Crowdfunding for business
Table of Contents
Crowdfunding is a new twist on an old idea – the idea of raising small amounts of money form a large number of individuals and pooling it to provide the capital required for a project, product or cause – or a business.
The twist is, of course, the internet, which makes pooled funding easier and faster than ever before. As a result, crowdfunding can provide a new way to raise the cash you need to get your business ideas off the ground.
In all cases, the entrepreneur seeking the investment pitches for funding via a website, explaining what they do and what they would use the money for. But there can be confusion about what is involved with crowdfunding as there are three basic models: equity-based, reward based and loan-based.
It is important to understand the differences before deciding is whether crowdfunding has potential for your business.
Equity-based crowdfunding
Equity-based crowdfunding is where individuals and private investors take a percentage of equity – in effect, a share in the company in return for their investment.
The average person can invest in a business that he or she finds interesting but, in the main, this type of funding is usually the preserve of traditional private investors such as business angels, networks or syndicates and venture capital funds. There is no fixed percentage return but, if your company does well, the potential for the investor is huge. This type of backed will be discerning, and they will need to understand the financial details of your proposition – after all, they are taking a share in your business!
Reward-based crowdfunding
Reward-based crowdfunding can be popular for very innovative concepts. It allows individuals to pre-purchase products or agree to support product development, cause or project and, in return, receive a reward – often one of the first products.
This type of crowdfunding is only possible if you have very good marketing skills and a clear vision. You need to get people to commit to buy a product that doesn’t exist, and to do so months or even years before they have any chance of receiving it.
It tends to be the preserve of enthusiasts, and although it has in the past provided the funding for the launch of successful businesses, its popularity is small, particularly in the UK.
Loan-based crowdfunding
Loan-based can be considered as the most popular type of crowdfunding, and has become recognised as a leading type of business funding because of the advantages it offers to both lenders and borrowers.
With loan-based crowdfunding, investors lend money to businesses in much the same way as a bank will lend money – there will be set repayments that your business will need to make. This type of lending can be cheaper for borrowers than a bank as it cuts out the middleman – although, in practice, the platform arranging the loan will take care of credit checking and receiving monthly payment, much as a bank would.
Loan-based crowdfunding has become a mainstream business funding process. There are now many lending platforms in the market who manage to offer excellent returns to individual lenders, while often undercutting banks.
The costs of loans to borrowers may not, however, be their greatest strength. The fact that platforms will vet borrowers carefully is a safeguard for lenders, but the lending criteria they adopt tend to be much less restrictive than banks. This means that businesses such as start-ups, which often struggle to raise funding from banks, can be approved by crowdfunding platforms.
There are also strict legal guidelines to protect the lenders and borrowing businesses with loan-based crowdfunding. These are similar to those for other lending products, providing reassurance that the sector, although innovative, is entirely legitimate and subject to full governance and legal oversight.
- Information about the platform must be clearly and plainly presented to investors
- All communication must be fair and not misleading
- The lender’s money must be ring-fenced from the crowdfunding platform itself. If the platform faces financial problems, the lender’s money will remain safe
- There must be guarantees so that loan payments continue to be made if the platform goes out of business
- If there is no secondary market for the loan, the investor must be free to cancel the loan within 14 days
- Investors have access to the financial ombudsman
- Prudential requirements of £50,000 or a percentage of loaned funds imposed on crowdfunding platforms, which must be ring-fenced
However, although crowdfunding is subject to external scrutiny by the FCA, investment in it remains outside the Financial Services Compensation Scheme (FSCS).
Who is crowdfunding for?
Anyone with a UK-based limited company can apply for funding via crowdfunding platforms – although some will insist on doing business only with either partnerships or limited businesses with at least two years' published accounts.
This means that there may be scope for your business even if it is a start-up.
To find out more about getting the support you need with funding your start-up, finance for scale-ups, growth equity financing, P2P or any other type of funding, or working in partnership with Rangewell to find better answers to your business needs and those of your clients, call contact our team. Our service is free.