What is equity crowdfunding?
Equity crowdfunding enables privately-owned startups and early-stage companies to sell shares to non-professional investors as a means to generate investment funding and accelerate their growth. This is in contrast to other forms of crowdfunding, such as reward-based crowdfunding, in which backers receive non-financial rewards such as a product or service. Access to private equity investment opportunities was very limited before the arrival of equity crowdfunding, and it provides many more people than before with opportunities to support new companies and potentially benefit from their growth in value.
Benefits of equity crowdfunding for investors
Equity crowdfunding offers investors a range of benefits and opportunities.
1. Low entry barriers
In the UK, eligibility to invest involves registering with one or more of the crowdfunding platforms. It requires completing a self-assessment process to show adequate awareness of the financial risks. Once registered and qualified as eligible, investors can search the crowdfunding platforms they have registered with for investment opportunities.
Low entry barriers also include the amounts invested, which can be as little as £10. This enables investors who use equity crowdfunding to diversify their portfolio by backing a range of companies across different business sectors, and gain experience and confidence at no great cost. However, some may choose to restrict their investments to areas where they have some industry knowledge through their business career or perhaps leisure interests. They may feel this gives them better insight and an ability to make better decisions.
2. Added benefits beyond equity
Some investors may still choose a specific sector, such as brewing craft beer, for example. Many of these people are determined to take advantage of shareholder benefits such as discounts on any products bought, or opportunities to attend exclusive events. Buying products at a discount can be regarded as a way to offset risk: buy enough products and the savings will offset, or could even outweigh, the initial sum invested.
The diversification strategy of such investors is to simply invest in as many startups in the sector as possible. However, the Covid-lockdowns exposed the risk of such a single-sector approach related to the hospitality industry.
3. Risk versus reward
Investors can also choose to diversify by investing in businesses at different stages of their development. The highest returns usually go to the investors who back a startup at the earliest opportunity. They are taking the highest risk, particularly when they back startups that have not yet started to generate an income, and may not yet even have a provenly viable product or service. As an example, two years after it first raised cash through equity crowdfunding, the fintech startup Revolut saw its valuation soar from £42m to over £1.2b. The earliest investors enjoyed a return of 1,900%.
Returns of this scale make headlines, though are very uncommon. Investing in a startup company carries a high level of risk. 20% of new businesses fail in their first year and around 60% will go bust within their first three years. Yet as startups gain early market traction, and begin to build a positive reputation, the perceived risk of investing in them is lower. However, the cost of buying equity at the later stages of their development will most often be higher.
4. Impact investing
Some investors use equity crowdfunding to invest for less purely financially-focussed reasons. This can include investing in startups where they identify with a business’s aims, and recognise the benefits for wider communities of achieving them. Examples of such impact investing are sustainable energy producers, plant-based food and agritech innovators, waste reduction, and healthtech providers.
Other investors may choose to steer their investments towards local businesses, supporting job creation and economic growth. A few may even harbour ideas of somehow getting involved with local businesses they have shares in through offering their professional services, or perhaps joining a locally-based company as a share-holding employee.
5. International diversification
Under new EU regulations that cover crowdfunding in mainland Europe, and include the UK, startup businesses can use authorised crowdfunding platforms to offer investment opportunities to over 300 million people across the continent. Currently, the maximum raise amount is €5 million. Investors are thus able to more easily diversify through making investments in different countries.
6. UK Government encouragement
Investors who are UK taxpayers may be eligible for significant financial benefits. Investors in companies registered with HMRC under the Enterprise Investment Scheme or the Seed Enterprise Investment Scheme (EIS and SEIS) can reclaim up to 50% of the amounts they invest. If any of those companies provide a return on investment, it can be sheltered from Capital Gains Tax. When invested companies fail, the investors can reclaim more of the initial sums they put into them.
There are time constraints that apply to how long the shares must be held. The details of these schemes should be studied carefully to maximise any returns from equity crowdfunding investments. EIS and SEIS benefits are not carried over when shares in privately-owned businesses are bought and sold in secondary markets.
Disadvantages of equity crowdfunding for investors
Equity crowdfunding isn’t perfect. We have already said that investing in startup and early-stage companies is inherently risky, and many companies that raise funds through equity crowdfunding may not succeed. This means investors could lose all or part of their investment. There are some other matters that investors should be aware of. They will not all apply to every investment opportunity, and there may be ways to overcome or offset them. Here is some insight into what experienced investors know to look for.
1. Lack of liquidity
Once an investment is made through equity crowdfunding, it may be difficult or impossible to sell the shares. This has become less of an issue with the development of secondary markets, though not all businesses seeking investment through crowdfunding agree that their shares can be traded on secondary markets. It’s a detail to look for when making initial investments.
2. Limited information
The information provided to investors in an equity crowdfunding campaign may be limited, and the company may not be required to provide the same level of disclosure as a publicly traded company. If there is additional information you’d like to see to help you make an investment decision, use the crowdfunding platform’s Q&A forum. What you want to know may already be there is a previous answer, or ask for it directly from a startup founder.
3. Limited or no voting rights
Investors may not have voting rights in the company they invest in, so they will have no say in company decision-making. You can always check voting eligibility before investing.
4. Limited legal protection
The legal protections for investors in equity crowdfunding may be limited, and it may be difficult to take legal action if something goes wrong.
Is the crowdfunding platform you are considering investing through a member of any organisation with a Code of Conduct? Is it authorised by a financial regulator? UK equity crowdfunding platforms must be authorised to operate by the Financial Conduct Authority, and some are members of the UK Crowdfunding Association.
The regulatory environment for equity crowdfunding is still evolving, and investors should be aware of the legal and regulatory requirements that apply to any particular campaign, platform, or country they are considering investing in or through. There could also be future changes to the regulations covering specific business sectors that will impact on company business plans. There are reasons to hold a diverse investment portfolio.
In closing, remember that there is no such thing as a guarantee of success. Even if a company successfully raises funds through equity crowdfunding, there is no guarantee that the company will be successful or that the investment will generate a return. It pays to check as much information as you can, and to be confident in any crowdfunding platform’s due diligence process.
CrowdInvest will be a cross-border equity crowdfunding platform offering UK-based sophisticated investors opportunities to invest in impact-driven, high-growth tech startups operating in emerging economies. You can join the waitlist today at https://www.crowdinvest.com/ to stay up to date with developments on how to be involved.