What is Crowdfunding?

More and more people are learning about crowdfunding and how it is being used to raise money for businesses, good causes and how it is bringing products and ideas to life.  Did you know that crowdfunding is also being used across many different industries including property?   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 (including business start-ups) can raise money through online portals (crowdfunding platforms) to finance or re-finance their activities and enterprises.”

In its simplest form, crowdfunding is the ability to raise finance for a business, property project, product invention or social reason from a number of people, each contributing varying amounts towards the cause.  In return individuals receive some form of acknowledgement, reward or investment return.  The crowdfunding platform is the ‘matchmaker’, connecting individuals who have money with those looking to raise funds. 

Although crowdfunding is still relatively new, the concept has been around for centuries. Even the great composer Mozart used it, asking for funds to put on a concert, offering manuscripts and other rewards in return.  Modern crowdfunding has been driven by the growth of the internet, making it easier to reach out to large groups of people, globally.  

The 4 types of crowdfunding: 

Peer to peer lending

Peer to peer lending (also known as loan-based crowdfunding) is where you provide a loan on a fixed-term, fixed-return basis.  Interest is paid either at regular intervals or at the end of the loan term, with the loan being repaid at the end of the term.   The rate of interest offered is often higher than that of traditional savings accounts.  Peer to peer lending is widely used for property and small business lending.  Platforms such as Simple Crowdfunding and Funding Circle offer peer to peer loans.

Equity crowdfunding

Equity crowdfunding is where the fundraiser (company raising funds) offers investors a share of the company in return for their investment.  The longer-term value of these shares is determined by the success of the company.   Platforms such as Simple Crowdfunding and Seedrs offer these types of investments.

Donation based crowdfunding

Donation based crowdfunding is where people or companies invite the community to donate to a ‘good cause’.  Examples of donation-based crowdfunding include supporting an amputee to buy a wheelchair, a new music hall for a school and a relief fund for a recent disaster.  Doners do not get a return other than knowing they have contributed to a good cause.  This is the most philanthropic of the crowdfunding types.  An example of a donation-based platform is Just Giving. 

Reward based crowdfunding

Reward based crowdfunding is where the fundraiser offers to supply something (a reward) in return for community backing.  A reward can be virtually anything, such as credits in a film, first copies of a published book, gym membership, a cool box and more.  The backer may receive the produced item, receive substantial discounts or simply reserve the right to buy the item earlier than the rest of the market.  Crowdfunding platforms such as Kickstarter specialise in this area.   

How does crowdfunding work?

Businesses or individuals seeking to raise finance will bring their project or investment opportunity to a crowdfunding platform. The crowdfunding platform will review the information and administer and coordinate the fundraising.  The project or opportunity will be published on their website, where investors can look at the information, do due diligence and decide whether they want to invest or not.  So, in simple terms the crowdfunding platform is a matchmaker between the fundraiser and investor.

How is crowdfunding regulated?

Donation and reward based crowdfunding are not regulated in the UK.  Peer to peer lending and equity crowdfunding is regulated by the FCA.  Before investing through investment-based crowdfunding platforms where you are expecting a return on your money, you should understand the risks as these can include loss of capital and illiquidity.  Risk disclosures should be clearly accessible on all regulated platforms.

If you do decide to look into crowdfunding, ensure that you also do your checks on the fundraising platform.  Check whether the platform is authorised and regulated by the Financial Conduct Authority by checking out their FRN (Firm Reference Number) on the FCA website.   This is usually found in the footer of the website.  



Also, a number of crowdfunding platforms, including Simple Crowdfunding are members of the UK Crowdfunding Association (UKCFA) that has a voluntary code of conduct that members agree to abide by. 

What are the benefits of crowdfunding?

There are many benefits that both fundraisers and investors experience.  Here, we focus on investment based crowdfunding, namely, peer to peer lending and equity crowdfunding.

Benefits for investors

Crowdfunding has been growing rapidly over the last few years and has opened up the investment marketplace to everyone. Here are some of the main benefits that investors receive:

• Small entry price. The beauty of crowdfunding is that everyone can start building an investment portfolio from a few hundred pounds.
• Diversification. Investors can diversify their investments across multiple projects, spreading investment risk.
• Take control of your investments. Using a secure online crowdfunding platform, investors can create and manage their investment portfolios online.
• Choice of investment types. Depending on your appetite for risk, you can choose to invest in debt projects (fixed returns over a fixed period of time) or equity projects (projected higher returns, with higher risk).
• Tax Free returns.  Investors have the ability to invest using their pension and/or ISA allowance for tax free returns.
• Learn from the crowd and the developer. Through crowdfunding, investors become part of a like-minded community where they can learn from other investors and the developer.

Benefits for fundraisers

Crowdfunding offers a creative way to raise finance without going to banks, venture capitalists, private equity or angel investors. Here are some of the main benefits for fundraisers:

• Access to investors.  Crowdfunding platforms let you present your project and company to hundreds or thousands of potential new investors.  You have the ability to tap into a highly engaged community of investors looking for the right opportunity to invest in.
• Improve your product.  You can ask the crowdfunding community to share their thoughts. Because they have a vested interest for you to succeed, they will be keen to give you feedback. They’ll tell you what they like, what they don’t, and how to improve the offering.
• Create a ‘raving fan base’ who love what you do.  Crowdfunding allows you to develop more meaningful relationships with your investors.  Crowdfunding helps you create a ‘raving fan base’, strengthen your brand and allow you to shine.
• Manage many investors, simplify paperwork, and communication.  Whether you are raising loan or equity finance, crowdfunding platforms have the technology and processes in place to manage multiple investors. This includes processing Anti-Money Laundering (AML) and Know Your Customer (KYC) checks, collection and distribution of funds and distribution of shareholder or loan agreements.
• Stretch your marketing budget.  The crowdfunding platform will also market your project and campaign with you. This will help extend your reach and exposure, far more than you can do by yourself.
• Future proof your business.  Meeting investor expectations or even surpassing them, will have investors keen to invest in your business and projects, over and over again. What a wonderful way to grow your business.

The future of crowdfunding

The 2008 financial crisis was a real catalyst for the development and growth of investment-based crowdfunding (peer to peer lending and equity crowdfunding).  With the reduction in global interest rates and the constraints on banks meant that businesses were finding it more challenging to raise funds. Investors had less opportunities to get reasonable risk-adjusted returns on their money.  Whilst crowdfunding has been around for a while now, it is still in its infancy stage.  However, awareness is growing rapidly throughout the world and it is becoming the new way of raising finance, investing and doing business.