Crowdfunding is marching on as an alternative funding option for entrepreneurs as funding for new businesses has dried up from the banks.
Regulators and tax authorities in Britain and the United States have voiced some concerns over protection crowdfunding platforms and entrepreneurs seeking money offer investors.
To help investors with their decision whether to get involved with a project, here are some answers to the most frequently asked questions about crowdfunding:
What is crowdfunding?
Crowdfunding generally takes place online by companies, individuals and charities pitching for cash contributions to finance specific projects. The aim is to pool small amounts of cash from a large number of investors to fund a deal
What are the returns on a crowdfunding investment?
This depends on the entrepreneur making the pitch. Some just say thanks for the cash and list donors on their web site or offer a small gift, like a discount on the product or a T-shirt.
Bigger projects often exchange equity in the business for cash, so the return depends on whether the business takes off and if the value of the shares increases.
What’s the benefit to a crowdfunded business?
Money raised by crowdfunding is equity rather than debt to a bank. That means the company can spend money as the directors see fit without repaying a loan plus interest to a bank.
The downside for an investor is the success of the business rests with how well the project is managed and they lack control over how and when their money is spent.
What do the regulators say about crowdfunding?
The Financial Conduct Authority (FCA) ion the UK warns investors that crowdfunding projects are outside of the scope of the Financial Services Compensation Scheme. As a result, if something goes wrong with the deal, investors have no redress through the Financial Ombudsman and are unlikely to see their money back.
The FCA has published a number of rules aimed at regulating crowdfunding in the UK and advises inexperienced investors should avoid crowdfunding projects. These come into effect from April 2014.
The main thrust for the rules is crowdfunding platforms should have a process in place to protect investment cash if the crowdfunded project fails.
Where can investors find out more about the crowdfunding rules?
The FCA issued a recent press release and will follow up with more detailed information before April 2014.