Crowdfunding Investment: What You Need To Know

Crowdfunding is a way for businesses, charities and individuals to raise capital without the need for bank loans or traditional sources of private equity. It involves raising small amounts of money from a large number of individuals, with contributions starting as low as $10. There are different types of crowdfunding, including equity-based, loan-based and reward-based. Each type comes with its own set of risks and potential rewards. For example, equity crowdfunding allows backers to receive equity shares in the company, but it also comes with a high risk of losing your entire investment. On the other hand, reward-based crowdfunding offers backers symbolic rewards, such as products named after funders, but it may not provide any financial returns. Before investing in crowdfunding, it is important to evaluate the situation and conduct due diligence, as it carries a high level of risk and there may be restrictions on who can participate and how much they can invest.

Understand the different types of crowdfunding

There are several types of crowdfunding, each with its own unique characteristics and benefits. Here are the most common types:

• Donation-based crowdfunding: This type of crowdfunding involves individuals donating small amounts of money to support a specific idea, cause, or project. It is often used for personal needs, community-based projects, charities, and disaster relief efforts.
• Reward-based crowdfunding: In this model, donors receive rewards or incentives based on the amount they contribute. The rewards are usually related to the product or service offered by the business or organisation. This type of crowdfunding is commonly used by startups or organisations offering a product or service.
• Equity crowdfunding: Equity crowdfunding allows contributors to become part-owners of a business by investing capital in exchange for equity shares. This type of crowdfunding is often used by small to medium-sized companies seeking a large amount of capital to launch or grow their business.
• Debt-based crowdfunding: Also known as peer-to-peer lending or crowdlending, this type of crowdfunding involves individuals or businesses borrowing money from contributors, with the promise to repay them at a later date, usually with interest.
• Real estate crowdfunding: This model allows multiple investors to pool their money together to invest in real estate projects. Each investor contributes a smaller amount of money and receives a share of the profits from rental income or property sales.

These are the most common types of crowdfunding, each with its own advantages and disadvantages. When deciding which type of crowdfunding to pursue, it is important to consider the specific needs and goals of your project or business.

Research crowdfunding platforms

Researching crowdfunding platforms is an important step in deciding whether to invest in crowdfunding. There are over 250 live crowdfunding platforms in the UK, including Crowdcube, Seedrs, SyndicateRoom, Indiegogo, Funding Circle, and Kickstarter. Each platform offers something different, catering to different types of crowdfunding, such as equity-based, loan-based, or rewards-based, and focusing on different areas, such as start-ups, music, arts, science, health, or technology.

When researching crowdfunding platforms, it is essential to consider your investment interests and goals. For example, if you are interested in investing in start-ups, platforms like Seedrs and Crowdcube might be a good fit. On the other hand, if you are passionate about supporting scientific research, platforms like Experiment, Crowd.Science, or RocketHub, which have a specific focus on science and research projects, might be more aligned with your interests.

Additionally, it is crucial to review the investment opportunities presented by each platform and conduct due diligence on the projects you are considering. Look into the business model, management team, and risks involved. Understand the project timelines, returns, and potential pitfalls. Remember that crowdfunding is a risky endeavour, and there is always the possibility of losing your entire investment.

It is also worth noting that each platform has different policies and fee structures. Some platforms, like RocketHub, allow you to keep the funds you raise even if you don't reach your funding goal, while others, like Experiment, only release funds to researchers if they reach their funding target. The fees charged by platforms can vary, typically ranging from 4% to 9% for site fees, with additional payment processing fees.

Finally, remember that the success of your crowdfunding campaign will depend not only on the platform you choose but also on how effectively you promote your project. It is essential to tirelessly promote your project to your network and build a strong online presence to increase your chances of success.

Know the rules and regulations

Crowdfunding is a relatively new phenomenon, with the first instance recorded in 1997 when a music group from the United Kingdom raised money for a concert tour from fans. ArtistShare, the first crowdfunding site, was launched three years later. In 2012, the Jumpstart Our Business Startups (JOBS) Act was enacted, creating a regulatory system for companies to find investors through crowdfunding. The JOBS Act established equity crowdfunding in the US and initially limited it to accredited investors. However, provisions like Title IV and Title III later expanded access to non-accredited investors and early-stage startups.

The Securities and Exchange Commission (SEC) regulates equity-based crowdfunding ventures in the United States and oversees these regulations, ensuring transactions occur through registered intermediaries. The SEC also adopted final rules in 2015, referred to as Regulation A+, to facilitate access to capital for smaller companies while providing investors with more investment choices. These rules are mandated by Title IV of the JOBS Act.

There are restrictions on who is allowed to fund a new business and how much they are permitted to contribute. These regulations aim to protect unsophisticated or non-wealthy investors from putting too much of their savings at risk, as many new businesses fail, and investors could lose their principal.

For non-accredited investors, the amount they can invest depends on their annual income or net worth. If their annual income or net worth is less than $124,000, they can invest up to $2,500 or 5% of the greater figure. If their annual income and net worth are equal to or greater than $124,000, they can invest 10% of the greater figure, up to a maximum of $124,000.

It's important to note that crowdfunding platforms may have their own rules and policies, so be sure to review these before investing. Additionally, the rules and regulations around crowdfunding can vary by country, so ensure you are familiar with the specific laws and guidelines in your jurisdiction.

Before investing in any crowdfunding opportunity, it is crucial to conduct thorough due diligence on both the investment platform and the specific investment opportunity. Understand the risks involved and only invest what you can afford to lose, as crowdfunding can be a risky endeavour.

