Innovation in both finance and technology
One of the main innovations in both finance and technology over the past few years has been the advent of crowdfunding. Crowdfunding is a way of raising finance by asking a large number of investors each for a small amount of money. In the past, financing a business, project or venture typically involved asking a few investors for large sums of money. Crowdfunding switches this idea around.
If it appeals to you, you’re debt-free, willing to increase your risk tolerance and put money away for a longer term, then the best way is to start by dipping your toe in the water.
Main ways of crowdfunding
There are three different types of crowdfunding: equity, debt and donation.
1. Equity crowdfunding involves a company raising finance by selling a pre-determined amount of equity in a business to investors for a certain sum of money.
2. Debt crowdfunding is when a company raises money by way of loan to investors who do not receive any equity in the business but do receive a pre-agreed rate of return on the money invested.
3. Charitable crowdfunding involves no equity or debt investment; charities raise money for projects from large groups of investors to support their causes.
Since the financial crisis, it has become very difficult for smaller businesses in particular to raise the money required to expand and grow. As high street banks have withdrawn from corporate lending, a ‘funding gap’ has emerged that has in part been filled by the meteoric rise of crowdfunding. Additionally, with interest rates at rock bottom for the past six years, investors have been seeking unique returns and are more prepared than ever before to invest money into new types of investments in the hope of achieving a return higher than that offered by their bank account.
The Government’s promotion of enterprise in the UK has also meant that over 95% of all equity crowdfunding campaigns attract valuable tax benefits (such as Enterprise Investment Scheme [EIS] or Seed Enterprise Investment Scheme [SEIS] relief which allow for any losses to be claimed back on a tax return) which has further enhanced their appeal. It is against this backdrop that crowdfunding has flourished.
However, crowdfunding is still a very high-risk venture and, as with all forms of investment, comes with no guarantee of success or even return of capital. Among the main reasons to exercise caution is the price the investor pays for the equity. When a large business seeks to raise money, the numbers used to calculate the value of the business will have been audited and verified by an independent valuer.
Another key risk that investors need to consider is one of dilution. Many of the companies raising money on the equity crowdfunding platforms are high-growth businesses expected to go up in value significantly over a very short period of time. To fund this expansion, it is somewhat inevitable that these companies will need to continually raise further funds to maintain their level of growth.
While not all crowdfunding campaigns are run by start-ups, the average age of a company raising money on crowdfunding platforms is 3.32 years. Crowdfunding is undoubtedly a welcome addition to the options available for companies looking to raise money, and the effect that this has on the level of enterprise in the UK is a very positive development.
For investors, however, it is clear that great levels of caution should be taken when making any form of crowdfunding investment, and a reliance on the tax benefits will not be enough to offset the real risk of capital loss.
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