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Everything you need to know about crowdfunding

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Crowdfunding platforms connect businesses and investors, allowing ideas to develop and companies to flourish, but is it for you? Read on to find out.

The internet has changed many of the ways we do business and live our daily lives and unsurprisingly, it has also opened up new avenues in which we acquire fund or invest in things that interest us.

In the UK, crowdfunding is undoubtedly popular with hundreds of millions raised within just a few years. Businesses have used crowdfunding to launch new products and expand, while individual investors can now support ideas and hope that they can make more than what they have put in. It isn’t just for business too – artists, writers, filmmakers, as well as those in need can also use crowdfunding sites to raise fund.

In this article, we aim to discuss:

  • What is crowdfunding?
  • The four common types of crowdfunding
  • The risks of crowdfunding
  • Can investors get tax relief?
  • EIS and SEIS
  • Should you list your business on crowdfunding?

What is crowdfunding?

Crowdfunding refers to a method of raising finance by asking a large number of people each for a small amount of money. In most cases, crowdfunding takes place on an online platform where a business or an individual can create a campaign to raise funds.

If it is a business project, the company usually includes an overview of the business plan, details of the management, and the amount that they hope to raise. If you invest, you may get a reward (the finished product, for example) and/or some shares in the company. In some instances, you may also get your money back plus interest – this is also known as peer-to-peer lending. While there are investors who just want to support an idea (especially an innovative one), most investors do hope to make a good return on investment.

As crowdfunding allows anyone to present an idea to a large group of people, savvy business people also use the process to test out their ideas and gather insight.

Crowdfunding is also not restricted to new ideas or products – there are plenty of companies conducting a second or third round of funding to spur growth.

Then there is the humanitarian side – GoFundMe is the largest platform for this and it has helped organisers raise over US$5 billion to help someone in need.

The four common types of crowdfunding

1. Equity-based

In essence, you invest in a company and receive shares of the company in return. There are usually two types of shares on offer – with and without voting or pre-emption rights. If the company does well, your shares will increase in value and you make a good return when you sell them. However, if the company fails, you will lose your investment. Also, it must be said that the company involved may not issue shares directly to you, but to a nominee company (usually a company set-up by the platform).

2. Reward-based

A highly popular model, this will see you invest a small amount of money and receive a reward at a later stage. The size of the reward often corresponds to the amount contributed. For example, you may get an ‘e-hug’ for a £10 contribution or a finished product for a £200 contribution.

3. Donation-based

This model sees you donating money to a person, charity, community or cause without expecting any reward in return, except in knowing that your donation can help to make a difference.

4. Loan-based or peer-to-peer (P2P) lending

In this model, you lend a business some money and expect to receive the money back plus interest.

The risks of crowdfunding

  • The target amount may not reach
    Every project sets a target amount and if the project cannot attract enough investors before the deadline, then those who have already invested will get their money back, but the project will not be able to move forward.
  • The business may fail
    Investment is inherently risky, more so when young companies are involved. It is said that 30% of new businesses fail in the first two years of operating, so there is a good chance that you may lose your money.
  • Investors may not be able to sell the shares
    If the company remains unlisted, it is not easy to find another buyer to purchase the shares.
  • Dividends are unlikely
    If the company becomes profitable, it may distribute the profits to its investors in the form of dividends. However, most companies listed on crowdfunding platforms are in the early stages and they tend not to make enough to pay dividends.
  • The platform may fail
    In the UK, several notable platforms have gone bust, leaving both companies and investors frustrated.
  • Ideas may get stolen
    As companies get much attention on crowdfunding sites, it is highly possible that others may take the opportunity to copy and improve upon the original ideas.
  • Learning curve
    In most instances, companies involved do not issue shares directly to the investors but to a nominee company (usually a company set-up by the platform). Both companies and investors not familiar with this arrangement will need to educate themselves quickly.

Can investors get tax relief?

