Have you heard of crowdfunding? Most of us have, at least in terms of crowdfunding campaigns established to help people who might be in need, whether they have medical bills or some other expense they cannot afford. But the truth is, such charitable efforts are not the foundation of crowdfunding. The concept of crowdfunding actually comes from equity investments. As such, you can invest money yourself through crowdfunding.
Crowdfunding in the investment arena is simply a way to raise capital by bringing together a large number of smaller investors willing to pool their resources rather than relying on a limited circle of venture capitalists and angel investors. Let us take a minute to understand why it works.
Prior to the development of crowdfunding, entrepreneurs looking for start-up or growth financing would either have to go to a bank or approach a group of individual investors. Investors could be either venture capitalists or angel investors. Banks were generally reluctant unless an entrepreneur could present a very strong case in support of borrowing; venture capitalists and angel investors were more willing but demanded a large piece of the action in return for their investments.
Crowdfunding bypasses traditional channels and goes straight to large groups of people who have money to invest and are willing to take a chance on a start-up or growth company. Entrepreneurs raise funds online through popular platforms such as IndieGoGo, Kickstarter, AngelList, and CircleUp.
How to Invest via Crowdfunding
Investing via crowdfunding is pretty simple. Investors log on to one of the many available platforms and immediately start searching for projects. Investors can contribute whatever they can afford to spend, be it £10 for £10,000. In exchange, they receive liquid 'shares' of the new venture that can later be redeemed at face value.
There are two additional forms of crowdfunding; one is suitable for investment while the other is not. The first is something known as micro-lending. Under this model, all of the investors contributing to a project are essentially micro-banks. Rather than receiving shares in the venture, they receive a return on their investment by way of interest payments. Investors can draw their money out at any point.
The other form of crowdfunding is donation-based. This is not appropriate as an investment because all contributions are treated as donations without any financial return. Investors may receive some sort of token in exchange for their donations, but that token in no way represents any kind of return on investment.
Reasons People Invest Via Crowdfunding
Crowdfunding is rather loosely regulated compared to other kinds of investing. For this reason, venture capitalists and angel investors approach it with caution. But that does not stop entrepreneurs from raising tremendous amounts of money through crowdfunding platforms. There are plenty of instances of people looking for a few thousand pounds that ended up raising millions.
Why do people invest through crowdfunding? There are lots of reasons:
- The Opportunity – A lot of crowdfunding investors do what they do because they love the opportunity to be part of something that could potentially be big. It might be worth it to invest £100 in the project that, if successful, could end up being worth tens of millions of pounds in total.
- The Potential – Companies like Uber and Lyft clearly demonstrate the potential of a new economy based on offering services on-demand. If an investor hits on the right project, the potential return could be enormous. Moreover, the return could be realised in just a few years as opposed to investing in stocks for decades.
- The Excitement – There is a certain excitement attached to going outside the norms. There are a lot of people who do what they do just to be different; just to push the boundaries to see how far they can go. This is as true in the world of investing as it is in any other segment of society. There are individuals who invest in crowdfunding platforms simply because these are a daring alternative to the norm.
There are, of course, plenty of risks attached to crowdfunding. Investors can spend a tremendous amount of money on projects that barely get off the ground. They can put a lot of hope and trust in an entrepreneur only to have it squandered. And there is always the risk of being scammed.
Crowdfunding is not necessarily a bad investment option on its face. Used wisely, it can be part of a diversified portfolio that offers higher returns. Our recommendation for crowdfunding investors is twofold: only invest through registered platforms and make sure plenty of research and questioning takes place before any investment is made.