Investing can be a pain – but there are certain asset classes that genuinely bring the joy back into it.
One such asset class is venture capital. Here, you invest in early-stage startup businesses looking to become the next big thing or solve some of the world’s biggest problems.
Crowdfunding is probably the simplest way to introduce yourself to the world of venture capital investment (also known as “VC investing”). On one crowdfunding website, some people on average make an average IRR of 50% annually! Much more on that below.
For a start-up, it’s a route that companies like Monzo used to become who they are today (more on that too below!)
In this article, we’re going to focus on equity crowdfunding, which is a particular type of crowdfunding mostly used by entrepreneurs and investors.
- What is Crowdfunding?
- Crowdfunding v Angel Syndicate
- Crowdfunding v Venture Capitalist
- Where can you start crowdfunding?
- How can you do it successfully?
- Pros and cons
After reading, you’ll feel well equipped to make a judgment of whether crowdfunding is for you – because to be honest, although it’s not too difficult, it’s not right for everyone.
What is Crowdfunding?
First, let’s get on the same page – what is crowdfunding?
Crowdfunding is a public way of raising money from many people for a specific goal. This is mainly done online and especially through crowdfunding websites. Once all the money is pooled together, the capital is used to finance the project or goal.
Crowdfunding is used by all sorts of individuals, such as entrepreneurs, politicians or charities.
It’s hugely popular. According to Moneypenny, In 2018 there were 6,455,080 crowdfunding campaigns, and this number is expected to nearly double in the next four years.
An example of a success story includes Monzo, who in 2016 hosted their crowdfunding on the popular website Crowdcube. They achieved £1 million investment in just 96 seconds.
There are different methods of crowdfunding. Broadly it can be done in the following two ways:
1. Debt crowdfunding
This consists of different types of crowd-based lending, such as peer-to-peer lending (aka P2P) and invoice financing. It works in the same way as a traditional loan, however, the money borrowed is from multiple people.
2. Equity crowdfunding
In exchange for cash, public investors get a proportionate slice of equity in the business venture.
The exchange of cash for equity means this method goes a step further than normal crowdfunding.
It’s more common to find start-ups using equity crowdfunding.
Crowdfunding v Angel Syndicate
An angel syndicate is a group of investors clubbed together to invest in an early start-up.
It’s different from crowdfunding because in a syndicate, the investors could be hand-picked, exclusively invited or would have had to buy in with a larger amount of cash. Crowdfund investors can be anyone – with very little cash required (usually just £100).
Angel syndicates often have one lead investor who picks the best deals and then bring the rest of the syndicate in on the deal.
Think of angel syndicates like a sophisticated crowdfunding operation where only selective startups get on, and the host of the whole syndicate is always investing themselves.
As angel syndicates are far more hush hush than crowdfunding platforms, they get access to better deals. The best startups would usually much rather keep very quiet about what they’re doing if they can.
What we do at the IFG Angel Syndicate is therefore a specialist form of equity crowdfunding, where we’ll only invest in high-quality sharia-compliant start-ups.
It’s better to use an angel syndicate if you’re not completely sure of what you are doing. You’ll also get access to a sophisticated network, better companies and better deals.
Crowdfunding v Venture Capitalist
A venture capitalist (VC) is a fund manager that has raised many millions of pounds from pension funds, sovereign wealth funds, banks and other institutional investors, who provides capital to companies that they believe show high growth potential. In exchange for their investment, they receive equity.
The difference between investing through crowdfunding or a VC, is that to invest with a VC fund, you’ll typically need a minimum ticket of £100,000, and often over a million.
VCs are incredibly choosy about their investments, but they have a much shorter time horizon to angel investors as their fund needs to wrap up and give back money to their own investors within 7-10 years.
VC investors probably get access to the best deals. Thereafter you have angel investors. Finally you have crowdfunding platforms.
Where can you start crowdfunding?
Now we know what crowdfunding is, where does one begin?
This is done primarily online. A few popular places include:
- Funding Circle
If alternatively you want to go for an angel syndicate, we at IFG have an angel syndicate you might want to check out.
How can you do it successfully?
We’ve talked about where you can go to invest/raise money from crowdfunding. Now let’s look at:
- How much it costs to use crowdfunding platforms; and
- Investing on these platforms – what you need to know
As a start-up, the cost is super important to consider. Crowdfunding websites will charge to host you. Additional costs (if not already included) may have to be spent on marketing, promo, support, etc.
If you’re an investor, you should check if they’ll charge you to invest or have any fees on profits you make.
Example – Seedrs
Let’s take Seedrs as an example. They will only charge a start-up if they successfully raise. This includes a 6% charge on however much is raised, and a completion fee of £2,500 (excl. VAT). You can pay for further promotion and campaign support.
