Although Britain has long been recognised as a country of pioneering scientists, inventors and entrepreneurs, it has historically been poor at making sufficient capital available for this creativity to blossom fully to the UK’s economic benefit.
However, the last 7 years have seen the concept of ‘crowdfunding’ taken well beyond its original roots to become a fully regulated and increasingly mainstream source of much needed capital to startups and smaller businesses.
Although the major banks have only ever played a limited role in financing startups, they had previously been far more active in lending to SMEs than they are now, despite some cheesy advertising to the contrary. Crowdfunding has stepped in and now accounts for a growing percentage of the capital lent to small businesses.
So what is crowdfunding?
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 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 pitch for their project or business on an online crowdfunding platform such as one of the members of the UK Crowdfunding Association.
The project or business can then use social media, alongside traditional networks of friends, family and work acquaintances, to raise money. The crowdfunding platform chosen facilitates the investment, manages the whole process and does its own marketing to encourage the public to look at the investments it is offering.
There are a number of distinct forms of crowdfunding, with the variations relevant to who it is appropriate for, both in terms of the ventures seeking funding, and the profile of the potential investors.
Donation / Reward Crowdfunding
This is where the concept of crowdfunding started. People invest simply because they believe in the cause raising money.
Returns from this kind of crowdfunding are considered intangible. Donors have a social or personal motivation for putting their money in and expect nothing back, except perhaps to feel good about helping the project.
While the American ‘Kickstarter’ was the first platform to scale, UK sites include www.fundit.buzz,
Rewards can be offered (leading to the name ‘reward crowdfunding’), such as acknowledgements on an album cover, tickets to an event, regular news updates, free gifts and so on.
Investors receive their money back with interest.
Also called Peer-to-Peer (p2p) lending, 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.
In the case of microfinance, where very small sums of money are leant to the very poor, most often in developing countries, no interest is paid on the loan and the lender is rewarded by doing social good.
Sites include: www.abundanceinvestment.com,
www.simplecrowdfunding.co.uk, www.fundingknight.com, www.downingcrowd.co.uk
People invest in an opportunity in exchange for equity.
Money is exchanged for shares, or a small stake in the business, project or venture.
As with other types of shares, apart from community shares, if it is successful the value goes up. If not, the value goes down. Because so many startups do end up failing, this is considered the most risky form of crowdfunding from the investors point of view.
Sites include: www.crowdcube.com,
For scientists, inventors and entrepreneurs looking to start a new venture, equity crowdfunding is the most relevant. While wealthy ‘angel investors’ have long been a source of seed capital for startups in the UK, the success of equity crowdfunding has improved capital flow considerably, by making it feasible – for the first time – for less wealthy people to invest.
Previously, the costs of access, legal services and administration meant it was hard to economically invest less than £10,000 in a single startup, making the diversification essential when investing in startups (because of the high risk) impossible for anyone with less than hundreds of thousands to spare. People can now invest as little as £10 per startup, making sensible diversification easy for a much wider cross section of the public.
This ‘democratisation of investing’ is one of the major positive impacts of crowdfunding, and not just equity crowdfunding. Small investors interested in exploring new investment asset types now have a whole range available – from the higher risk/potentially higher returns of shares in startups, right through to those looking for steadier, lower risk returns that still beat inflation from lending money via debentures in renewable energy projects.