But how big are the risks?
Apprentice runner-up Luisa Zissman may have failed to persuade Lord Alan Sugar that her baking brand was a winning idea after losing to Leah Totton in the 2013 final – but she had no trouble convincing online investors that Baker’s Toolkit is worthy of investment.
After brushing aside the disappointment of Lord Sugar not pointing his ‘You’re Hired’ finger at her, Zissman lost no time in telling fans via Twitter that she was considering crowdfunding. In the end she decided on a more focused investment strategy bagging 16 backers through an angel investment website, Angels Den, but as her tweet highlighted crowdfunding is now sweeping into the mainstream.
The traction it has gained meant that even experienced City high flier ‘Supermum’ Nicola Horlick opted to raise £150,000 for her new film fund venture through crowdfunding.
Second place: Apprentice runner-up Luisa Zissman is searching for potential investors via crowdfunding platform Angels Den
Crowdfunding investment returns tend to be long-term and variable. You might have to wait for many years before a start-up makes money and you strike it rich, or you might lose your money.
Platforms provide a simple, low cost, arena for investing novices to cut their teeth and learn from more experienced investors, who post probing questions on forums about each idea or business plan, which the firm’s owner is obliged to answer.
Just don’t leap in without having done proper research on what you are investing in and having steeled yourself for the potential of losing money.
Although there are some crowdfunding websites that allow lenders to give money for reasons other than potential returns – for example to help their community – there are plenty of opportunities for, sometimes significant, financial returns.
But what are the best ways to invest via crowdfunding? And how do you actually go about doing it?
Regulation: how well protected is your money
According to Julia Groves, managing director of Trillion Fund and chair of the UK Crowdfunding Association, the biggest draw for most people is that the industry operates outside of traditional banking structures, meaning you have greater direct control over your investments.
But, at present, official regulation of the crowdfunding industry reflects the patchy range of platforms that operate under it.
FCA regulated firms include Crowdcube, Seedrs and Abundance Generation.
Crowdbnk and Trillion Fund are both appointed representatives of an authorized firm – and are therefore also regulated by the FCA.
There are also other crowdfunding platforms out there that are not regulated, as firms do not have to operate with this.
FCA regulation means the platform will have had to jump through a number of hoops to get accreditation, including how their IT systems work.
It also means there is an official complaints channel and the company can be held legally responsible for any wrongdoing.
Remember, just because the platform is FCA regulated, this does not mean your money is safe.
Just like any high-risk investment, the value of what you have put in depends on what happens to the value of the company you have invested in.
However, your money is protected from any problems caused in the event that the crowdfunding company goes bust.
The UK crowdfunding scene this year established its own code of conduct through UK Crowdfunding Association. If you are considering investing this is something to watch out for.
They provide strict guidelines to vet platforms before giving their seal of approval – including making sure your money is ringfenced away from the main finances of the company in case it goes bust, and allowing you a ‘cooling off’ period in case you change your mind after making a donation/investment.
However, just because a crowdfunding platform is unregulated does not necessarily mean it is unsafe. Because companies are operating in fairly untested waters, they sometimes fall outside of official channels regulated by the FCA or CFA. Equally it could mean they have not signed up to safe practices. Take time to do your research if you are interested in a non-regulated platform.
What are your investment options?
The beauty of crowdfunding and lend-to-save firms is their range and creativity, so it can be difficult to pigeon hole platforms.
But, for the purposes of ease, we have divided investment opportunities into five rough sectors – although there are many more companies out there that will not fall into these brackets.
Lend-to-save: helping to fund businesses
Although by rights lend-to-save isn’t strictly crowdfunding, the concept is very similar and established.
Lend-to-save matches investors with individuals and firms seeking to borrow money, lenders can decide what rate of return they are looking for, evaluate prospects’ credit ratings and spread their cash across many different borrowers.
There are currently a number of lend-to-save (also known as peer-to-peer) firms in the UK, but some stand head and shoulders above the rest in size and and standards.
Ratesetter, Zopa and Funding Circle helped to pioneer this form of financing. They have their own industry body – the Peer-to-Peer Finance Association.Although not regulated by the FCA, it lays down strict compliance standards for its members. Official regulation by the FCA is expected in April next year, although details have not yet been revealed.
Thincats is the Association’s most recent member – and the first company to join since the three founding members (including Funding Circle - see below) launched it.
Invest in a business
Funding Circle lends to creditworthy small and medium enterprises in the UK, many of which have been left high and dry by the banks. The default rate is slightly higher, at 1.4 per cent as opposed to around 0.3 per cent on personal borrowing, because businesses potential for failure is higher.
