12th December 2011
This website describes crowdfunding: "Businesses can use Crowdfunding to obtain lots of small sums of money (or micro-payments) which together enable them to fund their activity. The Crowdcube website allows 'ordinary people the chance to invest in British businesses in exchange for equity' from as little as £10. Businesses looking for investment need to record and upload an elevator pitch to the site which potential investors can then view to help them decide if they want a stake."
The Crowdcube website has been the trailblazer in the UK. Businesses give a brief description, plus updates. Potential investors can see how much money the group has already raised and it then offers them the means to invest.
The founder of Crowdcube Darren Westlake – interviewed here in the Telegraph – has spent three years and £100,000 in "friends and family" finance developing the site and believes it will "democratise investment": "Banks adopt a no-risk approach to lending, while business angels and venture capital funding are difficult to access. We are leveraging the potential of the crowd to pool small amounts of investment," he said. Mr Westlake claims the site is the world's first equity-based crowd funding site for small companies. The target investor is "anyone with a little bit of disposable income" and a typical investment would be around £50, he said. "We're aiming at the mass market. It is crowdfunding, and the bigger the crowd the better."
The idea originated in the US and Kickstarter is the leading website there.
There can be tax advantages to these schemes. A number of the businesses listed quality for tax relief under the Enterprise Investment Scheme. The reliefs available through the scheme are generous and can help mitigate an income tax bill.
It also plays into the post-credit crunch trend of investors taking matters into their own hands, disintermediating the banks and being generally mistrustful of financial authority. "The financial crisis that led to so many small-scale investors losing money had two relevant impacts. Firstly, it made clients far more cautious about the validity of financial advice and secondly, the losses incurred meant that for some, the price of financial advice no longer seemed a price worth paying.
"Where did those people turn? Well, it seems like a good chunk of them went online. More and more people are turning to social networks and online investment forums for financial advice and a recent report from Cisco reported that more than 50% of wealthy young investors rely on investor forums or social networks for financial decision making."
However, there are drawbacks to this type of investment. The protections for investors are not entirely clear, as community member IG points out on this discussion site:
"If a company invested in failed, a non-sophisticated investor could sue the directors personally to recover their money arguing that as a non-sophisticated investor they never should have been sold the equity in the first place. Whether they succeed or not depends very much on the nature of the legal grey areas which you're using, so not being open about it means that entrepreneurs could actually be exposing themselves to a huge personal risk without knowing about it."
He adds: "You need to be careful how you describe it to make sure you don't violate the Financial Services and Markets Act, you need to be very clear that you're not offering an investment opportunity but are rather looking for patronage."
These investments are, by their nature speculative. There is no past performance data and no protection for investors should they fail. The ownership structure can be a little murky.
However, investors may reason that they have lost a lot of money in fully regulated investments over the past few years and £50 lost here or there in a speculative investment won't hurt their overall portfolio. Of course, there's even a chance they might make some money, while supporting small businesses at the same time.
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