Photo courtesy of Flickr – Howard Lake
But there are a wealth of different crowd-funding models to choose from – and multiple sitses subscribing to each model.
In an attempt to bring some clarity to the basics, PathfinderBuzz presents its Top10 things to know about crowd-funding.
1. New regulations - Changes to regulation in the UK brings crowd-funding further into the mainstream. The UK’s regulator the Financial Conduct Authority (FCA) has defined three types of crowd-funding models – donation/reward based funding, investment funding and loan-based funding (explained in more detail below).
The FCA has opted to not regulate donation/reward based funding, modify existing investment regulation to better include crowd-funding and to adopt new regulation to cover loan-based crowd-funding.
2. Donation/reward based models - This is perhaps the most well known method of crowd-funding and is the basis for sites such as Kickstarter. In the model an investor is given a reward in return for their participation in the fund-raising.
The rewards are set by the organisation looking for money and can vary in value but do not result in ongoing returns.
For example a business such as LIFX, sellers of an intelligent light-bulb, essentially offer investors the chance to purchase the product and demonstrate that it is a viable business idea before setting up a permanent facility.
But other projects However, projects can offer proportionally less valuable rewards – such as autographed copies of a DVD in return for funding a movie or a chance to participate in a charity fund-raiser.
3. VC worries - Some commentators have also worried about venture-capital interest in the reward/donation based model. If a company goes onto exit, the initial investors receive only the ‘reward’ they signed up for, while behind the scenes, venture capitalists can be making healthy profits.
4. Equity crowd-funding - Equity crowd-funding enables many investors to buy shares in a company in return for their investment. They can then collect if the business grows in valuation and ‘exits’ in some method – be it being bought over, sold to new investors or floated publicly. However, some equity crowd-funding models allow businesses to dilute already-bought shares in order to raise money in subsequent rounds of funding.
5. FCA equity rules - The FCA has modified equity investment rules to better consider the crowd-funding model. Previously only certain types of investors could take part in risky equity crowd-funding (the FCA estimates between 50-70% of new UK businesses fail). That meant that investing was limited to those that should know the risks or be able to afford them, the FCA thought. It only allowed self-certified high net-worth investors and experienced (sophisticated investors), or those receiving certified advice, to take on the risks.
Now crowd-funding’s ability to pool smaller amounts together means that more people should be able to take advantage if they want. As a result the FCA has allowed anyone to invest up to 10% of their net assets (essentially liquid savings: any money not tied up in things such as pensions, mortgages, taxes and other expenses) for their first two investments. After that they can self-certify as experienced investors and are no longer limited.
6. Self assessment - The self-certification aspect of equity crowd-funding could prove to be an issue down the line and the FCA may look at it again. Commentators, such as Darren Jordan, partner at Kingston Smith, an accountancy firm – wondering if the regulations are doing enough to protect consumers. Currently the onus is on crowd-funding firms to put in place checks that allow only investors who can afford the risks.
7. Peer-to-peer (P2P) lending models - In this model a crowd-funding site collects money from investors, pools it together as a loan to a business which then pays interest back to the site and investors. Businesses are required to have significantly more detailed business plans and financial information available for this model.
8. Taken under the wing - Previously P2P lending was not regulated by the FCA. It now requires crowd-funding sites engaged in this model to maintain a pool of cash in order to avoid financial difficulties and to have mechanisms in place to continue to collect money from businesses and pay it to investors if the site was to run into trouble.
9. Wealth of choices – The number of new crowd-funding sites are growing all the time (with some raising the funding they need to launch on other crowd-funding sites). It can be difficult to choose which model works best for each individual entrepreneur and investor. Careful reading of the terms and conditions, as well as what each site uniquely offers, is a must.
10. High profile players - Despite the risks, equity crowd-funding continues to grow in popularity, with ‘celebrity’ business-investors such as Steve Smith of Poundland and Kevin McCloud, the designer and presenter from Grand Designs, both investing through equity crowd-funding platforms. For high net-worth individuals, tax discounts can prove to be significant incentives for investment.
Next steps and more information