says they are becoming increasingly concerned that crowdfund investors have little or no protection if the business or project fails to meet performance goals.
The FSA also warns that crowdfunding should be targeted at sophisticated investors who understand the niche.
Crowdfunding is a joint financial venture between a large group of people each contributing money to support a business, project or campaign.
“The funds raised are often used as startup capital, or may help a business expand or even avoid going bust. But how do you invest in these funds and how is your money protected?” said the FSA.
“We want it to be clear that investors in a crowdfund have little or no , and that they will probably lose all their investment if it does.
No FSA permission or authorisation
“We are also concerned that some firms involved in crowdfunding may be handling client money without our permission or authorisation, and therefore may not have adequate protection in place for investors.”
Crowdfunding is a new investment concept in the UK. The market is small compared to the US, where the phenomenon started.
Investments are generally arranged online through specialist websites and social media networks.
“The business makes a pitch, to try to attract contributions from as many people as possible. Investors can contribute as little as £10 in a business or project, usually with no upper limit,” said the FSA.
“Most crowdfunding platforms require a specified target to be reached during the fundraising period before the money is passed to the business or individual. This model is known as ‘all or nothing’, with contributions returned to investors if the target is not met.
Greater risk with rare high returns
“However, on some platforms the business or individual can decide whether or not to return money to investors if the fundraising target is not reached. This model is known as ‘keep it all’.”
Crowdfunding rewards range from shares in the business, discounts on products or gifts like T-shirts or branded mugs.
“It can be rewarding to be involved in a business or project as it develops, or to support a local initiative, friends or family,” said the FSA
“Some crowdfunding platforms promote the potential for higher returns than generally achieved on mainstream investment products. While this may be possible in some cases, a crowdfunding investment is likely to come with greater risk and higher returns are rare.
“Nonetheless, crowdfunding could make up part of a diversified portfolio, especially for sophisticated investors.
Investors should take care
For businesses, crowdfunding can be a useful way to gain direct access to investors and finance that more traditional investors, venture capitalists or lenders are not prepared to offer.”
The FSA lists crowndfunding risks investors should consider:
- Investors have no guarantee they will receive a return on funds – with many losing all of their money as the majority of startup businesses fail.
- While investors may receive a share of a business or project, dividends are rare and any investment could be diluted if more shares are issued.
- Startup businesses can take a long time to generate a profit, so investors must be prepared to wait for a return
“Most crowdfunds are illiquid, which means it can be difficult or even impossible to claim back money invested or have it converted back into cash. There is also no secondary market to sell your shares or crowdfunding investment,” said the FSA.
“Unfortunately, where money is changing hands – and especially where it is all done online – there is a risk of fraud, so investors should take care to protect themselves.”
Read the FSA page here : www.fsa.gov.uk/consumerinformation/product_news/saving_investments/crowdfunding
I would love to hear your comments about this. What are your opinions about Crowdfunding / Crowdinvesting?
I think that people that put their capital into crowdfunding should be professional investors that understand the market they are entering and can objectively analyse the business going forward or investors that are aware that this could be totally speculative and understand that their capital is likely to be at risk , with possibly a total loss.
Will many investors understand that the illiquidity in the early years means their money is not available to be repaid to them and there is a possibility that there is no market for their investment and that dividends won’t be paid until the enterprise is profitable? I am sure that many will not understand this.
As with a lot of these things, it is a niche market that will be profitable for those that know what they are doing.