An overview of crowdfunding

Funding for businesses and in particular those wanting to invest in development and growth has become extremely difficult to find. Banks have become risk averse and need evermore capital-liquidity provisions which has combined to make it uneconomic to lend to SMEs and those who can’t provide asset backed security.

This has led to the popularity of raising money using online via crowdfunding platforms.
Crowdfunding can be defined as the act of raising money via a website from a relatively large number of small investors.

This is a fairly new form of financing and the last two years has seen some clarity emerging as to the different types and what each involves.

In our next few blogs we will be looking at each type of crowdfunding. This first article is a short overview.

There are three main types of crowdfunding. They are Equity, Debt (aka peer to business or market place lending) and Donation (aka Reward) crowdfunding.

In the first, individuals provide capital for shares in the business looking for funding and expect to receive dividends and/or a profit from a future sale of the shares. They are typically used by start-ups, early stage & growth businesses.

In the second type, Debt crowdfunding, businesses are looking to borrow money as repayment loans, convertible loans or loans with warrant. Lenders are typically repaid at regular intervals with interest on terms that are often more competitive than can be achieved from a bank.

Donation crowdfunding is generally used to raise non-returnable money for a worthy cause, so there is a social component and the “reward” is generally in the form of recognition for investors’ contribution rather than any financial return.

There has been some concern that small investors in such schemes may be inexperienced in investment and its risks and this has led to the introduction of regulation via the Financial Conduct Authority (FCA) in an effort to protect them.

Since April 2015 any organisation offering Equity or Debt crowdfunding facilities must apply to the FCA for permission to operate and must supply supporting evidence including a detailed business plan, evidence of capital reserves, a website showing information that details not only the benefits but also the risks involved.

The FCA is responsible for regulating loan-based and investment-based crowdfunding such that only regulated firms should be used to raise finance. The main restriction relates to the marketing promotion to investors in Equity and requires each investor to acknowledge they are either a high net worth or sophisticated investor or to confirm that they will invest less than 10% of their assets in crowdfunding. This means that firms raising Equity should take advice before doing any self promotion of Equity crowdfunding.

The FCA does not regulate Donation crowdfunding.

For other sources of business finance you can download a free Finance Guide from our website using this link.

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