Crowdfunding can be a win-win for savers and borrowers
When Tristan Mackay began busking in Leeds six years ago, he didn't dare dream that one day he would release a best-selling blues album on iTunes. Six years later, Mackay has amassed a huge fan base that is actually paying him to record his follow-up album.
Mackay is using crowdfunding to record Wire and Wood, asking his own fans to raise money to help. By the time his funding offer closed he had managed to raise £12,203 from 243 backers. "It removed the middle man from the whole structure and brought me closer to the people who have helped make my album," he says.
Crowdfunding is a way of raising finance by asking a large number of people each for a small amount of money - and it's really taking off. According to Nesta, $1.5 billion (£926 million) was raised through crowdfunding for projects and businesses in need of funds in 2011, while the UK Crowdfunding Association says one project alone generated funding of $1 million (£618,000) last year.
The umbrella term covers three distinct areas: donation/reward, debt and equity. Some offer financial returns to savers and investors, while others merely offer creative rewards. Here's our guide:
The donation/reward sector is strictly for the creative and charitable community, where people invest their cash simply because they believe in the cause or endeavour. Leaders in this sector include Buzzbnk, Kickstarter and IndieGoGo.
If you invest your money in this type of project, you do so in the knowledge that you are unlikely to get any financial return on your cash. You will, however, see your chosen project come to fruition and this could mean you have helped fund anything from a water project in the developing world to a new album, book or piece of art being created.
People list a wide variety of projects on Kickstarter and IndieGoGo, from films, games, and music to art, design and technology. A Kickstarter spokesperson says: "A lot of backers are rallying around their friends' projects. Some are supporting people they've long admired. Others are inspired by a project's rewards -a limited edition or a custom experience related to the project."
As an example, in Brighton, Greg Allum and Quirky Joe were asking for £3,000 to create an illustrated children's book The Anteater That Didn't. At the time of writing, it was 84% funded. If it reaches 100% funding, backers will receive anything from a PDF copy of the book (for a £10 donation) to appearing as a drawn character in the book along with their name in the Thank You section (for a £250 donation).
At Kickstarter, if it goes wrong - for example, the creator fails to complete their piece of art - it's the legal responsibility of the creator to return funders' cash to them, and not Kickstarter's. However, it is likely that backers would have to take someone to court.
Peer to peer lending
Also called social lending or peer-to-peer (p2p) lending, the debt sector is an antidote to the stuffy world of high street banking. By cutting out all the expensive infrastructure that the likes of Barclays and HSBC have to deal with - a huge network of branches, thousands of staff, massive administration teams, etc - internet-based social lenders are able to operate quickly and cheaply.
They pair savers with borrowers, acting like middle-men in that they offer a place for the two groups to come together and agree lending arrangements.
This means savers are in effect ‘lenders', lending their own money (in the shape of a deposit) to those who wish to borrow; and getting a return on their money from the loan rate charged to borrowers (this loan rate is cheaper than the rate offered to borrowers by high street banks and building societies - otherwise borrowers would have no need to visit a p2p lender in the first place).
Leaders in the field include Zopa and RateSetter, which specialise in personal loans to individuals. Borrowers are the same type of people who take out bank loans - for example, since Zopa's launch in 2005, 45% of its borrowers wanted a loan to purchase a car, 21% to carry out home improvements and 2% to cover wedding costs.
RateSetter rules are typical: people can borrow between £1,000 and £25,000 for between one and five years. But unlike at a traditional bank, borrowers can repay a loan early or in lump sums if they wish. With p2p lenders, generally the better your credit score, the better the interest rate at which you can borrow.
Anyone over the age of 18 can lend (that is, save) on RateSetter or Zopa and you can lend as little as £10. RateSetter says someone lending £10,000 via the RateSetter Monthly Access account would have earned 72% more in interest (£440) than someone saving via the NS&I One Year Bond over the same period.
While rates for lenders have fallen in the past three years, they remain well above a typical high street bank or building society. At RateSetter, for example, its one-year bond had a rate of 5% in February 2012, but this has fallen to a current 3.5%. However, that compares favourably with banks and building societies, where BM Savings has the current best-buy, paying just 2% on a one-year bond.
However, p2p lenders are far from risk-free. They are unregulated and therefore lenders' deposits are not protected by the Financial Services Compensation Scheme, which protects savers to the tune of £85,000 if their savings provider goes belly-up.
That said, the Financial Conduct Authority is to regulate the sector from April 2014 while Zopa and RateSetter have introduced their own protections. RateSetter, for example, operates a ‘Provision Fund' that spreads the lending risk across all borrowers and allows for a lender to be repaid if borrowers miss a payment. But it is by no means a guarantee.
Its chief executive, Rhydian Lewis, says: "We've never had a situation where a lender has lost money. It's never happened. Our Provision Fund has always kicked in."
