Peer-to-peer lending ›› INVESTING COMPLETE GUIDE TO CROWDFUNDING Pooling your resources with other investors ›BY CATHY ADAMS owadays, everything is about the power to back start-up companies can provide of the crowd – whether that’s booking holiday accommodation through stellar returns but it is a high-risk strategy Airbnb or finding out the latest news on Twitter. It’s tipped over into investment Ntoo, and now anyone can invest in a start-up venture through crowdfunding. Crowdfunding – also called democratic finance – works by pooling small amounts of money from multiple investors to invest in small businesses or projects on an online platform, usually in return for equity in the company or a perk. Given cash returns are languishing, it’s hugely popular: last year more than £1,700 was raised every hour, according to the UK Crowdfunding Association. WHAT IS CROWDFUNDING? Crowdfunding is exciting, can offer stellar returns and is growing rapidly but it also comes with a huge amount of risk. Innovation charity Nesta predicts the alternative finance industry will grow to £4.4 billion this year, according to its 2014 Alternative Finance report. There are four main types of crowdfunding options. Probably the most familiar is the rewards-based scheme – epitomised by the likes of Kickstarter – where contributions are swapped for future services or products. Perks can range from loyalty cards to free products – past ventures have given away anything from free coffee or T-shirts to having your name credited on a film. Donation-based giving does exactly what it says on the tin – it’s purely philanthropic, and all you’ll get is a warm, fuzzy feeling of giving to a venture you believe in. If you’re looking for a return from crowdfunding, then there are two main options: equity- and debt-based schemes. Equity-based schemes involve investing in small, unlisted businesses in return for a slice of future profits – as well as a possible perk as a sweetener. Current projects on platform Seedrs range from: investing in a French vineyard, in return for around 30% of shared equity and membership of an exclusive wine club; a company making steel bike frames in return for around 14% equity; and an online property portal for 5% of stock. An estimated £84 million was raised through equity crowdfunding last year, according to the Nesta report, with two-thirds of investors investing more than £1,000. The report also found that the average investor had a portfolio size of £5,414, spread across 2.48 ventures. Debt-based crowdfunding – also known as peer- to-peer lending – involves investors lending money MAY 2015 | MONEYWISE.CO.UK 67 INVESTING Peer-to-peer lending ›› “I am investing in renewable energy” David Molony, an equity analyst from Bromley, invested £250 in e2 Energy, a wind energy project in Yorkshire and South Teeside, through Trillion Fund, a crowdfunding platform for the renewable energy sector. “It feels like it makes more of a difference to help start-up Chilango raised money on the platform last year, paying companies or projects that are cooperative and community-based,” 8% a year plus free burritos – which offer investors a Molony says. “The global climate crisis galvanised me too, and I fixed rate of return over a set period, plus initial capital, wanted to get more targeted on renewable energy.” although the companies are unlisted and therefore He has just received his first credit from e2 Energy – £10.91 – after much riskier. around nine months, and as a perk for investing early, he receives an Meanwhile, Funding Circle and Lending Works are extra 0.25% a year. debt-based schemes, or peer-to-peer lenders, and are Molony has also invested in e5 Energy, another wind energy project, typically choosier about who raises money on their as well as some solar energy projects in Kent, and considers these platforms. Funding Circle recommends investors lend investments as half social responsibility and half a business decision. to at least 100 companies, so no more than 1% of your “You shouldn’t only think about financial returns,” Molony adds. “My capital is with any one business. Lending Works is very similar and will match investors with creditworthy intention is to spread investments across a hundred local projects.” businesses for a fixed return. The minimum investment varies from platform to platform but some start from as low as £5 – meaning to both individuals and businesses in return for a regular you can effectively spread your capital around many income. This crowdfunding sector is growing particularly crowdfunded projects at once. quickly, with £1.2 billion lent last year, according to the Peer-to-Peer Finance Association. Around 30% of people WHAT ARE THE RISKS? will lend between £1,000 and £5,000 to businesses in There’s no getting around