A Beginners Guide to Crowdfunding

Raising finance for a business idea has traditionally been done through banks in the form of loans, or borrowing money from family and friends. However, there are multiple options available when it comes to raising business finance, one of which is called crowdfunding. In this article, we will explain what crowdfunding actual is, how it works and the potential benefits that it can have for both businesses and investors.

What is crowdfunding?

Crowdfunding serves as an alternative way for business owners and individuals to raise finances for their company or project. Crowdfunding allows the applicant to attract the interest of a ‘crowd' of potential investors who will show an interest in an idea or in some cases, take a small stake in the business proposal in exchange for contributing towards a funding target online.

Crowdfunding means that many entrepreneurs are able to execute their ideas more easily as they are not limited by the need to find a sole investor. What is more, those who are willing to finance such projects can do so with less investment and more manageable figures, allowing them to add to their potential investment portfolio while enjoying a varied range of interests and minimising the risks or large investments in one unproven idea.

What is the cost of Crowdfunding?

Most crowdfunding sites do not charge entrepreneurs and business owners to list their idea, although the majority will take a percentage commission upon the investment target being met. Typically, there will be a charge of 5% commission, and so this should be considered when targets are calculated. The majority of platforms will not charge at all if the funding target is not met.

In some instances, investors may be offered a small stake in the business, though many crowdfunding projects repay the support of an investor through staggered rewards such as first refusal on products, discounts on the idea once it materialises or recognition in marketing and branding.

The Benefits of Crowdfunding

Crowdfunding offers businesses and individuals a host of advantages, such as:

Sourcing finance cheaply and in a fun way as opposed to seeking expensive loans or submitting business proposals to individual investors in the hope that one will commit.

Achieving an excellent support network for an idea or business plan. Many investors from Crowdfunding projects show a significant interest in the ideas that they support and help to encourage its start-up, popularity and success by promoting it and communicating it throughout various channels, such as social media for example.

Some Crowdfunding investors will offer direct support to those that they invest in. This may be through business knowledge, manufacturing support and legal advice and this can significantly reduce overheads as well as give entrepreneurs access to established and experienced minds.

Crowdfunding can also act as an excellent marketing and promotional tool in itself. A well-written pitch can serve to encourage interest from potential customers as well as investors, and by reaching such a large audience from the start-up of an idea, the entrepreneur is able to gain significant interest from the outset. What is more, business connections can be cemented successfully in this way too, with potential suppliers, manufacturers, distributors and marketing professionals being afforded the opportunity to watch, support and include themselves in a new business idea.

Crowdfunding can be a much quicker way for an entrepreneur to reach their financial targets when compared to raising capital through single investors or loan providers. Some projects reach their targets in a matter of days, and this can be done with the start-up creator not even having to leave their home meaning that time, costs and inconvenience are minimised.

The government offers tax relief under the Enterprise Investment Scheme. This means that anyone who invests between £500 and £1m into a qualifying business idea is given the additional incentive of eligibility for income tax relief. This is worth 30% of the invested amount.

As a further incentive, through the Seed Enterprise Investment Scheme, investors who pledge between £500 and £100,000 into a qualifying business idea will be eligible to receive 50% relief.

How to decide if Crowdfunding is right for your business?

Crowdfunding is most likely to be suited to start-up projects that benefit from a story or have a creative or unique history. Whether this is related to the entrepreneur's personal life, their passion or the reason for them beginning their business idea, projects that capture the interest, empathy or excitement of investors are those that are most likely to do well from Crowdfunding.

It is therefore important to write an impressive, imaginative and captivating pitch in order for investors to be enthused by the idea. Those who have a mundane or unoriginal pitch are far less likely to do well from Crowdfunding.

Can a business idea be copied from a Crowdfunding site?

There is a potential risk that copyrights could be infringed when using a Crowdfunding site to communicate a business idea. That said, the risks of copyright infringement should not be any higher through using this type of platform than they would be in the startup of a business that opted for alternative investment sourcing methods.

In some ways, Crowdfunding sites can serve to protect the originality of an idea in that if the business model is unique, it is more likely to gain recognition and support for being the first of its kind and as such, it is less likely to be successfully copied.

What happens when a Crowdfunding target is reached?

Once the Crowdfunding investment target is reached, the investors will be afforded a ‘cooling-off' period as is offered with the majority of other types of business deal. This allows the investor to review their support and commit to their pledge. Those who cannot commit will be given the option to withdraw.

The crowdfunding site will then have a legal team review and formalise the investments, and the funds will be transferred to the applicant. Investor contact details will be provided so that updates and communications regarding the project can be provided and the investors may be provided with a certificate to confirm their shareholding.