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What is Equity Crowdfunding?

Equity crowdfunding and investing in the shares of start-up and early-stage companies can be satisfying and financially rewarding, but it is also very risky and the investor needs to be able to afford a total loss of the capital invested. Click here for our full risk warning.





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.

Equity Crowdfunding: What is it?

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. 

What are the main types of crowdfunding?

There are various types of crowdfunding, however, the below are considered to be the main types:

  1. Equity crowdfunding: When a business raises funds in return for equity/shares in that business
  2. Debt crowdfunding: This is when a large group of investors all make a small contribution to a company or person who is looking to borrow money. This is in return for the loan being paid back with interest over time. This is otherwise known as peer-to-peer (P2P) lending. Funding Circle and Zopa are two popular P2P platforms
  3. Reward crowdfunding: When individuals invest in a project they are passionate about, they receive a reward in return. This is usually non-monetary, such as a gift or recognition in some way. Kickstarter and IndieGoGo are two popular reward-based crowdfunding platforms
  4. Donation crowdfunding: This is when people donate money to a specific (usually charitable) cause. A key example is JustGiving

What are the benefits of equity crowdfunding?

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.

What are the risks of equity crowdfunding?

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.

 

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.

 

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.

 

What is the Seed Enterprise Investment Scheme (SEIS)?

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:

1. The company:

  • cannot raise more than £150,000 in total through the SEIS
  • has less than 25 employees in total
  • have assets of less than £200,000 before share issue
  • incorporated for less than 2 years prior to issuing the shares
  • cannot operate in a trade/industry out of the HMRC SEIS permitted list

2. The investor cannot:

  • cannot be an employee prior to the share issue, unless also a director
  • cannot hold more than 30% of shares

 

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.

 

What is the Enterprise Investment Scheme (EIS)?

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:

1. The company:

  • cannot have assets greater than £15 million
  • has less than 250 full-time employees
  • all capital employed must be engaged in the company within 24 months
  • is subject to a decision and audit made by an appointed tax officer
  • must not be listed

2. The investor:

  • may not have more than a 30% interest in the company
  • no partner or associate of the investor may have other interests in the company
  • cannot have preferential shares

 

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.

 

 

Equity crowdfunding

 




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