Because of the slightly bigger risk, rates currently fall between 6.4 per cent and 11.2 per cent.
Funding Knight runs a similar business model to Funding Circle. The platform is still its early days, as it only launched in December. While it currently has an incredible default rate of 0 per cent, this is not a true reflection of the business because most loan cycles are far from coming to an end.
Currently, average interest rates are set at a much higher 11.2 per cent. This is because it is still a fairly new platform, so there is less competition among lenders.
Fees vary, but usually investors pay a percentage of their profits, which is sometimes included as part of the rates. A fee will also be charged if you want to sell a loan on a platform’s secondary market.
Any profits are subject to tax – the amount depends on your tax bracket and will be taken out before returns are paid back to you.
The risk is that borrowers will miss a payment, which could mean money is lost for long periods, or completely. Plus, if you fund a three-to-five year loan, your money is tied up for that period of time, and it can be costly to sell your debt on a secondary market.
Crowdfunding: taking a share in a business
Equity crowdfunding sites, for example Seedrs or Crowdcube, operate using probably the most popular and accessible model.
The concept is simple; people invest in an opportunity in return for equity and money is exchanged for a share in the business, project or venture.
As with other types of shares, if it is successful the value goes up. If not, the value goes down and you could lose your money completely.
Businesses pitch via the site and potential investors can view a business plan, watch a video of the pitch and use the forum to ask business hopefuls questions directly.
Investments start from around £10 upwards – although some platforms accept as little as £5, which means almost anyone can invest in a business.
As a smaller investor, you can still contribute advice and work with the management team, but you are unlikely to take a board seat tens of pounds.
If the start-up company grows then shares can become very valuable.
Where an investor uses a platform, for example Seedrs, that enforces subscription agreements with its investee companies, they get the full investor protections that venture capitalists and business angel investors would get.
Note that this does not apply to most platforms, where investors do not have the benefit of a subscription agreement and therefore are largely unprotected.
Investors usually don’t pay fees to pledge money to a business.
Tax-wise, where the company is eligible for EIS (Enterprise Investment Scheme) or SEIS (Seed Enterprise Investment Scheme) qualifying profits from sale of shares are usually not taxed at all thanks to generous breaks and investors get a buffer from tax relief.
For other companies, profits will likely be subject to capital gains tax, and this is payable directly by the investor. Dividend payments are likely to be subject to tax depending on the investor’s tax status.
The major risk with crowdfunding is that you may never see any of your money again.
You are reliant on a rare success to make money, so make sure you build a portfolio of investments by spreading your risk across a number of different businesses that do different things – don’t just put all your eggs in one basket.
Another big risk is lack of regulation – crowdfunding is by nature an ‘alternative’ finance option, and their are pros and cons of breaking away from tradition and entering uncharted waters.
Investing is inevitably going to be a risky business, but make sure you check the smallprint to see if your money is protected in the event of a platform going bust.
Contact the FCA or UK Crowdfunding Association if you are unsure about a firm’s credentials.
Investors should also be wary of share dilution – this could happen if the company you’ve invested in offers up more shares in their firm, which may result in yours being worth less.
There are ways to avoid this. As a shareholder, you will probably be given preferential treatment to buy new shares, if and when they are available, so you can decide if you want to put more capital into the company via a follow-on investment, increasing your share exposure.
Alternatively you may decide to cut your losses if you no longer rate the company. Even if your shares are diluted, this does not necessarily mean you won’t get a healthy return if the business ends up doing well.
If you are nervous about managing your investment, depending on your platform you can sometimes opt for a ‘nominee service’, so that the platform manages any investments on your behalf – for a fee.
Seedrs, for example, offers this service, but charges 7.5 per cent on any profits.
WHY I DECIDED TO INVEST VIA A CROWDFUND
Robert Epsom, 27, a sustainability consultant living in London, recently starting investing in small businesses via Seedrs.
He says: ‘I’ve always been a fan of the show Dragons Den and through my Hargreaves Landsdown account I regularly invest in stocks. Therefore when crowdfunding reached the UK it was a no-brainer for me.
‘I see it as a bit of fun. You don’t need to put down as much as you normally would on the main stock market to be able to get a good return and there is no trading fee – only a small percentage charged on any profits realised.
‘I also hope that as I start to invest larger sums that I can begin to support some of my investments by providing feedback on ideas.
‘The attitude I have is that it’s like planting lots of seeds and hopefully every now and again over the next decade I’ll get a cash bonus here and there as some of the start-ups I selected grow and make it to a mature business.’