Investment crowdfunding is a method of raising business finance from a large pool of investors, and in return, the company issues shares to these investors. Each share purchased has a pound for pound value increase in the company's cash balance (excluding transaction costs).
Startups or smaller businesses often use crowdfunding to raise money in exchange for shares in a short amount of time. The most popular platforms in the market are Seeders and Crowdcube.
Crowdfunding gives the company an injection of cash to grow, but at the cost of introducing shareholders who own a proportion of the company. If the business is successful, the value of the investments will rise. The converse is also true. Should the business fail, investors will lose their entire investment.
There are now a large number of platforms which offer crowdfunding services, typically conducted online.
For example, in November 2018, Monzo Bank (a unicorn) raised £20m from 36,006 investors. BrewDog has also raised funds through crowdfunding and have previously raised £39.33m from investors via crowdfunding.
These are substantial investments from a pool of private investors. Crowdfunding isn't going anywhere soon and is an excellent way for companies to quickly raise finance from a pool of investors. It's also great for investors with excess capital to fund companies via crowdfunding for reasons I will cover in this article.
Why Do Companies Raise Capital by Crowdfunding?
People often say that crowdfunding is for businesses unable to attract institutional investors, but this is simply not true.
Monzo had several investors willing to invest in their latest round (at the time of writing). However, they decided to raise £20m from the general public as a way to share their success with their users and the balance from institutional investors.
This method of raising finance can often be desirable to the company.
- Control - funding is raised in small amounts from a large pool of individuals, meaning there are no dominant shareholders and control can remain in the hands of the founders.
- Cost - small startups with relatively little trading history may find it difficult to raise funding from traditional sources, e.g.banks, VCs or PEs. These conventional routes often require a detailed business plan, some sort of due diligence, credit checks, assets for security, constant reporting of the business performance etc. If raising finance from a bank, the interest rates are also likely to be very high, to compensate the bank for the risk it's taking.
- Time - it is often cheaper and far quicker for the company to raise finance through crowdfunding sources than through traditional routes. Monzo was able to raise £3m from investors in just 60 seconds. It's less of a drain on management's time, whose focus remains on the actual running and growing of the business, as opposed to raising finance.
- Regulation - Raising finance from the public can often be illegal, so companies will be required to obtain the necessary approvals from the regulators. But, raising finance through crowdfunded campaigns is much easier as the crowdfunding industry is much less regulated. There is less paperwork as there are no requirements for the accounts to be audited.
Why Do Investors Deploy Capital Through Crowdfunding?
Investors have never been more willing to part with their cash to support relatively small or unknown businesses, due to greater access to capital. Crowdfunding can offer several advantages to retail investors not obtainable elsewhere.
- Support - investors want to support businesses and ideas they feel passionate about and allows ordinary individuals to invest in the next hottest startups. It was a key reason for Monzo in raising finance through crowdfunding, allowing their customers to enjoy a share of their growth. For Brewdog, the crowdfunding community has been key to their success.
- Convenience - it is often easier to invest in companies via crowdfunding campaigns. It's possible to sign up to a crowdfunding platform and invest in a company within 5 minutes. It is far quicker than investing directly with the company or investing through a brokerage firm.
- Diversification - it offers investors the ability to invest in smaller, privately-owned companies to diversify their portfolio with relative ease. Without crowdfunding, this options is unlikely to have been available to investors.
- Tax - crowdfunding often involves investing in smaller, early-stage companies, where many tax reliefs are available, such as Enterprise Investment Scheme ("EIS") and Seed Enterprise Investment Scheme ("SEIS"). These are specially made available by the government to promote entrepreneurship. Without these, fewer people are likely to invest in startups, due to their high failure rate.
- Wider Audience - angel investors are traditionally a small pool of investors with large amounts of capital. However, crowdfunding is changing who the traditional angel investors are from the small pool of investors with large amounts of money to a large pool of ordinary, everyday investors. The angel investing landscape is changing.
Crowdfunding has emerged as a valuable, cheap and efficient way of raising business finance, both for companies and investors. It's resulted in exponential growth in the industry, that isn't going anywhere, anytime soon.
Crowdfunding in early-stage companies is inherently risky, and more often than not, investors will lose their investment. It is an inevitable outcome because the majority of startups fail within their first few years of existence.
Therefore, investors should carefully assess and evaluate the risk they are taking and ensure they're sufficiently diversified - not putting all their eggs in one basket.
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