Crowdfunding is a way of raising finance by asking a large number of people each for a small amount of money. Traditionally, financing a business, project or venture involved asking a few people (i.e. banks) for large sums of money. Crowdfunding switches this idea around, using the internet to talk to thousands – if not millions – of potential funders.
Nicola Horlick, the fund manager dubbed “superwoman” in the Nineties for juggling a career and family, has said it is a “no-brainer” that crowdfunding has become so mainstream, given that banks are not lending to small business and savers are fed up with receiving paltry interest rates in bank and building society accounts.
There is, however, a problem. Crowdfunding has grown at a rapid pace and there are a lot of sites out there, not all of them doing the best for either investors or business owners. It is absolutely paramount that before choosing this route to funding you do your research in depth.
Make no mistake, crowdfunding involves at least as much risk as the stock market. The watchdog, the Financial Conduct Authority, is taking a close interest in crowdfunding – and wants to ensure that private investors fully understand the risks involved.
Some of the sites vet the fundraisers – others don’t. Whether you are investing or seeking investment, I’d say you should walk away from anyone with no vetting.
The websites make money too, of course. This is usually in the form of a percentage – typically seven per cent – of money raised. And sometimes the site also takes a slice of returns paid to investors.
Apart from the potential returns, some of the business proposals listed on crowdfunding sites qualify for special tax reliefs under the Enterprise Investment Scheme (EIS) or Seed Enterprise Investment Scheme (SEIS) rules. This gives investors generous tax breaks.
Whether investing or aiming for funding, I would have a number of questions: how many companies have achieved full funding; how much time and money did they spend to achieve it; what is the key factor in a successful launch and what should be avoided at all costs. I would also phone the MD of any business that was similar to mine.
Crowdcube.com is one of the longest-established sites providing a variety of firms, from motor companies to pizza delivery firms, the opportunity to pitch for funding. Many of these businesses are already successfully operating and are seeking investment to expand their footprint in a particular market. Investors can view a business plan and a video, which details why the company is seeking funding and the potential rewards on offer. All businesses are vetted by Crowdcube and must present business plans with at least three years of financial projections. When you speak to these people, they come across as rock solid.
Seedrs.com is another well-known site, but has a greater focus on listing entrepreneurial firms that focus on helping entrepreneurs gain their first seed capital. Investors can back a start-up firm by providing seed capital, for as little as £10, in exchange for equity.
The company carries out full due diligence with all of the enterprises that list. But the firm also argues it is best “left to the crowd” to decide if the business is worthy enough to invest in.
There are plenty of other crowdfunding websites out there, the majority of which operate in niche areas. This could be ideal if you fit their criteria. As a case there are sites which focus on female entrepreneurs (although I wouldn’t call 50 per cent of the population ‘niche’).
Five main advantages of crowdfunding:
- It can be a fast way to raise finance with no upfront fees
- Pitching a project or business through the online platform can be a valuable form of marketing and result in media attention
- Sharing your idea, you can often get feedback and expert guidance on how to improve it
- It is a good way to test the public’s reaction to your product/ idea - if people are keen to invest it is a good sign that the your idea could work well in the market
- Investors can track your progress- this may help you to promote your brand through their networks
And five disadvantages:
- It will not necessarily be an easier process to go through compared to the more traditional ways of raising finance – not all projects that apply to crowdfunding platforms get onto them
- When you are on your chosen platform, you need to do a lot of work in building up interest before the project launches – significant resources (money and/or time) may be required
- If you don’t reach your funding target, any finance that has been pledged will usually be returned to your investors and you will receive nothing
- Failed projects risk damage to the reputation of your business and people who have pledged money to you
- Getting the rewards or returns wrong can mean giving away too much of the business to investors