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What is equity crowdfunding? A guide for first time investors
Equity crowdfunding, put simply, is an online version of Dragons’ Den
where you (and tens, hundreds, and thousands of other people) get to be "dragons".
Traditionally, investing in start up businesses was reserved for high net worth individuals and experienced, professional, or institutional investors.
However, the introduction of the Digital Age, along with all of the technological and online capabilities that brings with it, means that anyone can get involved.
Here, we’ll be answering the question, “what is equity crowdfunding?”
Online platforms, such as GrowthFunders, enable new online angel – or “crowd” – investors to invest into a businesses with high growth potential from as little as £10 (GrowthFunders is £100).
Investing means that you are purchasing shares in the start up business, thereby becoming a shareholder. (Some platforms allow businesses to offer “A” and “B” shares, whilst others operate a nominee structure).
Each individual will have different reasons for wanting to invest – to support a friend or family’s business venture, to support the next generation of great British businesses and their entrepreneurially-minded owners, or to generate some returns.
Equity crowdfunding platforms serve to formalise the process, thereby ensuring that your rights as the investor are protected and you won’t be “swallowed up” by larger investors.
Usually, you will have to become a member of the platform in order to view all of the supporting documentation of the investment opportunity you are interested in, which should include a business plan, financial forecasts, and company details, amongst other things.
Signing up and becoming a member on the majority of platforms is free. Also, the sign up process will be slightly different, depending on the platform you choose. However, the common element ensures that you understand the potential risks and rewards of investing into unlisted (start up and early stage businesses).
This is because equity crowdfunding is a regulated activity. The Financial Conduct Authority (FCA) is responsible for enforcing guidelines which ensure that platforms are transparent, trustworthy, and are operating within their permissions.
The early stage investment marketplace is one of the best performing asset classes, if you do it “properly”. Investing in start up businesses can be a risk, and you must be aware that you could lose the money you put in. However, there are ways in which you can mitigate your investments. For example, it is recommended that you:
- invest in start up businesses as part of a bigger diversified investment portfolio,
- take advantage of tax efficient investment opportunities. The UK government has introduced a number of tax breaks, including the Seed Enterprise Investment Scheme (SEIS) and the Enterprise Investment Scheme (EIS),
- carry out due diligence on the team behind the start up business. (NESTA, as mentioned below, recommends a minimum of 20 hours due diligence).
The above points were backed up in a report conducted by Robert E. Wiltbank, Ph.D. (Associate Professor of Strategy & Entrepreneurship at Willamette University, Oregon, USA) in conjunction with NESTA and the British Business Angel Association, entitled “Siding with the Angels”.
The report also highlights other ways in which to mitigate risk and get the best out of your investments, such as the finding that “those who invested in opportunities where they have specific industry expertise failed significantly less” than those who invested in sectors they had limited knowledge of. And finally, the findings suggest that the “holding period [for shares in a start up business] of just under four years, this is approximately a 22 percent gross Internal Rate of Return (IRR).”
Recently, NESTA published a new report in which findings from a survey they conducted in partnership with the University of Cambridge were analysed. This study looked at the Alternative Finance sector as a whole, which is growing at a fantastic rate as well as focussing more closely on the benefits of equity crowdfunding. Please click here to read our summary and download the report in full.
With technology opening up the opportunity to invest in businesses anywhere from pre-seed to start up and early stage to established, you could now possibly find yourself investing in the next Facebook or Google. Hold on to both your shares and your hat as the business goes on its growth journey.