You’ve probably heard of the term, but what actually is crowdfunding and why is it becoming an attractive option for so many companies and investors? In this article, our Managing Director and Co-founder, Tom, explains all.
Crowdfunding is simply a way of funding a project or venture by raising money from a large number of people who each typically contribute a relatively small amount. It’s an umbrella term that captures a wide-range of activities: from donation-based crowdfunding for charitable or non-business purposes (on sites such as JustGiving) and project-based crowdfunding for a particular projects (e.g. Kickstarter), to equity crowdfunding for SMEs and start-up companies (e.g. Crowdcube). It’s this last variety – equity crowdfunding – that we are now undertaking and we’re giving our community an exclusive opportunity to take part.
So, what actually is equity crowdfunding? Well, in essence, it’s the process that allows people (i.e. the ‘crowd’) to invest in an early-stage unlisted company (a company that is not listed on a stock market), such as Propio, in exchange for shares in that company. As a shareholder, investors will then have partial ownership of the company and will stand to profit should the company do well.
Previously only wealthy individuals, venture capitalists and business angels (think Dragons Den), could invest in start-ups. The rise of equity crowdfunding platforms have helped democratise the investment process by unlocking access to a larger pool of potential investors. In recent years, many of the UK’s (and indeed world’s) fastest growing firms have used equity crowdfunding to support them on their growth journeys: Companies such as JustPark, Monzo, Revolut, and BrewDog have tapped into the crowd to raise millions. And in doing so, they’ve not only acquired vital growth investment, but have built stronger, more engaged customer bases – many shareholders in fact go on to use (and regularly evangelise) the product or service on offer. It’s a win-win!
The UK government has put in place a number of tax benefits for investors in these kinds of ventures, which offset some of the risk involved with investing in early-stage companies and, at the same time, stimulate entrepreneurial activity. The Enterprise Investment Scheme (EIS), for example, is one of the most generous tax incentives in the world, offering 30% income tax relief. Good news, our latest investment round is actually eligible for this benefit.
What are the risks?
Equity crowdfunding for start-ups is risky by nature, so there are a number of things you need to be aware of if you’re considering investing.
Firstly, it can take years to see a return on your money. Despite the best intentions of founders, rapid share growth is not guaranteed, and it may take a long time for shares to increase in value. In some cases, shares may even lose value.
It’s also worth stressing that most start-ups are aiming to grow rapidly and because of this don’t make enough profit to be able to pay dividends to their investors. This means that you’re unlikely to see any return or profit until you are able to sell your shares, which can take years if it happens at all.
Equity crowdfunding investments are also highly illiquid. Even though many equity crowdfunding sites now have secondary markets in place where you can easily sell on your shares, sale, especially at a price above you paid, is never guaranteed.
Finally, there’s always the risk of dilution. That is, if the company you invested in raises more capital at a later date, new shares will be issued to the new investors and so your percentage shareholding within the company will be reduced (or ‘diluted’).
Equity crowdfunding definitely isn’t for everyone and should only be considered as part of a balanced investment portfolio. However, for those who enjoy backing bright new businesses that demonstrate early potential, it can be a highly profitable and ultimately exciting activity.
For more information on Propio’s Crowdcube crowdfund, visit our crowdfunding page.
Investments of this nature carry risks to your capital. Please Invest Aware.