Crowdfunding: Three things to consider
Crowdfunding is an increasingly popular method of acquiring financial investment if you are looking to grow your start-up.
The basic idea behind this is to raise money by presenting your project or business venture to a large audience via a website platform and provides a valuable means for you to showcase business ideas and raise funds directly. It provides social enterprise, entrepreneurs, SMEs and start-up companies, in particular, an alternative method to raise capital requirements with greater flexibility.
1. Decide on a crowdfunding platform
A crowdfunding campaign makes open calls to the wider public, i.e. the “crowd” of funders, on the internet. Projects are financed by small contributions made by a large number of individual funders.
The campaigner may collect contributions directly but most campaigners engage a web-based intermediary, the ‘crowdfunding platform’, which can publish campaigns, reach contributors and collect funds. These platforms usually charge a fee for their services, typically a percentage of funds raised (5% on average). A list of crowdfunding platforms is available on the UK Crowdfunding Association’s website. The P2P Finance Association’s website also lists those platforms which facilitate peer-to-peer lending.
Ensure you understand relevant regulations that are applicable for your chosen crowdfunding activity.
2. Select your funding model
Crowdfunding platforms follow one of two funding models:
“All or nothing” — this model is followed by the majority of platforms and requires a specific target to be reached during the fundraising period before the money is passed to the project initiator. Contributions are returned to investors if the target is not met.
“Keep it all” — the project initiator can decide whether or not to return money to investors if the fundraising target is not reached.
3. What form will this take?
Crowdfunding can take different forms. The main structures are:
Donations model — funders give money for a project without receiving anything in return. Although the size of this type of crowdfunding is small, this is the most commonly used model.
Prepayment / rewards model — funders receive a product, service or reward in exchange for contributions. This model is popular for financing artistic projects, social causes and new product ideas.
Loans-based model — often referred to as direct lending or peer-to-peer lending, this involves funders lending to individuals or businesses. Interest will normally be payable on the loan (although in some cases lending may take place at no interest for social purposes).
With this model it is difficult for funders to verify the creditworthiness of borrowers and there is no guarantee that lenders will get their money back if the borrower defaults.
Funders are however able to diversify their investments through various tools offered by lending platforms and as long as they are aware of the risks, peer-to-peer lending may make an alternative investment opportunity. It is also advantageous to borrowers as they can retain control and ownership of the business. Overall it is seen as an alternative to conventional lending in that it is potentially cheaper, easier and faster.
Investment-based model — funders receive shares or debt securities in return for their investment. With this model, funders (and the campaigners) should be aware of the risks of over-valuation of projects and understand the voting rights attaching to the shares. Also, exiting may be an issue as there is no secondary market.
In the UK, loan-based and investment-based crowdfunding will generally fall within the scope of the Financial Services and Markets Act 2000, requiring platforms to obtain authorisation by the Financial Conduct Authority (FCA), unless an exemption is available.
We hope this has provided you with some useful insight into the basics of crowdfunding if you are considering it as a way to fund your business. However, as with any business venture, crowdfunding is not risk-free. It is important therefore to do your research and select the platform and the form of crowdfunding that will meet your needs.
Please contact the Trowers’ team for more information. We have also produced a series of fact sheets to help you, so click here to access our online resources.