What's crowdfunding? What are the risks?
For investors, crowdfunding websites offer the chance to make money by investing in small fast-growing businesses. For entrepreneurs, they can be a great way to raise a business’s profile - and cash. But, if you are tempted to get involved, be aware of the risks.
What is crowdfunding?
Crowdfunding sites enable small businesses to raise funds from investors, ‘the crowd’, who all invest small amounts in the business. It started as a way to fund creative projects such as films, theatre projects and music recordings. It now allows enterprises of all types to raise money from friends, family or complete strangers. In return, investors might get shares in the business, discounted goods or freebies. Crowdfunding platforms include Kickstarter, GoFundMe and Indiegogo.
There are several different types of crowdfunding:
- Loan-based crowdfunding: also known as peer-to-peer or peer-to-business lending. You lend money to an individual or business in exchange for a set interest rate.
- Investment-based crowdfunding: you invest in a company and get a stake in the business, often in shares.
- Reward-based crowdfunding: you get a reward linked to the project you’re investing in, in return for the money you’ve donated.
- Donation-based crowdfunding: you donate to a charity or individual.
Be aware that the only type of crowdfunding FSCS protects is equity-based (investing) platforms, if the Financial Conduct Authority (FCA) authorises them. Make sure you check this before you get involved.
What are the risks of crowdfunding?
The FCA has warned that it’s difficult for investors to understand the risks and returns of crowdfunding and that marketing material can be unclear and misleading.
The biggest risk is that the business you invest in goes bust and you lose all your money. Another possibility is the crowdfunding platform itself going bust, in which case you could lose the money you’ve put into the business if it hadn’t yet been invested. There is also no guarantee you’ll get the return on your money you were hoping for.
Can I withdraw crowdfunding money?
You can’t pull out your money when you want; once you’ve put money in it can be tied up for a long time. Crowdfunding is not a get-rich quick scheme. You will only get your money back, including any return on your investment, if the company floats on a stock exchange, is bought by a larger company or if the management buys back your shares.
What are the benefits of crowdfunding?
Crowdfunding enables a business to raise money and its profile. It is often easier than getting a loan from a bank or raising funds from specialist venture capital investors.
For investors, crowdfunding offers an opportunity to support a local cause or business and can offer higher returns than traditional investments.
The Enterprise Investment Scheme and the Seed Enterprise Investment Scheme offer tax breaks when you invest in small businesses. The schemes enable you to offset a percentage of the money you invest against your tax bill. Any profits you make are also tax free. You're required to meet certain conditions though, like keeping your investment for a minimum length of time.
Should I invest in crowdfunding?
Most crowdfunding sites require you to complete an appropriateness test confirming that you are ‘sophisticated or high-net-worth’ or will not invest more than 10 per cent of your investments in the scheme. Remember that FSCS protection for crowdfunding is limited.
If you do decide to go ahead, choose your website with care. Platforms that the FCA regulates offer investors a higher level of protection.
Make sure you spread your risk by investing in a variety of businesses. Even so, be prepared for some losses. If you can’t afford to lose money, then don’t invest in the first place.
See compensation limits for more traditional investment products on our dedicated page.