What is equity-based crowdfunding?

The Momentum UK Team 19 December 2013

You may have heard of an investment option called equity based crowdfunding - but is it for you?

Equity based crowdfunding is a relatively new method of investing that has become increasingly popular in recent years. It works in a similar way to crowdfunding platforms like Kickstarter, where individuals and organisations appeal for public funding for their idea or project. Instead of the rewards offered by standard crowdfunding platforms, equity based crowdfunding offers investors the chance to fund a startup business in return for a share in the company.

How does it work?

Investors can use a website known as a crowdfunding platform, where you can browse companies and choose where to invest. You can then invest directly through the platform - usually as much or as little as you want, and often with low (or no) fees. Some platforms allow you to read business plans produced by different companies, to give you more detailed information before you invest.

Investors will receive shares in the company, allowing them to potentially benefit from profit made by the business. It is important to remember that you could lose some or all of what you put in, and there is always a risk that the company could go bust - taking your money with it.

What are the potential benefits?

One of the main things that often draws people to equity crowdfunding is the sense of community it brings. The world of investing can seem like a cold and uninvolved process at times, and feeling like part of a community, helping to fund a startup you believe in, can be rewarding - both for the business and the investor.

Many investors also enjoy having the freedom to choose exactly what they invest in, allowing them to support ideas and businesses that they’re enthusiastic about - without paying for the services of an adviser or broker.

Sounds great, but what are the potential drawbacks?

Since equity crowdfunding is relatively new, it is hard to know exactly what will happen if something goes wrong. There are concerns over the lack of regulation, with only two platforms (Seedrs and Crowdcube) having applied to be regulated by the Financial Conduct Authority (FCA). The regulator has suggested that inexperienced investors should only be allowed to invest up to 10% of their total portfolio through crowdfunding, but there are worries that this will be too limiting and make the concept of crowdfunding redundant.

A major concern is that not all investors will fully understand the risks of investing in this way, with many not taking any advice. If a company goes bust, there is no guarantee that you will get any of your money back - in fact it is extremely unlikely. Startups are generally considered to be higher risk than well established companies, and some commentators have suggested that, as crowdfunded companies begin to go bust (as some inevitably will), it will be harder to attract investors to crowdfunding platforms in the first place.

Crowdfunding is relatively young, so if you’re unsure about whether you can accept the risk, it may be better to invest elsewhere - at least until it becomes properly regulated. However, if you only want to invest a small amount and can accept the risk, you could find that crowdfunding is an engaging new way to invest.