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Crowdfunding

Crowdfunding – “peer-to-peer lending” (P2P) – is the seeking of finance from a large number of individuals where each gives a small amount of money, sometimes as little as £5, in exchange for a return which is not necessarily monetary.

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Why is crowdfunding popular?

Alternative finance options such as crowdfunding are growing increasingly popular. What started as a solution for British rock group Marillion who, in 1997, needed $60,000 to fund an American tour, is now a market worth £3.2bn, of which £1.49bn is used by businesses.

According to Peter Baeck, Principal Researcher at innovation charity, Nesta, crowdfunding represents 15.6% of total UK seed and venture-stage equity investment while equity-based crowdfunding has grown by 295% since 2014 to £332m.

SMEs and particularly microbusinesses are increasingly using crowdfunding or P2P loans. The average value of these loans is £74,000.

There are three main categories to crowdfunded finance.

Donation/reward

Lenders give because they believe in a project and not because they specifically want a return.

Instead of financial return, they may receive publicity, tickets to an event or a notional gift.

Debt

The investor’s reward is the interest returned on top of the money that they lend.

This is the form of crowdfunding that’s upsetting the traditional high street banks, as it is often more flexible with less interest to be paid.

Equity

Investors exchange cash for equity (shares) in a business.

This is arguably the most desirable form of crowdfunding as this can float a business without many of the traditional hurdles or costs.

Which crowdfunding platform is right for me?

When you’re looking to raise money through crowdfunding, it’s worth researching the different platforms to see which is the right option for you.

How much money has been raised by similar projects?
How many projects succeed in raising funds?
Do they claim to serve a niche (is there proof)?
Do they have proven financial backing?
Does the management have any background in crowdfunding or venture capital?
Does the platform feature set support marketing plans for a campaign?

What do I need to think about?

Be realistic
It’s very important to understand the amount of funding that is needed to be a successful investment. Being underfunded can lead to failure as much as anything else.

Be prepared
Applying for money via crowdfunding is no different from applying for a bank loan. You’ll need to write a business plan, offer company bank statements, a financial model, detail on key personnel and pass due diligence and credit scoring.

Often investors want more detail about a business than is presented on the crowdfunding site. For example, “how have you come up with your valuation?”

Create demand
You should make it easy for investors to invest before they get distracted. Publicity is everything and so projects need to carefully use social media and other promotional tools such as video. It’s a good idea to create demand before crowdfunding and also continuing to build interest before the project closes. It also advocates clear and regular communication with potential lenders, with among things, detail on those involved in the project.

Tally up the costs
P2P money provides a good summary of interest rates.

Rejection rates can be high
Crowdfunding platforms have to make good loans and so it’s not easy money. Platforms score loans according to risk categories and will apply different interest rates to different borrowers. Remember – they’ll be as unforgiving as banks if loan repayments aren’t made.

Tax deductions
Lenders may not be aware of the tax break available through the Seed Enterprise Investment Scheme (SEIS). By investing in a firm that qualifies for SEIS, lenders receive 50% of their investment back through a tax deduction.

Case study: The Stripes Company

The Stripes Company was conceived as a tribute to the deckchair and wanted to revive the use of stripes for those at leisure. The company applies striped textiles to a number of lifestyle accessories that are found around the house, in the garden, or at the seaside.

The company has borrowed more than £175,000 since January 2011 through three separate crowdfunded loans, to help with cash flow.

Maria Hopwood, owner of the business, says the process was invaluable. “We had completely run out of resources, we needed stock because we were selling it too quickly. We’d got into the realms of starting to pay wages, we’d started to run up costs. Our website was looking very dated. We had goods coming in, sitting at the docks – and we couldn’t clear them.”

Hopwood spoke to the banks and went down all of the usual routes, the problem was they were building a business in a recession – they had shut their doors to borrowers.

“My husband had found Funding Circle online and said that it would actually be perfect: if we wanted to pay off the loan very quickly there’s no penalty. We applied, they approved our application, they put it up on the site and within three days it was completely oversubscribed so we got our loan very quickly.”

The company has now set up an Australian website and is going to be setting up an American website. “We’ve been used in television – we supplied a lot of furniture for Downtown Abbey. Opera, theatre, ballet, films; we’ve done some Hollywood movies using our fabric. I really feel like how I can identify with our investors because they are the sort of people we want to love our company.”