the fact that crowdfunding is this way, with almost 23% lending between £20,000 and a risky investment route. The nature of investing in an £100,000, according to Nesta. unlisted start-up business means that many are likely to fail and even if they are successful, returns can take years HOW CAN YOU INVEST IN A CROWDFUNDED to realise. Jeff Lynn, chief executive of Seedrs, estimates PROJECT? that investors will wait on average between five and seven There are many online crowdfunding platforms, years to see a return from an early-stage business. catering to all kinds of schemes and projects. Lending to a company through a debt-based scheme Kickstarter and Indiegogo are pure donation- and is less risky, as many peer-to-peer lenders have a slush rewards-based platforms. Since Kickstarter’s launch in fund that kicks in if a company is unable to meet 2009, more than 83,000 projects have been successfully payments. Figures from the Peer-to-Peer Finance funded using the power of the crowd, with a total of Association estimate that the lifetime bad debt rate of more than $1.6 billion (£1 billion) donated. money lent through these platforms is 4.2%. CrowdCube and Seedrs are equity-based platforms, These debt-based platforms usually insist on offering investment in a start-up business in return for strict controls to ensure only the best businesses, or future equity. Schemes available on these platforms can individuals, are allowed to borrow. Some equity-based range from frozen yoghurt companies, through craft schemes will do this to some degree but many will breweries, to estate agencies. CrowdCube also offers leave the decision about whether or not it’s a sound mini-bonds as a crowdfunded investment – food chain investment completely down to the investor. Platforms 68 MONEYWISE.CO.UK | MAY 2015 investments and get as much information as possible Even if a start-up is successful, it before making a crowdfunding investment decision.” can be difficult to sell the shares WHAT ARE THE BENEFITS? Alongside blockbuster returns if the company is will make it clear that investing in start-up companies is successful, the promise of a free perk from the business incredibly high-risk, though – Seedrs says on its website you’re investing in is a huge benefit, especially if it’s that business failure is “more likely to happen than not”, something you use often. Equity-based platforms don’t for example. tend to offer regular perks – although when available It’s a “high-risk, high-return” asset class, according they can be anything from discounts on wine and beer to Seedrs’ Jeff Lynn. “You should only invest if you can to nursery equipment – while rewards-based platforms afford to lose the money invested but at the same time, such as Kickstarter offer perks instead of a financial you stand the chance of significantly outperforming return, and they can range from having an ice-cream other types of investments,” he says. “The key thing flavour named in your honour to having a song written to remember is diversification: you shouldn’t invest in for you to use. While they are clever incentives, treat it as just one or two businesses. You should look to build a a sweetener rather than a reason to invest. portfolio over time of 20 or more investments.” Plus, there are tax benefits. Equity-based One important point to note about equity crowdfunding is eligible to be included in a Seed crowdfunding is that as the industry is so young, it’s hard Enterprise Investment Scheme or an Enterprise to quantify default rates, losses and average returns. Investment Scheme, where investors can claim back While projects will usually detail the equity return, it’s 50% of their investment back in income tax relief. not an exact science, and Nesta notes in its report that A general rule of thumb is to never invest more than “most equity crowdfunding investors are yet to see what around 10% of your portfolio in crowdfunded ventures returns their investments can bring”. and stretch that across as many places as possible. There’s also a limited secondary market for these Patrick Connolly, a certified financial planner at businesses, and even if a business is successful, it can Chase de Vere, agrees: “For those who want to utilise be more difficult to sell the shares on if the company crowdfunding, for most people this should be only for is unlisted. And while debt- and equity-based a small part of their overall portfolio. Any investment crowdfunding platforms are regulated by the Financial that promises higher returns usually comes with greater Conduct Authority, neither are covered by the Financial risk and so it would be a mistake to directly compare Services Compensation Scheme, which would usually crowdfunding with bank and building society accounts.” pay out if a company goes bust.