Crowdfunding: what you need to know
Crowdfunding is a way for people, businesses and charities to raise money. It works through individuals or organisations who invest in (or donate to) crowdfunding projects in return for a potential profit or reward. Investing this way can be risky, so make sure you know what you’re doing.
What is crowdfunding?
If a company or person wants to raise money through crowdfunding, they can pitch for it by posting details of their project, business or idea on a crowdfunding website. This means they can avoid going to a bank. The ‘crowd’ in crowdfunding refers to the people, or organisations that provide the money.
What are the different types of crowdfunding?
There are several types of crowdfunding:
Neither donation nor reward-based crowdfunding are regulated by the Financial Conduct Authority, but loan and investment-based crowdfunding are. This article focuses on investment crowdfunding.
Investment-based crowdfunding. You invest in a business and receive a stake in return (normally shares).
Loan-based crowdfunding. You lend money to individuals or companies in return for a set interest rate. It’s also called peer-to-peer or peer-to-business lending (P2P or P2B). You can read more about loan-based crowdfunding in our guide to Peer to peer lending.
Donation-based crowdfunding. You donate to a person or a charity (you may be promised something in return).
Reward-based crowdfunding. You give money in return for a reward linked to the project or cause you’re supporting.
How does crowdfunding work?
If you visit a crowdfunding website, you should be able to see an overview of the projects being pitched. You might need to register with the website in order to see the pitches, to get more details, or to invest in a project.
Some crowdfunding websites charge investors a fee, which may be a percentage of any profit they make.
If you find a project you’re interested in, you’ll need to look for more details. The business, individual or social enterprise that’s looking to raise money should tell you:
- How much it wants to raise
- How much it has raised so far
- The share in the business offered (if relevant)
- What the money will be used for
- How long the pitch is open for
- How many people have already invested
- What you will receive in return for investing (such as shares in the company)
The investment can only go ahead if the business raises the full amount. You should have a 14 day ‘cooling-off’ period in case you change your mind.
What are the risks?
Crowdfunding is a new concept and investing in young businesses can be very risky. The main risks of investment-based crowdfunding are:
The business you invest in might go bust. Many new businesses fail in the first few years, so you could lose all your money.
The return is not guaranteed. The shares may not rise in value and you may not receive any dividend payment (a share of the profits).
It may be hard to sell the shares. The shares are normally unlisted, which means you may not be able to sell them easily in the way you could sell shares in a big company that’s listed on the stock market.
The crowdfunding platform itself may go bust. This could mean you lose money if you’d paid the crowdfunding website but it goes bust before your money was invested with the business.
Reducing the risks of crowdfunding investments
Only invest money you can afford to lose. You should invest no more than 10% of any money you have available for investing in any one year.
Before you invest any money using an investment-based crowdfunding platform, check the Financial Services Register to make sure it is authorised. Donation and reward-based crowdfunding platforms are not regulated by the FCA.
Money you invest should be kept in a separate account to the crowdfunding website’s own bank accounts before it’s handed over to the business. However, crowdfunding websites have limited protection under the Financial Services Compensation Scheme, so you may be able to claim compensation from them if the site goes bust.
What are the tax benefits of crowdfunding?
There are two main schemes which offer tax breaks if you invest in small companies: the Enterprise Investment Scheme (EIS) and the Seed Enterprise Investment Scheme (SEIS).
Both schemes let you offset a percentage of the amount you invest against your tax bill and any profits are free of tax. But there are conditions; for example, you must keep your investment for a minimum time.
Where can I complain?
The UK Crowdfunding Association has agreed a code for its members, which they must respect. You can check if a crowdfunding platform is a member of the UK Crowdfunding Association on their website.
If you have a complaint that the crowdfunding website is unable to resolve, you may be able to take your complaint to the Financial Ombudsman Service (FOS). However, you cannot complain to the FOS about donation or reward crowdfunding.
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