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Equity crowdfunding explained

Which? explains how equity crowdfunding works and the benefits and risks that investors could face.  

In this article
What is equity crowdfunding? How does equity crowdfunding work? What are the benefits of equity crowdfunding? What are the risks of equity crowdfunding?
What is the Seed Investment Scheme? What is the Enterprise Investment Scheme? Equity crowdfunding: your questions answered

What is equity crowdfunding?

Equity crowdfunding is a way of raising funds by asking a large number of people (the ‘crowd’) for relatively small amounts of money in exchange for shares or a small stake in a company.

If your investment in a company is successful - the value of shares will eventually increase, if not the value will go down.

There are a number of equity crowdfunding websites including Seedrs and Crowdcube

How does equity crowdfunding work?

Similarly to crowdfunding, equity crowdfunding works through a crowdfunding website - which is sometimes referred to as a crowdfunding platform.

Each start-up decides how much money it wants to raise for a percentage of its company.

The amount of the company you will be able to own will be proportionate to the level of investment you make.

If a company does not reach it intended target by the end of its deadline, your money is returned to you in full.

Below is an example of how equity crowdfunding works. 

 

What are the benefits of equity crowdfunding?

The benefits of equity crowdfunding include allowing you to support start-up businesses.

Equity crowdfunding platforms may also offer higher returns for your investment than those available from other financial products.

This way of financing can benefit the economy at a local and wider level.

What are the risks of equity crowdfunding?

Equity crowdfunding can come with a number of risks, even if a project or business is successful in raising funds.

Here’s a list of the main risks of equity crowdfunding to consider:

It may take a while to see returns

It may take a long time for your company shares to increase in value which will impact your ability to make a return if you sell them on.

Dividends are unlikely

You are unlikely to receive dividends - a distribution of the company's profits - because the companies involved often don't make enough profit to pay out to shareholders.

Selling shares is difficult

It is quite difficult to sell your shares on. There's no secondary market - a place for investors to resell their shares - for you to find buyers if you do want your money back.

Risk of dilution

Dilution risk is when a company lets more people buy shares  to raise additional funds but this ‘dilutes’ the value of your existing investment and causes it to decrease.

What is the Seed Investment Scheme?

The Seed Enterprise Investment Scheme (SEIS) aims to boost investment in small startups by offering income tax relief on the shares bought through crowdfunding websites.

You have to hold the shares for at least three years to qualify otherwise your tax relief may be reduced or withdrawn completely.

If you sell your shares in an SEIS-qualifying company after three years, any returns are free from capital gains tax.

Tax benefits include the following:

Income tax relief

SEIS allows you to claim income tax at 45% of the initial investment. 

There are no exclusions to this tax break and it can also be spread across the current and previous year’s income tax bill.

Capital Gains Tax Exemption

If you decide to sell your shares after the three year investment period, you will be 100% exempt from any gains that you have made.

Capital Gains Tax Reinvestment Relief

If you have other investments separate from SEIS and you decide to cash them in to reinvest in a project that qualifies for the scheme your capital gains tax on the non-SEIS investments will be reduced by 50%.

Loss relief

If the SEIS business you invest in goes bust, the government offer loss relief which can offset tax on other income. The loss relief will be offset at your highest income tax rate.

Inheritance Tax Relief

You will be eligible to receive 100% Inheritance Tax Relief on the value of your shares two years after the date of your initial investment purchase.  

Claims for tax relief must be submitted as part of a self-assessment tax return. Even if you don’t invest in an SEIS business, you’ll need to declare any earnings, including bonus payments.

Go further: self-assessment tax - find how to fill one out and how to use the Which? tax caluclator.

What is the Enterprise Investment Scheme?

The Enterprise Investment Scheme (EIS) offers tax breaks for investors in smaller, higher-risk trading companies.

The scheme offers 30% income tax relief for investments of up to £1m.

Similarly to SEIS, you must hold your investments for at least three years to qualify for the benefit.

Investors in EIS-qualifying businesses that go bust can offset any losses against income.

Claims for tax relief must be submitted as part of a self-assessment tax return. Even if you don’t invest in an EIS business, you’ll need to declare any earnings, including bonus payments.  

Go further: Who should submit a tax return? - find out if you need to fill out a tax return and how. 

Equity crowdfunding: your questions answered

 

What happens if the business I invest in goes bust?

 

If the business or venture that you invest in goes bust you risk losing all of the money you put in.

This means that equity crowdfunding is not for the fainthearted - you need to be prepared that a start-up business your backing could fail and you could lose a significant part of your investment. 

 

What happens if the crowdfunding website I invest through goes bust?

 

The crowdfunding website should keep your money separate from its own. This means that if the crowdfunding website goes into liquidation, the money you invested should be returned to you. 

You can check with the crowdfunding website before investing, to ensure that your money is safe should the worst ever happen.  

 

What is the difference between a donation and an investment?

 

An investment is where you pay money to a business, project or venture with the intention of making a return over time. 

A donation, on the other hand, is essentially a gift where you give money to a project with no intention of making returns - and you may or may not be rewarded for the amount you donate.

 

What if I have another question?

 

If you have any more question about equity crowdfunding, get in touch with our experts on the Which? Money helpline or email us using money-letters@which.co.uk