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Fintech Tips: Five things you need to know about Crowdfunding

Whether you want to back the next Facebook or drag high-flying Tory MP Boris Johnson to court, here is what you should know about this communal method of raising cash.

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Crowdfunding is a way for start ups to raise funds by asking a large number of people for relatively small amounts of money. Traditionally, new firms have raised cash by asking a small number of people for large sums of money, typically from angel investors or early-stage venture capital groups.

This way of raising cash became popular online in the early 2000s, pioneered by such ventures as peer-to-peer platform Zopa, or crowdfunding site Crowdcube.

However, investors should remember the risk of a bet on a young company is the same as it always been. It is an investment in an untried business that could go on to make billions, or more likely, may go bust, wiping out your stake.

How does crowdfunding work?

Investors will need to log in to a crowdfunding site, which are tech-savvy platforms, designed to automate much of the processes for backers and fundraisers. Those looking to raise funds may be a business, an individual or a social enterprise.

The platform will allow you to scroll through hundreds of pitches for cash, which can begin at just £5, and can range from a tech start up, funding a new movie, or Marcus Ball who has raised over £300,000 to fund a private prosecution against Conservative party candidate Boris Johnson for alleged misconduct in public office as a result of his role in the 2016 Brexit referendum campaign.

What should I look for in a pitch for cash?

The pitch should tell you:

  • How much needs to be raised

  • How much has been raised so far

  • The share in the business being offered

  • What the money will be used for

  • How long the pitch is open for

  • How many people have already invested

  • When you will receive a return for investing

Investments can only go ahead if the business, individual or social enterprise meets their target amount in the time specified - if not your money will be returned. If you do decide to invest, you will have a 14-day cooling-off period in case you change your mind.  

What are the different types of crowdfunding?

There are several different types of crowdfunding to choose from, these include:

  • Investment-based crowdfunding. Backers invest in a business and receive a stake in return, which is usually shares.

  • Loan-based crowdfunding. Investors lend money to individuals or companies in return for a set interest rate. This is more usually called peer-to-peer or peer-to-business lending.

  • Donation-based crowdfunding. You donate to a person or a charity, in this case you may, or may not, 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.

What are the benefits of crowdfunding?

The benefits of crowdfunding range anywhere from supporting projects as they develop to finding local initiatives to back.

Investing in a business through crowdfunding may also offer higher returns amid an extended period of low interest rates, following the 2008 financial crisis.

Crowdfunding can be a useful way for young firms or individuals to gain access to cash that banks or other lenders are not prepared to offer. Or, if they are, only at much higher rates on interest.

This way of financing can also benefit the wider economy, as it puts greater amounts of cash to use bidding to create value.

What are the risks of crowdfunding?

The business you invest in may go bust. Many new businesses fail in the first few years, so you could lose all your money. Also, most crowdfunding investments fall outside of the Financial Services Compensation Scheme, meaning no compensation is available to backers.

It may be hard to sell shares you receive in a crowdfunded business. These shares are normally unlisted, which means backers may not be able to trade them as easily as shares held in a firm listed on a public stock exchange.

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