Increasing numbers of investors are attracted to crowdfunding to generate a higher return from their cash than banks and ISAs are offering.
Crowdfunding is also popular with small businesses and entrepreneurs because the money they raise is an equity stake rather than debt that must be covered from their start-up cash flows.
But before deciding if crowdfunding is the best option, investors should consider the pitfalls as well as the risks.
According to industry statistics, crowdfunding saw an 11% improvement in the first three months of 2017 compared with the same time last year.
But finding independent information about the sector is hard – most guidance is published by crowdfunding platforms and trade bodies that have a vested interest in encouraging investors to stake their cash.
How crowdfunding works
The first place to look for guidance is the European Commission’s guide to crowdfunding for small businesses.
Although the advice is skewed towards entrepreneurs seeking funding, the guide gives an overview of how crowdfunding works across all the major European markets.
Crowdfunding comes in three flavours for investors:
- Equity crowdfunding – Taking a stake in a business in return for shares. The aim is to see the company succeed and to reap a profit from the increased value of the shareholding
Look at Seedrs for more information
- Peer-to-Peer or P2P lending – In P2P, investors group small sums of money together into a larger sum and lend the money to a business which repays the loan at an agreed interest rate
- Rewards-based crowdfunding – Not generally of much interest to serious investors, reward crowdfunding offers discounts, web mentions and free gifts in return for donations
Where to find crowdfunding deals
Business charity Nesta has a database of UK crowdfunding platforms with details about finance costs, returns and sectors.
The data is on a searchable web site called CrowdingIn
Although the returns from crowdfunding can beat most of what is offered elsewhere, remember the risk of losing money is high and disposing of unwanted shares or debts before the transaction term has ended is not easy.
Crowdfunding is not protected by the Financial Services Compensation Scheme (FSCS) and the only recourse when a deal goes wrong is likely to be through the courts.