What do you need to know about the hottest alternative finance option?
REVISED APR 18, 2017
Crowdfunding (online platform-based) is a way of financing a project or venture by raising monetary contributions from a large number of people, via the Internet. It is the latest addition to an already wide range of Alternative Finance options available to start-ups and small and mid-sized businesses. It is also the hottest.
There are two types of Crowdfunding for businesses: Equity Crowdfunding and Debt Crowdfunding. In this blog, we focus on the former, which many consider to be what Crowdfunding is.
Equity Crowdfunding
People invest in an opportunity in exchange for equity. Money is exchanged for shares or a small stake in a business project or venture. As with other types of shares, apart from community shares, if it is successful the value goes up, and if not, the value goes down.
Start-ups and businesses considering EC: in order to increase your chances of successfully hitting your project funding target, start your fundraising campaign only when you have at least:
- a fair valuation of your business and the % of control (shares) you are willing to give away
- the right EC platform – there are lots of them, with different requirements, fees, and sector focus
- a well-thought campaign plan (this may include promotional activities *off*line)
- two financial backers ready to book a meaningful number of your shares on campaign day 1
Getting through the four steps above (which may require a few iterations) will take from several weeks to months, depending on the project/ funding target.
Debt Crowdfunding
Investors receive their money back with interest. Also called Peer-to-Peer (P2P) Lending or Marketplace Lending, it allows for the lending of money while bypassing traditional banks. Returns are financial, but investors also benefit from having contributed to the success of an idea they believe in.
It also includes Mini Bonds, a way for individuals to lend money directly to businesses. Typically they have terms of three to five years. Investors are rewarded in the form of either regular interest payments (e.g. annually) or a lump sum at the end of the term, alongside their initial investment.
DC is a finance option for companies which have been in business for a while, making some money.
Tax breaks
In the UK, investors like EC, among other things, because there are two generous tax breaks for it:
The Enterprise Investment Scheme (EIS) seeks to encourage investment in smaller, higher-risk companies by offering tax relief on new shares in those companies that qualify. It is aimed at wealthier, sophisticated investors. They can invest up to £1,000,000 and receive 30% tax relief. However, they are locked into the scheme for a minimum of three years. If they sell after three years any returns are free from Capital Gains Tax.
The Seed Enterprise Investment Scheme (SEIS) seeks to encourage seed investment in early-stage companies. Investors, including directors, can invest up to £100,000 and receive 50% tax relief. Like EIS, the shares need to be held for at least three years to qualify for the benefit and then capital gains tax relief also applies.
Trends and challenges
Most sectors are now using Crowdfunding, including Fintech, Cleantech and Food.
There are over 100 Crowdfunding platforms in the UK and the fees they charge vary enormously. This makes deciding which platform to choose for raising funds quite challenging. Factors to consider are many, from the type of control a business wants to maintain to the campaign process a platform requires.
In Europe, the UK is leading in both Equity and Debt Crowdfunding. Globally, the UK is leading in Equity Crowdfunding – the US only recently has allowed this riskier type.
Most Equity Crowdfunding websites expect project owners to maintain an ongoing dialogue with their backers. Should problems arise, project owners are expected to provide project updates explaining the situation, timely.
Most Crowdfunding in the UK, Europe, the US and China is Debt. The World Bank estimated that Crowdfunding would reach $90 billion by 2020. Recent figures suggest that it may get there a lot sooner.
To learn more about Crowdfunding, please attend the following event on Apr 20:
