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.

Sites include: www.banktothefuture.com, www.crowdbnk.com, www.crowdcube.com, www.gambitious.com, www.microgenius.org.uk, www.crowdmission.com and www.seedrs.com

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.

Sites include: www.abundancegeneration.com, www.banktothefuture.com, www.buzzbnk.org and www.trillionfund.com.

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.

  • Rob Murray Brown

    Mr Mason – did you actually do any research fo this? Bank to the future is a con run by Simon Dixon, a great self promoter. The site has been dormant for a year now and will no doubt close when he gets around to it. More generally ECF has a few serious problems you do not mention.

    Information asymmetry leads to investors being given information by the site and or the pitch which whilst not always untrue is certainly not entirely true. Often it is impossible to verify and asking diffiuclt questions ont he forum results in them being removed.

    Ridiculous projections – you just to look at the results produced by comapnies that raised money on Crowdcube in 2012 (any later and the result are not out yet) to see that the projections used are in amny cases 10 times too optimistic. So rule of thumb, take their sales projections nd half them as a minimum. Of course unless you have saved the original plans (like I have ) you wouldnt have a clue about this massive gap.

    Dilution – for example you buy B shares which give you no rights and no premption. When the company runs out of money and has to rasie more, your holding will be diluted whether you like it or not. This has happened on numerous occasions on Crowdcube

    Rogue founders. Example – Front up Rugby rasied over £250k in three goes on Crowdcube (each time promising that this was the ‘last time and sales leads were fantastic’. The founder shortly after the third raise, arranged a pre packed deal with Lyle & Scott and administrators, where he was given a well paid fulltime job and his business loan paid off. L&S paid £20k for the assets of the company (book value over £200k), creditors and shareholders (more than £300k) where left with nout. Front Up was hailed by Crowdcube as Business of the Year!

    Do the Maths. Crowdcube themselves recommend you invest in at least 10 co’s – in the hope that 1 will turn up trumps. So you invest £100 in each – total £1000. Lets say one does come up trumps and sells for 6 times its post money valuation – so you make £600. Maybe another two keep limping along but have raised more cash diluting your holding by 50%. They then come good and sell for 5 times their post investment value – you make 1000 but that is halved by dilution so you make 500. The rest go bust. So over a 5 year period your £1000 makes you £100 or 2% pa. Hmmmmmmm. And thats with 3 successes!