Crowdfunding - Canny Investments or Risky Business?

The Financial Times tells us that the alternative finance market grew by 91% over the last 12 months and is expected to top £1.6bn this year.   So, what is crowdfunding and why has it suddenly become so popular?  More importantly, is it a good idea?

Crowdfunding is a new way to finance businesses where a large number of people can invest small amounts of money in the projects of their choice.

Online platforms are used to match potential investors to projects they might like to put their money into.  Recently, a large number of producers of alcoholic beverages have taken advantage of these schemes including micro-breweries and English wine producers.

A success story amongst the later, are Chapel Down, a wine producing company in Kent who have adverts on London Underground trains encouraging people to invest in their company.  They are now the largest winemaker in England and were tipped as a good investment by Midas Investment Management in 2013.

Julia Groves, chairwoman of the UK Crowdfunding Association, states that this type of investment is, “a real alternative for your savings” as low interest rates are making other forms of investment less attractive to savers.  There is also evidence that this form of funding is becoming popular due to the reluctance of banks to provide business loans so businesses are forced to look into other options.

While this seems like an interesting and potentially profitable venture to put your savings into, there are some definite downsides.  The biggest downside being that there is always a risk that the business you have invested in will simply not make it.  Many businesses started up through crowdfunding go bust within a few years.

Fortunately, there are higher and lower risk options for people wanting to invest through crowdfunding.  The lower risk strategy is to use debt crowdfunding where the business you have given money to are obliged to pay back the money regularly over time and paying back this debt would become a priority if the company were to go under.  A higher risk, but higher reward, strategy is to invest through equity crowdfunding.  This involves buying shares in the company and, essentially, become part of that company.  If the company were not to succeed in these circumstances then you would simply lose your money.

Although there are clearly benefits and risks involved in crowdfunding, this type of business finance and investment is part of a growing trend.  Good research is essential in deciding to invest in one of these schemes as well as full awareness of the risks involved.