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.

Unlikely returns

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."

Equity 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."

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Your Comments

Thanks for mentioning my Kickstarter project. A point that is erroneous or rather misleading in your article, or rather one main point is this:
'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.'
Kickstarter collects the funds on behalf of the creator, the money does not leave the bank account unless:
i) The Kickstarter hits it target
ii) There is sufficent funds in the account
At that point the money that is collected sits with Kickstarter for 2 weeks and then given to the artist. It is then the responsibility of the artist to complete and deliver the work.
What I find somewhat of a let down is that all my money was collected after 5 days of the Kickstarter ending, yet I am still waiting the full amount to be transferred meaning Kickstarter are earning interest on the money pledged, as well as an estimated 10% of the total obtained. For my project it's not much but if you take into consideration the amount of money received over 12 months then Kickstarter must be making a small fortune in interest.
Something worth investigating? Incidentally I received 111% of my target and completed the project with 11 days to go. The books will be delivered first week of December and off the back of the Kickstarter I've signed a licensing deal with a tea producing company in Canada to dual brand and develop our own Anteater blend.
Another point would it be possible that you can add links to my site to help promote my project as I stumbled across this article doinga  Google search.
My website for The Anteater That Didn't is
Where you can still pre-order the book :) Also the link to the Kickstarter
My personal artist's website is Greg Allum :
And if anyone if interested in getting in contact then please pass on my email

Funding Circle intermediarises Loans at Interest but
has no Equity Crowdfunding side