Some celebrities, including Andy Murray, are investing in crowdfunding, but the risks are high
They are, in effect, “pop‑up” stock exchanges: online marketplaces where almost any firm, no matter how new or small, can offer its shares to the public with minimal regulation.
Called “crowdfunding”, the idea has taken off in recent years, attracting money from celebrities such as Andy Murray and Kevin McCloud, the presenter of Grand Designs.
It’s an appealing idea, offering private investors the opportunity to “get in on the ground floor” and share in the potentially spectacular growth that dynamic start-ups can offer.
But it’s clearly highly risky too. Until now investors interested in crowdfunding have had little concrete data on the success or otherwise of firms that raise money this way. But a comprehensive new report has now given savers some idea of the odds of success of a crowdfunding investment.
The research, from AltFi Data and Nabarr, a law firm, analysed 367 businesses that secured investment from members of the public on the five biggest crowdfunding websites (Crowdcube, Seedrs, SyndicateRoom, Venture Founders and CrowdBnk) between 2011 and 2013.
It found that 70, or about one in five, of the firms were either no longer trading or experiencing “difficulties” likely to result in investors losing all their money, while 80pc were still in business.
Just one firm had so far realised a return for investors: E-Car Club, funded through Crowdcube in 2013, was acquired by Europcar in 2015. Although exact numbers are not available, investors are thought to have made about two-and-a-half times their original money.
Fifty-eight firms had gone on to raise further funds at higher valuations, suggesting that they had made a promising start.
The report described these outcomes as “impressive”. However, the authors suggested that transparency within the sector could be improved to ensure that investors were given every opportunity to understand the risks inherent in buying shares in young companies.
In total £18m was raised between 2011 and 2013, by firms that were on average a little more than three years old.
But over the past two years crowdfunding has become much more popular. It raised £59m for companies last year and AltFi Data estimated this year’s figure at £150m.
The popularity of crowdfunding is expected to increase further in 2016, particularly if certain investments become eligible for the new “Innovative Finance Isa”, due next April.
The Isa was created for “peer to peer lending”, which involves individuals lending cash directly to borrowers, typically receiving better interest rates than they would get from a bank, but the Government is considering whether crowdfunding should be included too.
Crowdfunding websites typically take a percentage of the money raised by the venture that raises funding.
Some celebrities, including tennis player Andy Murray, have caught the crowdfunding bug.
Andy Murray has invested in small business via crowdfunding
Mr Murray has taken a stake in Tossed, the salad bar chain, as well as investing in a 3D “virtual reality” company called Trillenium and the Fuel Ventures Fund, a venture capital outfit.
“The three businesses I’ve chosen are all in areas of industry I find interesting,” said Mr Murray, who joined the Seedrs crowdfunding platform in June.
One high-profile businesses that successfully pitched for funding was Hab Housing, established by Kevin McCloud. The firm raised just under £2m.
What is crowdfunding?
Crowdfunding websites give investors the opportunity to back fledgling enterprises they believe have the potential to grow and generate profit.
One of the most high profile businesses that successfully pitched for funding was Hab Housing, established by Kevin McCloud, presenter of Grand Designs. The firm raised just under £2 million.
Some of the business proposals listed on crowdfunding websites qualify for special tax reliefs under the Enterprise Investment Scheme (EIS) or Seed Enterprise Investment Scheme (SEIS) rules. These gives investors generous tax breaks, such as being able to claim back income tax on the money they invest.
But what about the risk?
Crowdfunding is risky. The firms are young and often have ambitious plans, that may not work out. But those who back the right business could make a small fortune.
The watchdog, the Financial Conduct Authority (FCA), has taken a close interest in crowdfunding. It wants to ensure small investors fully understand the risks they are taking.
On its website the FCA warns: "We regard investment-based crowdfunding in particular to be a high-risk investment activity. It is very likely that you will lose all your money. Most investments are in shares or debt securities in start-up companies and will result in a 100% loss of capital as most start-up businesses fail."
The FCA has previously noted that small investors should not have more than 10pc of their savings in enterprises.