Crowdfunding is one of the new buzz words for adventurous investors – but lending to entrepreneur start-ups does not come without risks.
Crowdfunding platforms quote the success of projects like Pebble smart watches and Oculus Rift, a technology start-up specialising in virtual reality headsets.
Both firms raised millions from investors pledging cash, but for every success story, the road to riches is littered with failed crowdfunding campaigns.
For entrepreneurs, crowdfunding is a way to raise finance and keep control of a business without having to go to the bank or a business angel.
Crowdfunding platforms are also a good way to test the water for a new product by monitoring market reaction.
Donation or investment?
The problem for investors is because so many pool their cash together to finance a project, they have little or no control over how their money is spent and when and if they may receive a return.
Even projects that successfully raise their funding target through a crowdfunding platform fail before they reach the final hurdle.
That means a huge risk to investors and the thought that perhaps they should write off the money as a donation rather than an investment and expect no real cash return for their input.
The problems for Crowdfunded start-ups include:
- Beating rivals to market
Pitching a project online means releasing business sensitive information into the public domain. Some Crowdfunded firms have found rivals have picked up the idea and ran to beat them to market.
- Funding foul ups
Sometimes entrepreneurs put their pitches out on crowdfunding sites to attract the intention of business angels rather than a pool of investors. However, crowdfunding a project can discourage professional investors by giving the impression that the entrepreneur has taken a route of last resort rather than seek venture capital.
- No equitable agreement
Crowdfunding is more about filling an order book with pre-sales than developing a business. The trouble for professional investors is they get no equity for their cash stake and the consequence is the entrepreneur is not accountable to them for the business decisions made or how the cash is spent.
Or more worrying is if investors stump up a large cash sum and the project goes south, who gets the cash and how much?
In essence, crowdfunding is okay for investors who want to back a project or product they really like, but for sophisticated professionals, going down the venture capitalist or Seed Enterprise Investment Scheme (SEIS) gives more protection.
We will soon see the explosion of Equity Crowdfunding such as platforms that advertise SEIS and EIS companies. There are a number of platforms that offer equity crowdfunding in the UK, however it is still a No Go in the USA at this time