Investing via crowdfunding: the basics

Investing via crowdfunding offers competitive returns with heightened risks

Investing via crowdfunding: the basics

Crowding funding is the latest innovative way for companies to fund their development and for small investors to invest in a start-up.

As an investor there are two main types of crowdfunding that you could consider; equity-based crowdfunding or debt-based crowdfunding. Both forms carry risks and aren’t for novice investors but, in an era of low saving rates, they may be attractive to some.

Equity based crowd-funding

People invest in an opportunity in exchange for equity. Money is exchanged for a share in the business, project or venture. As with other types of shares if it is successful the value goes up. If not, the value goes down and you could lose your money completely.

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Debt crowdfunding

Investors receive their money back with interest. Also called peer-to-peer lending or ‘lend-to-save’, it allows for the lending of money while bypassing traditional banks. Returns are financial, but investors also have the benefit of having contributed to the success of an idea they believe in.

However, these investments are not covered by the Financial Services Compensation Scheme.

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What are the risks?

As mentioned above both types of crowdfunding are high risk areas – although equity funding is generally higher risk than debt funding. In particular:

  • Investments are illiquid and tend to be long-term – 3 years minimum
  • These investments aren’t covered by the Financial Services Compensation Scheme and you are putting your capital at risk
  • With equity-based crowdfunding dilution is a risk
  • With debt-based crowdfunding the returns might not be met.

What are the benefits?

You can make a better return than just leaving your money in a bank. For example, Trillion fund currently has a 3-year secured loan for investors in wind power offering 7.5% a year.

You can also get the satisfaction of supporting projects that interest you.

Do your own research

As always, when considering investing in a crowdfunded project, do your own research as you can’t rely on sales literature, or the uninformed, to tell you if an investment is risky. In addition:

  • Make sure you sufficiently understand the business or project, how and when you might get a return, whether you will receive an equity share in the business or a regular dividend or interest payment, and the risks involved before investing in a crowdfund
  • Have you thought about tax breaks?  Some platforms allow you to search for companies signed up to the Seed Enterprise Investment Scheme (SEIS) or Enterprise Investment Schemes (EIS)
  • Find out how your money is protected if the business, project or even the crowdfunding platform collapses – in particular check whether the business has appropriate cash reserves or even insurance supporting it if it fails
  • Invest in what you know. It is less likely you’ll come unstuck if you stay within your circle of competence.

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Tags: Crowdfunding

About Author

Christopher Menon

Every Investor Editor Chris Menon is a financial journalist who has written regularly for national newspapers, magazines and websites about personal finance, with particular emphasis on investing.