What is crowdfunding?
Crowdfunding is a way for new and small businesses to raise funds by asking a large number of people (the ‘crowd’) for relatively small amounts of money.
Traditionally, if you wanted to finance a business, project or venture you'd have to ask a small number of people for large sums of money - often called 'angel investors'.
Crowdfunding has turned the tables on this traditional method and allows you to use the internet to engage with millions of potential funders.
Usually, those seeking funds will set up a profile about their business, project or venture on a crowdfunding website - which is sometimes referred to as a crowdfunding platform.
How does crowdfunding work?
You will need to register your details on the website if you want to start raising funds or see other people’s pitches to invest in.
For as little as £5, you can invest in a project that you’re interested in, which could range anything from a small startup to funding a film or theatre production.
The business, individual or social enterprise looking to raise money should tell you:
- How much needs to be raised
- How much has been raised so far
- The share in the business offered
- What the money will be used for
- How long the pitch is open for
- How many people have already invested
- When you will receive a return for investing
Be sure to contact them for further information if anything has been left unclear in their pitch.
If you decide to invest in a pitch, you will have a 14 day cooling-off period in case you change your mind.
Investments can only go ahead if the business, individual or social enterprise meets their target amount in the time specified - if not your money will be returned.
If things work out with the your investment, your returns could vary anything from seeing your share price rise, receiving dividends or potentially a finished product or service.
What are the different types of crowdfunding?
There are several different types of crowdfunding to choose from, these include:
Similarly to crowdfunding, equity crowdfunding is a way of raising funds by asking a large number of people for relatively small amounts of money in exchange for shares in a business.
Debt crowdfunding, also known as peer-to-peer lending, is when investors lend money to a small business or project looking to borrow. The loan is then paid back over time with interest.
Reward crowdfunding refers to investments made simply because you believe in a business, project or venture.
Investors are rewarded in a number of ways, including getting a product, tickets to an event, free gifts or acknowledgements.
What are the benefits of crowdfunding?
The benefits of crowdfunding range anywhere from supporting projects as they develop to finding local initiatives to give backing to.
Investing in a business through crowfunding may also offer higher returns than those available from other financial products.
Crowdfunding can be a useful way for organisations or individuals to access finance that banks or other lenders are not prepared to offer - or only offer at a higher cost.
This way of financing can also benefit the economy at a local and wider level.
What are the risks of crowdfunding?
Making a crowdfunding investment can come with a number of risks as it involves investing in young businesses - which are less likely to succeed.
The main risks of investing in crowdfunding include:
No FSCS protection
Most crowdfunding investments fall outside of the Financial Services Compensation Scheme (FSCS), meaning that if the business, project or venture you invest in goes bust, you will not get any compensation.
Returns are not guaranteed
Even if the business, project or venture gets off of the ground there is no guarantee that it will make a decent profit.
Selling your shares could be difficult
If you buy shares in a business it could be difficult to sell them on.
How is crowdfunding regulated?
Most crowdfunding platforms are regulated by the Financial Conduct Authority (FCA), the Uk's financial watchdog.
If your crowdfunding platform is authorised and regulated by the FCA, they must comply with a number of rules about how customers are treated.
You may also have access to the Financial Ombudsman Service (FOS), which resolves disputes between consumers and regulated financial companies.
Be sure to check whether the crowdfunding platform you use is regulated or not as this will affect whether or not they have to comply with the FCA and your ability to make a complaint about the running of the service.
Crowd funding: your questions answered
What happens if the crowdfunding website goes bust?
If the crowdfunding website keeps your money separate from its own - it will always be legally controlled by you.
This means that if the crowdfunding website goes into liquidation, the money you invested will 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 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 crowdfunding is not for the faint-hearted - many start-ups fail, and you run the serious risk of losing some, if not all, of your money.
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.
Does crowdfunding have any tax benefits?
There are tax benefits for people who invest through equity crowdfunding.
Through the Enterprise Investment Scheme (EIS) and the Seed Enterprise Investment Scheme (SEIS), you can offset a percentage of the amount you invest against your tax bill and any profits you make are tax free.
There certain conditions that must be met for you to qualify, for example, you must hold your investment for a minimum of three years.