Crowdfunding your business

15th August 2012

Crowdfunding harnesses the power of the internet to enable a large group of people to contribute money to support a business, individual or campaign. Investors hope for higher returns on their money than they might earn on a bank savings account or traditional investment, while businesses gain easier access to funding.

Crowdfunding dashes ahead

The market may still be small compared to the behemoths of the banking world, but it is expanding rapidly as different niche players accelerate off the starting blocks.

There are more than 450 crowdfunding platforms worldwide, as reported by The Economist, with American website Kickstarter as the largest. A total of $2.8 billion will be raised globally this year, according to calculations by research firm Massolution, up from $1.5 billion in 2011.

Here in the UK, the acceleration in crowdfunding prompted the Financial Services Authority to warn this week that it is only suitable for sophisticated investors who can grasp the potential risks, as highlighted by Mindful Money. Investors should be wary that their money could go up in smoke, rather than fuelling extensive returns.

Whether you are looking to back the next big thing, or merely untangle crowdfunding from peer-to-peer lending, Mindful Money highlights some of the websites to watch.

Backing businesses

Bank to the Future is the latest launch to connect businesses with investors, hoping to generate returns for both sides while bypassing the mainstream banking industry, as reported by The Daily Telegraph.

Founded by former investment banker Simon Dixon, Bank to the Future allows businesses to raise different types of finance in one place, whether debt, equity, or donations from consumers.

Mr Dixon said: "You can borrow, raise equity and offer rewards. The idea is to combine launching a business with raising finance and marketing all at the same time…We want to fund people through the whole cycle from idea to established business."

Bank to the Future therefore allows companies to raise money to validate their idea, before offering shares and eventually borrowing from the crowd, once a decent credit rating has been established.

The concept has caught the eye of Sir Richard Branson, making the shortlist for his "Screw Business as Usual" competition to seek out innovative business models.

Elsewhere Funding Circle and Crowdcube stick to providing loans to businesses.

Funding Circle describes itself as "an online marketplace to help businesses find fast finance and investors get better returns". 

Founded in 2010, Funding Circle allows businesses to borrow between £5,000 and £25,000 for up to five years, and has so far loaned £30m to 703 businesses. Investors may be tempted by the prospect of average gross yields of 8.3% on money loaned via the website. In terms of risks, Funding Circle calculates that bad debts come to 0.9% on average, compared to estimated lifetime bad debts of 3.1% overall.

Funding Circle itself has attracted investment from some heavy hitters, including Union Square Ventures, which backed Twitter and online games company Zynga, and Index Ventures, a fund which has invested in internet start-ups including Skype and online retailer Asos, as reported by The Sunday Times.

Crowdcube was also founded in 2010, and also allows entrepreneurs to access money from multiple small investors, while the investors hope to reap returns if the start-ups succeed. Crowdcube puts applications through a due diligence process. The remaining companies make their pitch online, and investors can pledge amounts from £10 upwards towards their funding target.

Keeping it personal

Zopa and Ratesetter facilitate loans to individuals, rather than businesses, matching up people with money to spare with those who want to borrow.

Zopa was established back in 2005, and has so far enabled 40,000 people to lend £220 million to 43,000 borrowers. Zopa selects potential borrowers based on their credit score, and then allows savers to lend as little as £10, and choose how much risk they want to take with their money. The lower the perceived risk, the lower the interest earned, but equally the lower the risk of the borrower defaulting.

Larger sums of money are spread in £10 chunks between multiple borrowers, to minimise the likelihood of losing the lot. According to Zopa, lenders earn 5.5% a year on average, even after deducting the 1% paid to Zopa and allowing for a 0.5% default rate.

Ratesetter follows a similar model of allowing individual borrowers to access money from individual lenders, with the addition of a Provision Fund to shield savers from bad debt.

Running the risk

As the Financial Services Authority is so keen to point out, anyone investing in a peer-to-peer website won't be covered by the Financial Services Compensation Scheme which would pay out if a bank went bust. Investing in a new untried business is always risky, as the majority of startup businesses fail.

 

More on Mindful Money:

Crowdfunding for dummies

Cutting out the banks

Should Spain go to Zopa?

The rise of peer to peer lending

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