Be aware of the risks

Crowdfunding is a relatively new way to raise money for projects or business startups. It has become very popular in recent years, but it's not without its risks. Here are some key risks to be aware of when investing in crowdfunding:

• Risk of Loss: All investments come with the risk of loss, but crowdfunding investments may be riskier than traditional investments. This is because crowdfunding investments are often made in early-stage companies with little history or track record, making it difficult to assess their viability and future success.
• Liquidity Risk: Crowdfunded investments are often illiquid and may not be able to be sold quickly or easily. This means that even if the venture is performing well, accessing your capital can be challenging. Many crowdfunding platforms lock in investments for extended periods, often several years, without a straightforward exit strategy.
• Potential for Fraud: Crowdfunding platforms are not regulated by the Securities and Exchange Commission (SEC), creating a greater potential for fraud. Scammers can exploit the enthusiasm surrounding new projects to deceive investors. It is essential to conduct thorough due diligence to mitigate the risk of falling victim to fraud.
• Non-accredited Investors May Lose Money: Crowdfunding opens up investment opportunities to a broader audience, including non-accredited investors who previously had limited access to venture investing. However, non-accredited investors may not fully appreciate the risks involved or have the capacity to absorb potential losses. The potential for total loss of investment is real, and non-accredited investors must exercise caution.
• Minimum Investment Amounts: Many crowdfunding campaigns have minimum investment requirements, which may require investors to commit more money than they are comfortable with. Evaluating your financial capacity and willingness to lock in funds for the long term is critical before making a crowdfunding investment.
• Fees and Expenses: Participating in crowdfunding involves various fees and expenses that can impact the overall return on investment. These fees can reduce net returns, especially if the crowdfunded venture generates only modest profits. Investors should carefully review all associated fees and calculate their potential impact on investment returns.
• Limited Information: Crowdfunding ventures may not provide comprehensive data, making it difficult for investors to conduct thorough analysis and assess potential risks and rewards. Relying on incomplete or overly optimistic information can lead to misinformed investment decisions.
• No Guarantee of Success: Just because a company successfully raises money through crowdfunding does not guarantee its long-term success. Many startups fail, and even projects that meet their crowdfunding goals may not achieve their objectives. Investors should be prepared for the possibility that they may not see a return on their investment.
• Dividends are Not Guaranteed: Crowdfunded companies may choose to reinvest profits instead of paying out dividends, leaving investors without the anticipated income. Understanding the company's dividend policy and long-term financial strategy is crucial before investing.
• Potential for Total Loss of Capital: The most significant risk associated with crowdfunding is the potential for a total loss of invested capital. If the venture fails, investors may have little to no recourse to recover their funds. Unlike traditional investments, crowdfunded investments are often unsecured and rank lower in priority in the event of bankruptcy.
• Security Risks: Crowdfunding portals and platforms are vulnerable to attacks from hackers and cyber-criminals. In addition to researching the investment, it is important to also look closely at the security of the platform.
• Lower-Quality Investments: There is a possibility that companies resorting to equity crowdfunding are doing so as a last resort after failing to attract funding from conventional sources. This suggests that crowdfunded businesses may be more mediocre investment opportunities with limited growth potential.

Consult a financial advisor

Before investing in crowdfunding, it is important to consult a financial advisor to assess whether it is a suitable option for you. A financial advisor can help you understand the risks involved and determine whether you have the risk tolerance for this type of investment. They can also provide expert guidance on navigating the complex world of crowdfunding and help you make informed decisions about your financial future.

Understanding the Risks

One of the key advantages of consulting a financial advisor is gaining a comprehensive understanding of the risks associated with crowdfunding. These risks include the potential loss of your entire investment, lack of liquidity due to the difficulty of reselling crowdfunded shares, and the dilution of your shares if additional funding rounds occur. A financial advisor can help you evaluate these risks and make an informed decision about whether to invest in crowdfunding.

Due Diligence and Research

Financial advisors are adept at conducting due diligence and thorough research on investment opportunities. They can help you evaluate the business model, management team, and risks involved in a particular crowdfunding project. This includes assessing the track record, financial health, and growth prospects of the company or startup seeking funding. Their expertise will enable you to make a more informed decision about where to allocate your investment capital.

Diversification and Portfolio Management

Diversifying your investments across different asset classes and sectors is crucial for managing risk. A financial advisor can help you understand how crowdfunding fits into your overall investment portfolio and ensure that you maintain a balanced approach. They can guide you in allocating your funds across various investments to minimise risk and maximise potential returns, based on your financial goals and risk tolerance.

Regulatory and Compliance Insights

The world of crowdfunding is subject to regulatory frameworks and compliance requirements, which can vary across different countries and platforms. Financial advisors are well-versed in these regulations and can help you navigate the legal and compliance landscape. They can explain the rules governing crowdfunding in your jurisdiction and ensure that you invest through registered intermediaries who adhere to transparency and investor protection guidelines.

Long-Term Financial Planning

Crowdfunding is often a long-term investment strategy, and financial advisors are adept at helping you align your crowdfunding investments with your long-term financial goals. They can provide insights into the potential returns, time horizons, and tax implications associated with crowdfunding. By integrating crowdfunding into your overall financial plan, they can help you build a robust and diversified portfolio that takes into account your risk appetite, investment objectives, and future financial needs.

Frequently asked questions