Seedrs also charge investors 7.5% of their profit when they generate a positive return on an investment and sometimes, they’ll charge direct fees.
There are a few important implications here to keep in mind:
- No high-flying startup that all the sophisticated investors in the know want to invest in, will need to use crowdfunding and pay money to Seedrs to raise for them. If you have VC funds and angel syndicates giving you £500,000 without any fees, why would you take £500,000 with a 6% fee?
- It might seem like you – the investor – are not paying fees and that feels good. But ultimately you are investing that money into the startup, and they will just use your money to pay the fees to Seedrs. So while its not actually coming out of your pocket, it is reducing your investment’s cash pile.
2. Investing – what you need to know
To help us understand, we can use the Seedrs 2018 Portfolio Update. It’s really good at showing us who are the people that make the most money.
There’s a big difference between those who pick and choose their investments to those who invest in everything without any thought.
Let’s say you had a hypothetical portfolio with all 577 deals available on the platform. This would produce a platform-wide IRR of 12.02%* (26.42% when EIS and SEIS tax reliefs are taken into account – more about these below).
Compare that to the top 10% of investors who have made 10+ investments. They achieved a crazy huge average IRR of 47.90% (62.45% when tax-adjusted).
In other words, the top 10% of people on Seedrs make 50% annual return. If you invest in everything on Seedrs, you’ll make a 12% return. Therefore, there’s a big difference between those who know what they are doing and those who don’t.
*(Note: IRR means “Internal Rate of Return. It shows how much the portfolio has increased or decreased per year. It’s the most common way to measure the performance of a portfolio of private equity or venture capital investments)
Ensure you diversify your portfolio to spread the risk and increases the chance of success. See if the crowdfunding website has a fund. On Seedrs an investor can create a diverse portfolio through a single investment into a passive fund over a period of time.
Consider fintech. In 2019, it was Seedrs most popular sector by amount raised, generating £73.8 million in investment and accounting for half of their deals. However, if sharia-compliance is a concern for you, then tread lightly here as most fintechs will not be sharia-compliant.
B2C businesses make up nearly 50% of Seedrs’ portfolio, with B2B accounting for 30% and mixed B2B/B2C making up the rest.
Investors remember this:
- Crowdfunding websites can get you good to get exposure to mass market B2C (business to consumer) related start-ups. This is as the best B2C startups will consider it is worth paying the Seedrs 6% fee to list on their platform just to get their brand out there.
- However, you won’t get access to an elite start-up, which focuses on B2B. This is because most of the time elite start-ups in this category couldn’t give a hoot what the mass market thinks of them.
So Crowdfunding is great for B2C startups. Take a look at Monzo and Revolut. They raised from VC investors but they also crowdfunded. They like their customers owning a bit of their business as it provides allegiance and brand awareness.
EIS (Enterprise Investment Scheme) and SEIS (Seed Enterprise Investment Scheme) tax reliefs may be available for your investments, so consider them.
- EIS – you can claim back up to 30% of the value of your investment in the form of income tax relief up to £1million per tax year.
- SEIS relief – this has so many benefits. Examples include an income tax relief of up to 50% and a £100k gov contribution allowance per tax year.
Other reliefs include capital gains tax reinvestment relief, capital gains disposal relief, inheritance tax exemption and loss relief.
Pros and Cons
- Crowdfunding is the easiest way for entering start-up investing.
- Can start investing with as little as $100 – making it a good way to learn.
- You could claim EIS and SEIS tax benefits on your investments.
- Potential for huge returns on your investment.
- Encourages business and job creation.
- The start-ups that are crowdfunding won’t be of the highest quality.
- Potential to lose all your money as an investor
- Start-ups are illiquid, and not always easy to sell your stake in.
- They carry a human risk – what if a founder leaves/has a dispute? Could they recover?
- Crowdfunding websites will charge/take fees – Seedrs charge start-ups 6% on any profit made.
- Minimal information may be available on the start-up.
- Usually a last resort for the start-up.
- No further due diligence is done by more experienced people.
- Mainstream crowdfunding platforms do not sharia-screen the start-ups they list, meaning there’s no way of guaranteeing that that company won’t take haram debt in the future.
Now you know not just the basics of crowdfunding, but the key ways in which people can make money from it.
If you’re an investor, don’t be scared of taking the plunge. It’s an easy, cheap and halal (depending on the company) way to make money.
Have a look at what we do at the IFG Angel Syndicate, it’s a good place to start if you’re interested in investing.
Any way you invest money, it carries risk. Equity crowdfunding carries greater risk due to the nature of the asset class. However, the rewards could be huge and it creates huge opportunities for people to grow their business and there are great tax reliefs.
If you’re still not feeling investing in crowdfunding, it’s probably better for you to join an angel syndicate instead. And, if you can invest in a £1m ticket, you could put that in a VC fund.