What is Crowdfunding?
More and more people are learning about
crowdfunding and how it is being used to raise money for businesses, property, good
causes and new product launches. So,
what exactly is crowdfunding?
The Financial Conduct Authority (FCA), the regulatory body in the UK, defines crowdfunding as this:
“Crowdfunding is a way which people, organisations and businesses can raise money through an online portal (crowdfunding platform) to finance or re-finance their activities and enterprises.”
its simplest form, crowdfunding is the ability to raise finance for a business,
property project, product or social reason from a number of people,
each contributing varying amounts towards the cause. It is an increasingly attractive method of raising capital, instead of using traditional finance. In the property sector, crowdfunding has become a very popular way to raise finance.
Property Crowdfunding is a method of working with the crowd to finance property projects. This type of investment opportunity is available to almost everyone, with many people investing small amounts into a property project. Some projects also offer learning opportunities, allowing the general public to learn how the property market and property projects work, whether it be planning gain, new build or conversion.
Property crowdfunding usually takes one of two forms. The two types vary in their risk and return profiles and it is really important to understand the differences. These are explained below.
In an equity based property crowd raise, the investor is typically buying shares in the company that owns the property. The property can be a plot of land, a building or other property asset. In essence, the investor becomes a part owner of the company.
Returns are received in the form of dividends and capital growth. Dividends can be paid throughout the project (based upon rental income for example) and capital growth usually at the end when the project is sold or re-financed.
If the company becomes successful and increases its value, so will the investor’s share in that company. If the company does not perform as well as expected, the value of the share will go down. Equity risk and return
With equity investments, other finance providers are likely to be paid back before shareholders receive their capital and projected returns. With property investment, the exit is often a refinance or sale. Some investment projects also provide regular interim payments in the form of dividends.
Equity is considered a higher risk investment than peer to peer lending and therefore usually offers a projected higher return. Naturally, the projected returns offered will vary from project to project and fundraiser to fundraiser. Ultimately, it is up to the fundraiser to decide what projected return could be made available to investors. Investors then decide whether they wish to take part.
Peer to Peer Lending
If you invest in a peer to peer loan, you lend money to the property developer. You are like the bank, loaning money for a fixed term, for a fixed return. Interest payments will be made periodically or, in some cases, at the end of the loan term. The loan is usually secured against the property, and usually on a first charge basis (first in the queue for repayment). One of the main advantages of peer to peer lending opportunities is that the investor can invest using an ISA wrapper. The ISA that can be used is an IFISA (Innovative Finance ISA). The benefit is that these IFISA’s are exempt from both income and capital gains tax on the investment returns, and no tax is payable on money withdrawn from the ISA scheme.
The terms peer to peer lending, debt and bonds are often muddled up and whilst in principal all are lending funds, there are significant differences from the technical, payment and regulatory perspectives.
Peer to peer lending risk and return
These investments are regarded as a lower risk than equity and typically offer a lower projected return. Peer to peer projects will typically have some form of security, which means that there is a ‘charge’ over an asset. Charges can be a first charge which ranks top and means these charge holders get paid first. Secondary (or later) charges means that the charge holder gets paid after the higher ranking charges have been paid. First charge holders typically control whether to trigger a demand for payment.
Some platforms require security in order to further secure investor funds. Whilst this does not guarantee that an investor will receive their funds back if a project does not go to plan, there is a better chance that the funds will be recoverable.
An obvious example of when security may exist is in a crowdfunded property project. If a fundraiser has a piece of land and wishes to raise finance for the development and build, the platform will look to take a registered charge on the land. The value of the land must be enough to cover the original amount borrowed and associated fees.
Investment Choices: Things to Consider:
- Lending provides a more stable and predictable return than equity
- Lending typically holds a charge on an asset
- The holding period is known for lending, and is often shorter than with equity
- It is possible to invest using an ISA for tax-free returns when lending
- Equity has the potential for bigger returns
- Typically, the higher the projected return, the higher the projected risk
Below is a graph that shows the payment priority alongside the risk and return profile for a typical project.
Simple Property Crowdfunding
At Simple Crowdfunding, we offer both equity and peer to peer lending opportunities. On our Invest page, it is easy to tell the difference between the two types of investments:
- Equity projects have a copper border and have an 'Equity' badge on the project image.
- Peer to peer loans have a grey border and have a 'Peer to Peer Loan' badge on the project image.
While the above sections discuss the relative balance of risk and return between equity and peer to peer lending, all crowdfunding investments carry a degree of risk and returns are not guaranteed. Remember to always do your own due diligence, read the information provided and ask questions.
Want to find out more? Contact the Simple Crowdfunding team
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