In the UK, the government has rolled out four types of schemes to help companies raise funds and they are:

  • The Enterprise Investment Scheme (EIS)
  • The Seed Enterprise Investment Scheme (SEIS)
  • Social Investment Tax Relief (SITR)
  • Venture Capital Trust (VCT)

Among them, the Enterprise Investment Scheme (EIS) and Seed Enterprise Investment Scheme (SEIS) are specially designed for small companies with a higher risk to raise fund. How it works is that investors who purchase new shares in these companies can claim tax relief. If you are interested in this, keep a lookout for companies listed on crowdfunding sites with the words EIS or SEIS-approved.

Enterprise Investment Scheme (EIS)

Under this scheme, you (the investor) make an investment that is locked for a minimum of three years to qualify for the benefit. The scheme allows you to claim up to 30% income tax relief on investments up to £1 million per tax year, and you do not have to pay Capital Gains Tax if you sell them after three years. Here is a simplified example:

  • You invest £10,000 in a company and you can claim back £3,000 (30%) in income tax relief. You must submit the claim as part of your self-assessment tax return.
  • After three years, if you sell your shares for £20,000, you do not have to pay Capital Gains Tax.
  • In the event that the company goes bust, you can offset the losses against income.

EIS can get very complicated in practice, so it is best to call us up on 020 8108 0090 and discuss any questions you may have pertaining to EIS.

Seed Enterprise Investment Scheme (SEIS)

Similar to EIS, SEIS allows small businesses to raise fund easily by offering investors tax relief. But unlike EIS where qualified companies tend to be bigger (with less than £15 million in gross assets and less than 250 employees), SEIS is used solely by start-ups that are less than two years old, have less 25 employees and less than £200,000 in gross assets. The maximum amount a company can raise under SEIS is also limited to £150,000.

Under this scheme, the investment made is also locked for a minimum of three years. Here is a simplified example:

  • You invest £1,000 in a company and you can claim back £500 (50%) in income tax relief. You must have received an SEIS3 form from the company which you have invested before you can claim tax relief through your self-assessment tax return.
  • After three years, if you sell your shares for £2,000, you do not have to pay Capital Gains Tax.
  • If the company goes bust, you will receive some loss relief (which is a certain percentage of your investment multiple by your tax rate).

SEIS can also become complicated quickly, so give us a call on 020 8108 0090 and let us understand your situation first before recommending how you should go about claiming your tax relief and/or loss relief.

Should you list your business on crowdfunding?

If you have tried raising fund from banks and angel investors but without much success, then it is worth getting your business listed on one of the crowdfunding sites. But before you do that, it is best to answer the obvious question – why did your application get rejected in the first place? The people who will back your business on a crowdfunding platform are investors – meaning they are more likely to part with their money if they can see a good return on investment. So perhaps it is wise to spend some time to improve your product or service and make it more appealing before you list your business. Also, rewrite your business case if necessary.

Having said that, you must consider carefully what you can offer to your investors realistically. Will it be equity-based or reward-based? Perhaps a combination of both? If it is equity-based, do you want to have two categories of shares (with and without voting or pre-emption rights)? Do you need a nominee company?

Most importantly, the temptation to offer generous perks for larger investments is ever-present, so how do you know that you have inadvertently over promised your investors? These hard questions deserve clear answers from independent small business accountants at Tax Agility, and one of our small business specialists will be delighted to help you run through some figures and answer any questions pertaining to share structure.

If you would like to know more about funding options, this article The complete guide to business funding makes a good read.

Get advice from Tax Agility

Though it has a fair share of risks, crowdfunding has connected many investors and companies. It has helped companies turn their ideas into realities and facilitate growth. It has also given individuals like you and I a chance to invest and receive tax relief.
If you are a company director who needs help with numbers before listing your business on a crowdfunding site, or if you are an investor wanting to understand how EIS and SEIS can work for you, call your local London accountants on 020 8108 0090 use our Online Enquiry Form.

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