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Author: Sacha Bright & Oliver Murphy
For companies that need to raise capital, there are a number of options they can choose from. Whether it be investing personal capital, securing a loan, or even finding a venture capitalist, there is no question that the process is difficult. It takes time. Sometimes too long.
But there is hope for entrepreneurs looking for alternative ways to access capital: equity crowdfunding.
As the alternative finance aggregator, NextFin has carved a reputation on its independent and impartial ratings and comparisons within the equity crowdfunding market. Over the last few years, we’ve tracked and researched over 4,679 equity crowdfunding pitches.
But what exactly is ‘equity crowdfunding’? Who can invest? Where can you invest? And what can be considered to be the advantages and disadvantages?
In this guide, we explore these questions and offer the facts behind this appealing alternative finance method.
The clue is in the name. Equity crowdfunding is a process whereby the ‘crowd’ (people) can invest in an early-stage unlisted company via an online platform in exchange for shares in that company. Such a company is one that is not listed on a stock market.
As a shareholder, you have partial ownership of a company and can stand to profit should the company perform well. However, the opposite is also true: should the company fail, investors can lose some, or potentially all of their investment.
Whereas previously, only wealthy individuals such as venture capitalists could invest in startups, equity crowdfunding platforms have been responsible for opening up the investment process to a larger pool of potential investors.
When a start-up decides it wants to crowdfund, it must first decide how much money it wants to raise for a percentage of its company. The amount of the company that an investor owns is proportionate to the level of the investment made.
If a company does not reach its target by the end of its deadline, an investor’s money is returned to them in full.
There are various types of crowdfunding, however, the below are considered to be the main types:
There are of course several benefits to why a business may choose to raise capital and an investor invest via equity crowdfunding. We have listed the main ones below:
Benefits for businesses |
Benefits for investors |
Access to capital: Equity crowdfunding connects businesses that are looking for cash with a crowd of people who are looking to invest. The process is also quickened, with the average Seedrs campaign reaching its target within 30 days. |
Support a start-up business: Equity crowdfunding allows investors to buy into a business they believe in and thus have a financial share of the rewards of any potential success of that business. |
Exposure: Equity crowdfunding campaigns can give businesses that much needed public exposure. When it comes to seeking capital, you’re not only presenting your business to those who might invest, but also prospective customers. A campaign can be a great way to tell your story and generate brand awareness. |
Higher returns: Although startups are, by their nature, risky ventures, there is still the possibility that a company may perform far better than expected and provide lucrative returns to investors. |
Engagement: Similar to above, an equity crowdfunding campaign can provide businesses with the perfect opportunity to engage with customers by offering them the chance to buy into that business. This can consolidate customer loyalty. |
Benefiting the economy: This way of financing can benefit the economy at a far more local level, enabling a wider range of start-ups to succeed. |
However, any party that is willing to participate in equity crowdfunding must be aware of the associated risks. We have listed the risks below, but greatly advise that you read our full risk warning before investing.
Risks for businesses |
Risks for investors |
High risk of failure: A business that has received capital through equity crowdfunding can run a greater risk of failure than if it has been invested through venture capital. It's important to remember that funds are not enough to guarantee success. A business plan and support structure are required. |
It may take time to see returns: It may take a long time for company shares to increase in value which will impact an investor’s ability to make a return if they sell them on. |
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Dividends unlikely: It is unlikely for an investor to receive dividends because the companies involved often do not make enough profit to pay out to shareholders. |
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Low liquidity: Potential investors should be aware that securities purchased on equity crowdfunding platforms are highly illiquid. As a result, exit options can be limited and investors may have to wait several years for their investment to pay off. |
A large number of startups are beginning to make use of the tax incentives offered by the government.
The Seed Enterprise Investment Scheme (SEIS) aims to offer a boost to small startups by offering income tax relief on the shares bought through crowdfunding websites.
Shares have to be held for at least three years to qualify, otherwise, tax relief may be reduced or withdrawn. It is best to check the documentation for this with any entrepreneur claiming to be able to offer SEIS tax relief before investing.
To qualify for SEIS:
If you sell your shares in a SEIS-qualifying company after three years, there are a number of tax benefits:
Tax relief |
Explanation |
Income tax relief |
SEIS allows you to claim income tax at 50% of the initial investment. There are no exclusions to this break and can be spread across the current and previous years income tax bill. |
Capital Gains Tax Exemption |
If you decide to sell your shares after the three year investment period, you will be exempt from any gains that you have made. |
Capital Gains Tax Reinvestment Relief |
If you have other investments aside from SEIS and you decide to cash them in and reinvest in a project that qualifies for the scheme your capital gains tax on the non-SEIS investments will be reduced by 50%. |
Loss Relief |
If the SEIS business you invest in goes bust, the government offers loss relief which can offset tax on other income. The loss relief will be offset at your highest income tax rate. |
Inheritance Tax Relief |
You will be eligible to receive 100% Inheritance Tax Relief on the value of your shares two years after the date of your initial investment purchase. Claims for tax relief must be submitted as part of a self-assessment tax return. Even if you don’t invest in a SEIS business, you’ll need to declare any earnings, including bonus payments. |
The Enterprise Investment Scheme (EIS) is a UK government scheme that helps younger, higher-risk businesses raise finance by offering investors generous tax reliefs to investors.
To qualify for EIS:
This scheme offers tax breaks to investors in smaller, higher-risk trading companies. Below are the tax benefits available:
Tax relief |
Explanation |
Income tax relief |
Tax relief of 30% can be claimed on investments of up to £1 million in one tax year. |
Capital Gains Tax Exemption |
Any gain is Capital Gains Tax free if the shares are held for at least three years and the income tax relief was claimed on them. |
Loss Relief |
If shares are disposed of at a loss, the investor can elect that the amount of the loss, less Income Tax relief given, can be set against income of the year in which they were disposed or, on the income of the previous year instead of being set off against any capital gains.
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Disclaimer:
To the best of our knowledge, the information we have provided is correct at the time of publishing. SEIS and EIS tax benefits are dependent on your financial circumstances. Sacha Bright is not a solicitor or accountant and we recommend that you seek professional advice on any topic discussed.
Risk Warning:
Investing in equity crowdfunding and early-stage businesses involves high risks, which may include long-term investment horizons, illiquidity, lack of income and potential dilution. Any investor needs to be in the position to afford a total loss of capital invested.
NextFin is targeted at members who have the knowledge and experience to understand these risks and make their own investment decisions. You will NOT invest through NextFin but through the relevant crowdfunding website which also has signed off the content as a Financial Promotion on its own website. NextFin is not the originator of the financial promotions that appear on its site. However, we do to the best of our ability carry out limited compliance checks on the originator and the company seeking funding to ensure they are conforming to FCA regulations and anti-money laundering equity/requirements as appropriate. Business Agent Limited, trading as NextFin, takes no responsibility for this information or for any recommendations or opinions made by the companies or its users. Click here for our full risk warning.
Tagged: Entrepreneurs Tax EIS SEIS Seedrs
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