Wednesday 01 June 2016 1:43 am

Should you invest in crowdfunding?

From craft beer to knitting and films, crowdfunding allows you to invest in the things which matter to you.

It’s grown massively in the last five years and revolutionised the possibilities for start-up businesses. Rather than rely on friends for their generosity, or wait months for a bank to say no to a loan, entrepreneurs have turned to the crowd for cash. “Crowdfunding has proved a godsend as many banks, still seemingly recovering from the effects of the financial crisis, remain reluctant to lend money,” says Patrick Connolly of Chase de Vere.

It’s spawned some interesting success stories. East London knitwear company Wool and the Gang raised over £1m from 400 investors on website Crowdcube, and it counts John Lewis among the places its wares are sold. Kamm & Sons, which manufacturers a spirit made from Ginseng, raised £325,000 from 64 investors on the same website. The spirit is used in cocktails in chic bars around the world.

WHAT IS CROWDFUNDING?

There are now around 400 websites, or “platforms”, globally where start-ups can raise cash from ordinary people.

Investing in small, private companies was previously the reserve of the rich. So-called business angels or venture capitalists would meet at networking clubs, and they would arrange Dragons’ Den style presentations with entrepreneurs. Although they provided a valuable lifeline to fledgling companies, it was a closed and cliquey world.

Now, the crowd can help anyone get a business off the ground, whether they have £10 or £20,000.

An entrepreneur uploads their pitch onto a website, and prospective donors browse the site and pick their favourite. Crowdcube, Seedrs, and Kickstarter are among the biggest in the UK. Some have specialities, such as Unbound, which is for funding books.

It can be confusing to decide which one – but it’s free to sign up to any of them and browse.

Normally the business will have a fund target and a timescale in which to raise it. If they hit that target, they receive the money – minus a fee of up to 7 per cent taken by the website, once all the charges are taken into account.

DONATION OR INVESTMENT?

Crowdfunding is about contributing to the success of a new idea. Many of the businesses on these websites aren’t making money yet and it may be a long time until they do. It’s useful to think of crowdfunding as falling into two camps: donation-based, and equity – where someone invests in return for a small holding in the business.

Many entrepreneurs seeking money to get their idea off the ground are explicit about the fact they can only offer a small reward or nothing in return. I helped fund a new sourdough bakery and a sewing school in my East London community. The latter gave me a cotton tote bag as thanks. The real reward was helping spur local ventures. It’s a fun pastime for people who want to see an interesting documentary get made or a quirky gadget come into existence. Crowdfunder and Indigogo are two rewards-focused crowdfunding websites

GET RICH QUICK?

With investment, or equity, crowdfunding, the hope is the business will get big enough to return profits to investors – and ideally it will turn out to be the next Asos or Google.

This is called an “exit” and generally happens when the company is bought by another or lists on the stock market. It’s still extremely rare.

The Camden Town Brewery blossomed through the trend for craft beer and was sold for around £85m to drinks giant AB InBev, owner of Budweiser, Stella Artois and Beck’s, last December. Another big exit was E-Car club, an electric car sharing scheme, which was acquired by Europcar, making money for the 63 investors who backed it in 2013.

These successes are outliers – and generally investors will have to be very patient, although it does depend on how far along the business is when it crowdfunds. Much of the investment world is focused around looking for the next big thing.

It’s worth remembering the smaller the investment, the smaller the potential return. The average investor in E-Car Club put in £1,500. Arguably, if you only have £10 to invest, you’d be better off saving your money or putting it towards more traditional investments first.

FAILURES

In the UK, 50 per cent of start-ups fail in the first five years according to insurer RSA. Crowdfunded ones are no exception. This is despite the fact a funding campaign can effectively act as a marketing tool. The businesses vary massively from those with products and stores up and running to ones which remain just ideas. Calibre of the entrepreneurs varies too – Wool and the Gang’s chief executive had 20 years experience and had worked at Yahoo and eBay.

There have been some high profile failures too – and investors’ cash has gone down with them. Mini drone company Zano was Europe’s most successful crowdfund on the Kickstarter platform, but it went bust last November. Over £2m raised from 12,000 investors went down with it.

The UK’s biggest failure was in February. Rebus, a claims management company, raised over £800,000 from 100 investors on Crowdcube. One investor handed over £135,000, and the company has since been accused of misleading practices.

It’s undoubtedly a risky way to invest. Your cash is locked up – unlike putting money into an investment fund or buying shares on the stock market, you can’t get it out again.

Most crowdfunding investments aren’t covered by the UK’s Financial Services Compensation Scheme, which reimburses people when their investment fails.

OTHER WAYS TO INVEST

While crowdfunding has exploded like a mushroom cloud, traditional venture capitalists are still investing in small businesses their way. “This type of direct investing into unquoted, illiquid companies can carry a very high degree of risk and there are other ways to access unquoted, smaller companies with very generous tax advantages available,” says Jason Hollands of Tilney Bestinvest.

People with larger sums to invest (thousands, rather than hundreds of pounds) can look at enterprise investment schemes or venture capital trusts, both of which offer tax breaks in return for investing in small UK companies. Investment clubs are also undergoing a revival in popularity.