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Crowdfunding – an alternative way to fund your small business

It may be form a relatively small percentage of overall business lending today, but ‘crowdfunding’ is growing at a phenomenal rate. Here, we take a closer look at this innovative method to funding your small business idea.

What is Crowdfunding

What is crowdfunding?

As the name suggests, crowdfunding platforms enable groups of people to pool their resources to invest in new ideas – either for profit, or to help causes they believe in.

Since the credit crisis, this type of alternative funding has grown at a rapid rate. Kickstarter, a US-based platform raised $480m in 2013 alone, and UK-based Funding Circle raised £130m for new businesses in 2013.

Many small firms have been unable (or unwilling) to secure traditional bank lending, so securing funds from a collective of willing investors is an attractive alternative. Firms have the opportunity to raise money from like-minded individuals without having to wade through layers of red tape, and would-be investors have the chance to invest in what could be the ‘next big thing’ – for a profit, or otherwise.

Potential investors should be aware that they take on a risk when funding any type of new business – Kickstarter reports a ‘success rate’ of just under 44%, for example. If you’re a small business owner, on the other hand, this type of investment idea could be just what you’ve been looking for.

So, what types of ‘crowdfunding’ options are there?

There are a number of different types of investment available via hundreds of online crowdfunding platforms.

1. Debt – where a community of investors lend money to fund a new business idea. Otherwise known as peer-to-peer lending, loans are paid back over time, at a pre-agreed rate of interest.

2. Equity – where investors trade cash in exchange for a share in the business. Later in 2014, the FCA plans to make changes to its existing regulations to govern crowdfunding equity investments – which will protect all parties, and may set a maximum investment ceiling. Previously outlawed in the US, this type of investment has since been cleared by the SEC thanks to the Jumpstart Our Business Startups (JOBS) Act in early 2012.

3. Donation – where investors do not expect to receive anything in return. Often used to fund social or political movements, including charity work. An example of a donation model is JustGiving.

4. Reward – investors providing the funding for a new scheme or business in return for the promise of future ‘perks’. You may be the first to receive a prototype gadget, for example. US-based Kickstarter is the most well-known example – the site matches potential investors with projects as diverse as creating new comics, funding art exhibitions, and filming full-length movies.

Crowdfunding sites

The massive rise in interest in alternative funding since the recession has resulted in the creation of literally hundreds of crowdsourcing platforms. These sites typically take a fixed percentage cut of the total amount raised in return for listing the auctions, and oversee the entire process.

Some of the leading UK sites include:

Funding Circle – has just announced total lending has passed the £200m mark, with almost two-thirds raised in 2013 alone.

CrowdCube – lists over 55,000 potential investors, and has funded 85 businesses to date.

Seedrs – invest from £10 upwards, and now lists business ideas from across Europe too. Raised finance for new ‘Happy Days’ musical.

For general information, try the UK Crowd Funding Association, and NESTA’s new microsite here.