However, Patrick Connolly, an IFA at Chase de Vere, says: "Crowdfunding or peer-to-peer lending is proving incredibly popular. But any investment that promises higher returns usually comes with greater risk and so it would be a mistake to directly compare bank and building society accounts with crowdfunding."
This is where people invest money in small business ventures, usually in return for an equity stake in the business or for a promised return when the business turns a profit - turning lenders into mini dragons à la Dragons' Den. Market-leading sites include Crowdcube, Funding Circle, Thin Cats and Seedrs.
Seedrs says investors can expect average returns far superior to UK shares, property or gilts; at Funding Circle (strictly speaking more of a business loans broker than an equity crowdfunder), investors have reaped an average net annual return (after fees and bad debts, but before tax) of 5.8%.
But equity crowdfunding is far higher risk than p2p lending as shares in any business can rise and fall in value, while small businesses and start-up firms are riskier still because so many go bust.
Given the age we live in, most companies looking for funding tend to be digital or mobile businesses, though not exclusively. At Crowdcube, for example, a drinks firm called Turtl UberSquash is asking for £50,000 in return for a 14% equity stake in the business.
Similarly, at Seedrs, successful funding was recently obtained by Hollywood financing group Glentham Capital, run by respected fund manager Nicola Horlick. She was asking for £150,000 in funding, in exchange for 10% of the company - and managed to raise the lot.
Darius McDermott of Chelsea Financial Services says: "These are definitely investment options for higher-risk and sophisticated investors. Investing in start-ups is risky business - they are illiquid investments and should only really be a small part of a wider, diversified portfolio. They also won't give any dividends.
"Having said that, if they are eligible for the SEIS (Seed Enterprise Investment Scheme), there are some great tax advantages and if they succeed you can make a lot of money."
A financial adviser who is not tied to any financial services company (such as a bank or insurance company) and is authorised by the Financial Services Authority (FSA). They can advise on financial products to suit your circumstances. All IFAs have to give consumers the choice of paying by fees or commission and have to explain which would best suit the customer in that particular instance. Also, if commission is paid either by the client or the financial service provider recommended by the IFA, the IFA must disclose what that commission is.
The name given to a certain type of financial transaction which takes place directly between individuals or “peers” without the use of a traditional financial institution such as a bank. Various social lending websites incorporate a number of strong risk controls, and screen all potential borrowers by checking their credit history. Lenders agree to lend a specific amount for a stated return and lenders’ cash is pooled between borrowers, spreading the risk. The major social lending companies are Zopa, RateSetter, Funding Circle, Quakle and Yes-Secure.
The familiar name given to securities issued by the British government and issued to raise money to bridge the gap between what the government spends and what it earns in tax revenue. Back in 1997, the entire stock of outstanding gilts was £275bn; by October 2010 it had surpassed £1,000bn. Gilts are issued throughout the year by the Debt Management Office and are essentially investment bonds backed by HM Treasury & Customs and considered a very safe investment because the British government has never defaulted on its debts and this security is reflected in the UK’s AAA-rating for its debt. Gilts work in a similar way to bonds and are another variant on fixed-income securities.
Enterprise Investment Scheme
A scheme set up to encourage investment into small, unquoted trading companies and give investors tax breaks to compensate for taking risk. Because the companies in the scheme are not listed on a stock exchange they often carry a high risk, so the tax relief is intended to offer some compensation. An EIS company cannot be a subsidiary, must trade wholly in the UK, can’t employ more than 50 people and certain activities (including forestry, farming and hotels) preclude companies from offering EIS relief.
Your credit score is a three-digit number (ranging from a low of 300 to a high of 850) calculated from the information in your credit report. Your credit score enables lenders to determine how much of a credit risk you are. Basically, a low credit score indicates you present a higher risk of defaulting on your debt obligations than someone with a high score. If you have a low credit score, any products you successfully apply for will carry a higher rate of interest commensurate with this risk.
This is a mutual organisation owned by its members and not by shareholders. These societies offer a range of financial services but have historically concentrated on taking deposits from savers and lending the money to borrowers as mortgages, hence the name. In the mid-1990s many societies “demutualised” and became banks. One academic study (Heffernan, 2003) found demutualised societies’ pricing on deposits and mortgages was more favourable to shareholders than to customers, with the remaining mutual building societies offering consistently better rates. In 1900, there were 2,286 building societies in the UK; in 2011, there are just 51.
An individual employed by an institution to manage an investment fund (unit trust, investment trust, pension fund or hedge fund) to meet pre-determined objectives (usually to generate capital growth or maximise income) in prescribed geographic areas or investment sectors (such as UK smaller companies, technology or commodities). The manager also carries the responsibility for general fund supervision, as well as monitoring the daily trading activity and also developing investment strategies to manage the risk profile of the fund.