Can you make money with crowdfunding?

3 March 2014

Equity crowdfunding companies are growing in number falling over each other to market their business to private investors like you. If you've not heard of them, these firms give individual the chance to invest in small, growing companies (in the same way the stars of Dragon's Den),  but you have to consider the many risk warnings if you go ahead.

Lending to start-ups is not without risk, but if you are comfortable with the concept, crowdfunding offers investors an easy way to become 'business angels' and offers a viable alternative to traditional high street banking products or stockmarket investing.

Equity crowdfunding and many peer-to-peer lending firms match businesses looking for investment with investors looking to make a decent return. So they benefit both parties: the small business community and private investors.

Crowdfunding for businesses

Alternatively if your business has struck out when applying for a bank loan you could pitch for investment through this alternative finance community, which is stepping up to help small companies.

The UK alternative finance market – which includes crowdfunding sites such as Crowdcube, and peer-to-peer (p2p) lenders such as Funding Circle – provided £463 million worth of early-stage, growth and working capital to more than 5,000 start-ups and small and medium-sized enterprises (SMEs) between 2011 and 2013.

According to enterprise charity Nesta, between 2012 and 2013, equity-based crowdfunding – where investors take shares in a company in return for their investment – alone grew by an astonishing 618%, while p2p lending grew by 211%.

Over the same time period, the Bank of England reported bank lending to SMEs fell from £251.2 billion in 2012 to £225.5 billion in 2013 - that's a reduction of more than 10% at a time when the government was pumping cheap money to the banks to encourage them to lend.

However, this year, Nesta predicts the UK alternative finance market will grow to £1.6 billion and provide £840 million worth of business finance for start-ups and SMEs. And while this is still just a tiny fraction of what the banks do lend – when they're in the mood – it's well worth considering pitching for your business's share of the money.

So what are the funding/lending options available?

The two most popular sources of alternative finance are equity-based crowdfunding and peer-to-peer lending.

Equity-based crowdfunding is a way of raising money for your business whereby rather than pay interest on a loan, investors are rewarded with a share of the company.
It is often used by start-up companies which need money to grow, but do not have the track record of revenue generation which is usually crucial to secure traditional funding.

Crowdfunding websites marry up the companies in need of funding, with investors looking for places to put their money to work. The businesses have to submit financial information and business plans to the sites to be verified and then use video pitches to present themselves to investors and explain what they intend to do with their money.

The 'crowd' bit comes in by attracting lots of investors who invest smaller amounts of money – from as little as £10 - into a person, company, product or idea.

It is for this reason that p2p lending tends to be used by more established companies who don't want to give away a chunk of their enterprise. Instead, they are happy to repay money lent to them and pay an affordable level of interest.

Similarly to crowdfunding, the money comes from lots of different people but the more who come forward to lend, the lower the interest rate the company can secure.

Repayment charges also vary by lender and loan amount. With p2p site Funding Circle, the average loan size is £60,000 and the fee payable depends on what risk category the company finds itself in after its financial information has been assessed by the site. The most robust are given a rating of A+, while the most risky the site is happy to help are given a C. Repayment rates vary from 6% a year for A+ companies to 13% for the C category.

And the average rate of interest an investor whose money is pooled across 100 businesses makes is currently 6%, according to Funding Circle. This compares to around 2% on market-leading savings with high street banks and building societies.

Companies pay a one-off fee of between 2% and 5% to access the funding, depending on how much they borrow. And investors pay 1% of the amount they lend each year.

Crowdcube charges businesses a success fee of 5% of the investment they secure, plus legal and admin fees that amounts to £1,750. Investors don't pay any fees.
What kind of companies could you lend to?

The answer to this is… all kinds of companies. For example, LawBite, a small company that helps to simplify legal jargon for other small firms successfully secured £400,000 of funding from Crowdcube last May, and another £120,000 in January.

And e-Go, the first aeroplane to have been designed and manufactured completely in the UK since 1969, raised more than £500,000 through crowdfunding platform SyndicateRoom in less than a month. Its lightweight aircraft will shortly go on sale in the UK and US at a cost of around £50,000.

Saber Powersports - Europe's largest 'power boat experience company' – secured a p2p loan of £25,000 through Funding Circle to buy an engine for a new boat.

What are the secrets to a successful pitch?

If you'd rather borrow than lend you need to think about your pitch.

"Your pitch should be compelling and comprehensively cover your idea, the market opportunity and the team that's going to deliver success," says Luke Lang, co-founder of Crowdcube – which facilitated £12.2 million of investment in small companies in 2013, or £2,355 every hour.

Alan Moore, head of strategic marketing at LawBite, adds: "We perfected our pitch by blending a powerful story with good financials. It also helped that our founder, Clive Rich, is great in front of the camera, which made our video compelling to watch."

But nailing your financial credentials is really the key. Jude Cook, the chief executive of new crowdfunding site ShareIn - exclusively for British technology and health companies – adds that it's absolutely crucial to include a sensible valuation, whether you're going for crowdfunding or a p2p loan.

"Valuations based on a multiple of projected cash flows/revenues at some point in the future are all very well but if your company is very early stage they are a fiction," she says.

Instead, there are two sensible starting points for a valuation. "Firstly, how much would it cost to replicate your company and, secondly, how much have you spent in money and your time," she explains.

Don't use too much jargon, either. "Don't presume people know anything about your industry. Using jargon doesn't make it sound technical, it turns people off," she says. "Be clear what problem your company solves, your market, your competition, your team and how you will make money."

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