Can I crowdfund my start-up business?Posted 08 Jun 2018 Paul Clapham assesses the pros and cons of using increasingly popular online fi nance platforms
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 (ie banks) for large sums of money. Crowdfunding switches this idea around, using the internet to talk to thousands - if not millions - of potential funders.
Typically, those seeking funds will set up a profile of their project on a website. They can then use social media, alongside traditional networks of friends, family and work acquaintances, to raise money.
Cutting out the middleman
Nicola Horlick, the controversial fund manager who was dubbed ‘Superwoman’ in the nineties for juggling a career and family, has said it’s a “no brainer” that crowdfunding has become so mainstream, given that banks are not lending to small businesses and savers are fed up with receiving paltry interest rates in bank and building society accounts.
“Crowdfunding is all about cutting out the middleman and allowing small businesses to get the funding they need without banks taking a slice of their margins in fees when fi rms take out business loans,” she says. “For savers, these ventures off er the potential for much greater returns.” 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’s absolutely paramount that before choosing this route to funding you do your research in depth.
Needless to say, not everybody has a City expert’s understanding of risk and, 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 private investors fully understand the risks they are taking.
Some of the sites vet the fundraisers - others don’t. Whether you’re investing or seeking investment, I’d say you should walk away from anyone with no vetting. In most cases, the investors, who can usually subscribe as little as £10 per venture, are offered shares in the business.
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 or Seed Enterprise Investment Scheme rules. This gives investors generous tax breaks, such as being able to claim back income tax on the money they invest.
Whether investing or aiming for funding, I would have a number of questions, including:
- 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?
This is one of the longest established sites providing a variety of businesses, from motor companies to pizza delivery firms, with 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 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.
Another well known site, Seedrs.com allows investors to 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 it also argues it’s 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 an example, there are sites that focus on female entrepreneurs (although I wouldn’t call 50 per cent of the population ‘niche’).
Eight advantages of crowdfunding
- It can be a fast way to raise finance with no upfront fees.
- Pitching a project or business through an online platform can be a valuable form of marketing and result in media attention.
- Sharing your idea means you can often get feedback and expert guidance on how to improve it.
- It’s a good way to test the public’s reaction to your product/idea. If people are keen to invest, it’s a good sign your idea could work well in the market.
- Investors can track your progress - this may help you to promote your brand through their networks.
- Ideas that may not appeal to conventional investors can often get financed more easily.
- Your investors can often become your most loyal customers through the financing process.
- It’s an alternative finance option if you’ve struggled to get bank loans or traditional funding.
Six disadvantages of crowdfunding
- 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 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’ll receive nothing.
- Failed projects risk damage to the reputation of your business and people who have pledged money to you.
- If you haven’t protected your business idea with a patent or copyright (which may not be possible), someone may see it on a crowdfunding site and steal your concept.
- Getting the rewards or returns wrong can mean giving away too much of the business to investors.