The concept of raising cash by asking lots of people to stump up small amounts is often thought of as a vanity funding mechanism: publish your book, record your music, enlarge your breasts (yes, really). However, as banks have become more wary about lending money to businesses, so the appetite to raise funds via other means has meant an increased demand for crowdfunded finance.
Whether it’s a startup needing capital or an established company with a new product to finance, crowdfunding might be the answer.
Does crowdfunding actually work, though?
Crowdcube, one of the best-known busines-level crowdfunding sites in the UK, had funded more than 350 businesses by the end of 2015. On average, 245,000 investors spend £2,000 each (for a total of £138 million), with each campaign funded in an average 40 days. Crowdcube has a success rate of 55%, so it doesn’t work for everyone.
Why might it not work for my business?
The main reason would be that your business or product doesn’t inspire people to invest – or it could be you. Crowdfunding relies on your pitch standing out, for the business to have an interesting story that will catch the eye and, of course, the rewards you offer.
Rewards? Do you mean shares in my business?
You can go down the Dragons’ Den route to crowdfunding, offering equity in your business in return for investment, but this isn’t necessary. Many crowdfunded projects operate on a rewards basis whereby investors are enticed by offers of free products, benefits or services. These can vary from “thank-you tweets” (boring) to free product or event invites (better) or limited edition “backer merchandise” such as T-shirts (surprisingly effective). The more creative and unique the reward, the better.
READ ALSO: 10 steps to creating a successful Kickstarter crowdfunding campaign
One of these people could be a potential investor
So, what are the downsides to crowdfunding?
Sometimes, despite solid research and a great pitch backed by rewards, a crowdfunding target isn’t hit. If you’ve opted to raise money using the fixed funding approach, you’ll receive nothing – even if you miss a £25,000 target by only £25. According to crowdfunder.co.uk, the average pledge for such all-or-nothing projects is £50, compared to £11 for schemes where you keep whatever is pledged regardless of targets. Potential investors are happier to risk more if they know there will be no investment at all should the funding requirement not be met. Keep your money target and timescale realistic.
How can I minimise the risk of failure?
Most potential investors look for reassurance that others like your idea. Some will invest only once they see others are already pledging. Use whatever means you have at your disposal – such as social media, existing business contacts, even friends and family – to get the funding started. You have to work on promoting your pitch, but the initial seeders of a fund act as promoters. That said, unless you have a high risk tolerance, crowdfunding probably isn’t for you…
What will this cost me?
The average cost of using a crowdfunding service is 5% of the amount raised – so budget a cost of £5 (plus VAT) for every £100 raised. There will also be a fee deducted by the payment service being used to collect pledges, such as PayPal. This could be as high as 3.5%, plus 20p per pledge.
What about the tax implications?
Crowdfunded backing is taxable at the date on which you receive the funds, rather than when the pledges were made. You can offset the cost (as a deductible expense against corporation or income tax) of any rewards offered in exchange for pledges. If your business is registered for VAT, then VAT as normal applies to pledges. This means that a £120 pledge should be treated as £100 of funding plus £20 in VAT for HMRC.
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