Find out how crowdfunding works, some of the benefits and risks, and our view of this type of investment opportunity.
Crowdfunding is a way in which people and businesses (including start-ups) can try to raise money from the public to support a business, project, campaign or individual.
The term crowdfunding applies to several internet-based business models, which are regulated in different ways.
- loan-based crowdfunding: also known as ‘peer-to-peer lending’, this is where consumers lend money in return for interest payments and a repayment of capital over time
- investment-based crowdfunding: consumers invest directly or indirectly in new or established businesses by buying investments such as shares or debentures
These are regulated activities under the Financial Services and Markets Act 2000.
We also regulate payment services provided in connection with:
- donation-based crowdfunding: people give money to enterprises or organisations they want to support
- pre-payment or rewards-based crowdfunding: people give money in return for a reward, service or product (such as concert tickets, an innovative product, or a computer game)
How crowdfunding works
Crowdfunding usually takes place on a website platform that allows businesses or individuals to raise money, and investors to provide that money. The business or individual seeking finance often explains their project in a pitch to attract loans or investment from as many people as possible.
There are different models and, as the market is still evolving, it is possible that new types of platforms and new risks will emerge.
The benefits of crowdfunding
Consumers may find it rewarding to be involved in a business or project as it develops, or to support a local initiative or other individuals. Crowdfunding platforms may offer higher returns than those available from other financial products, though there are usually greater risks.
Crowdfunding can be a useful way for organisations or individuals to access finance that banks or other lenders are not prepared to offer, or only offer at a high cost. So this source of finance could benefit the wider economy, or a local economy.
The risks of crowdfunding
Different platforms and loans carry different levels of risk. Consumers who invest via loan-based crowdfunding platforms need to be aware that:
- you won’t have access to the Financial Services Compensation Scheme (FSCS)
- although some platforms have a way of cashing in your investment (a secondary market), you may not always be able to cash it in quickly or for as much money as you paid
- loan-based crowdfunding is higher risk than holding money on deposit. You may lose some or all of the money that you invest
Due to the potential for capital losses, we regard investment-based crowdfunding in particular to be a high-risk investment activity. As well as the risks associated with loan-based crowdfunding, for equity crowdfunding you should also be aware that:
- 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 often result in a 100% loss of capital as most start-up businesses fail.
- Your capital will not be repaid and/or dividends will not be paid if the company you invest in defaults or there is a fraud.
- If you hold shares in a business or project, it is unlikely that income in the form of dividends will be paid. The value of your investment may be diluted if more shares are issued, and this is likely as many start-up businesses undergo multiple rounds of funding.
- You should be prepared to wait for a return on your investment, as even successful start-up businesses tend to take time to generate income
- If firms do handle clients’ money without our permission or authorisation, there will be no protection for investors in place. This is a particular risk if a platform fails and becomes insolvent.
- Most platforms do not have a way you can cash in your investment (a secondary market).
For debt security crowdfunding:
- It is likely that you will lose some or all your money. Most debt securities on offer through such platforms are issued by start-up companies and can result in capital loss if the businesses fail.
- Your capital will not be repaid and/or expected coupon payments will not be paid if the company you invest in defaults or there is fraud.
- The company can become more likely to default over time, increasing the risk of the investment.
- If firms do handle clients’ money without our permission or authorisation, there will be no protection for investors in place. This is a particular risk if a platform fails and becomes insolvent while holding client money.
- Securities offered on such platforms are not usually traded on a secondary market and most are not transferable, this means you may be unable to cash in your investment. You should be prepared to hold any securities you buy until maturity.
How to protect yourself
Before investing, you need to understand:
- what due diligence (checks made on the business or person looking for funding) has been performed
- that you are happy with the level of risk to which you will be exposed
- the value for money offered by an investment after charges, taxes and allowance for defaults
Our view on crowdfunding
We believe that consumers looking to invest in crowdfunding offers should take care. Given the typical risks involved, under our regulations, firms are only allowed to promote illiquid securities to particular types of experienced or sophisticated investors, or ordinary investors who confirm that they will not invest more than 10% of their net investable assets in investments sold via investment-based crowdfunding platforms.
You should only invest money you can afford to lose.
Find out more about our crowdfunding policy and how you can protect yourself in our policy statement on crowdfunding.