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Obtaining finance through crowdfunding

Another day, another crowdfunding venture hits the headlines… The most recent one is David Attenborough’s campaign to raise £110,000 in order to help the critically endangered mountain gorillas in Africa.

Crowdfunding works well as a form of charitable fundraising, where no return on investment is required other than a sense of satisfaction at having supported a good cause. But crowdfunding is increasingly being used as a form of business finance, helping entrepreneurs to access finance that they might otherwise find difficult to obtain.

So what exactly is business crowdfunding?

A brief explanation

In very general terms, business crowdfunding occurs when a number of people pool their money together to invest in a particular privately held business – usually via a website. It allows startups and young businesses to obtain much-needed investment or lending, and investors to potentially obtain a higher rate of return than would be available from more traditional investments. It is, however, regarded as very high risk. The Financial Conduct Authority (FCA) warns:

“There is no guarantee investors will receive a return on funds contributed to a crowd fund. In fact, investors could lose all of their money, as the majority of startup businesses fail.”

 How does it work?

From the business point of view, a number of steps are involved:

  1. Applying to your chosen crowdfunding website – each platform carries out its own vetting process, and many proposals do not make it through this first stage.
  2. Pitching your proposal via the platform – you need to market your business idea and find a ‘crowd’ to sell it to
  3. Achieving your fundraising target – if you do not reach your minimum fundraising target then most platforms will return the funds invested to the investors. A time limit is set for reaching this target.
  4. Dealing with your investors – interaction with your investors will not end once you receive the funding. Lenders and shareholders have to be paid what they are due, and be kept informed in the meantime. There will be additional involvement if you have given your shareholders voting rights.

Crowdfunding is not something to go into lightly, either as an investor or as a startup seeking investment. It is essential that you take advice but, as a starting point for your discussion, here are a few basic points to consider:

 Are you looking for a loan or equity investment?

There are different types of crowdfunding, but the two that are most likely to apply to businesses are loan-based crowdfunding (peer-to-peer lending) and investment-based crowdfunding. Different rules apply to each.

Loan-based crowdfunding is seen as the less-risky type, and so there is less financial regulation involved. Nevertheless, the FCA is currently consulting on plans to tighten up the regulatory scheme. In particular, it will require that plans are in place to ensure loan repayments continue even if a crowd funding company collapses. A 14 day cooling off period will also be introduced to allow both borrower and lender to withdraw without penalty from the agreement if either changes their mind.

With regard to investment-based crowdfunding, the FCA is strengthening existing rules to ensure that they are only promoted to those who understand the inherent risks or have the financial capacity to cope with any losses.

Which platform should you go for?

There are a number of crowdfunding platforms around, and you should do your homework before deciding which one is right for you. Check out their charges and consider the amount of support they will give you in preparing and marketing your pitch. Also try to work out whether they specialise in any particular sector, and the type of investors they attract.

Marketing your proposal

Crowdfunding only works if you have a ‘crowd’ to sell to. It’s up to you to create your crowd and you cannot do this from a standing start. Social media is key here and you are more likely to be successful if you can leverage a large following to help you. So start building it well in advance of your crowd funding campaign.

You will also need to interact online with your potential investors, engaging them in your idea and keeping them informed throughout the process. Do it well, and they will sell your idea for you.

Is crowdfunding really right for you?

There are a number of things to think about here, including:

Will your proposal actually appeal to investors? If it is too complex or hard to explain, then it might be difficult to sell. It might be better to obtain funding elsewhere.

You will have to provide a lot of information to investors in order to persuade them to invest in you. If much of your information is ‘sensitive’, you might not want to make it public.

Is your business structured appropriately? For instance, if you are looking to offer shares in return for investment, you will need to be in a position to issue these before you launch your campaign. Again, get this sorted out in advance.

And finally, think about the future. If you are likely to need a lot of support from your investors, or maybe a further tranche of lending/investment, then you might be better off with a more traditional type of funding.

Obtaining finance is just one of the big issues facing small businesses every day. Find out how Rocket Lawyer UK business documents and Quick Guides can help you start up and run your business. If you would like to discuss funding or shares with a lawyer then we can easily connect you with a Rocket Lawyer On Call solicitor.

Mark Edwards

Vice President & General Manager UK at Rocket Lawyer
Mark has a decade of experience as an innovator and business leader in the UK legal industry, specialising in creating and growing new businesses based on sound market insight and customer need. As the General Manager of Rocket Lawyer UK, he is focused on growing the business which launched in November 2012.