Last updated: March 2014
Buzz Around Crowdfunding
The current global financial environment is hostile. Banks are reducing their lending activities, access to finance is becoming increasing difficult, bank interest rates are at an all time low and ethical investment funds are sometimes not what they claim.
Yet these current bleak conditions appear to be nurturing an exciting, dynamic and diverse alternative finance market, with crowdfunding and peer-to-peer lending playing an important role. By removing the middle-man, crowdfunding and peer-to-peer lending open up investing to a wider audience than just institutions and wealthy individuals.
Crowdfunding offers a range of opportunities to directly invest in social and environmentally progressive projects, no matter what your financial position. It can offer better returns for savers than traditional bank accounts, and presents an excellent opportunity to develop financial literacy.
Although traditional forms of crowdfunding (donations), remain the largest sector in this market, the government has reported on the rapid expansion of equity-based and loan-based crowdfunding.
Between 2012 and 2013 equity-based crowdfunding grew by 618% and registered £28 million in 2013; peer-to-business lending grew by 211% and recorded £193 million in 2013; and peer-to-peer lending grew by 126% and recorded £287 million in 2013.
What is crowdfunding?
Crowdfunding refers to a wide range of activities, but primarily involves connecting a group of individuals who are able to donate, lend or invest money with those who need financing for a specific campaign, business idea or item. This matching process is commonly done over the internet and is facilitated by crowdfunding platforms such as Crowdcube, Seedrs and Indiegogo. (Crowdfunding platforms generally charge for their service if borrowers raise their target amounts).
What is exchanged in return for money lent is one key factor that distinguishes different forms of crowdfunding. Lenders may donate in exchange for:
- the greater good (donations),
- their money back with or without interest (loan-based crowdfunding or peer-to-peer lending),
- a reward of some sort (reward-based crowdfunding),
- an item which the money pre-bought,
- shares in the company (equity-based crowdfunding).
Each form of crowdfunding carries its own level of risk. Due to the young nature of the market, a well established secondary market (one in which you can easily re-sell shares in small businesses) does not yet exist. Plus, the current lack of standardised regulation across all crowdfunding platforms results in consumer protection issues such as fraud, and misleading advertising and advice. Some of these issues may be addressed when the Financial Conduct Authority (FCA) takes responsibility for the regulation of the consumer credit market in April 2014.
Regulating the crowd
From April 2014 the FCA will implement guidelines for loan-based and equity-based crowdfunding platforms. These regulations will essentially involve implementing safeguards to check whether investors are able to understand and bear the risks involved in investing money.
Tom Hardwood from Abundance Generation (a crowdfunding platform currently regulated by the FCA and specialising in renewable energy projects) commented that the FCA’s move to regulate crowdfunding platforms was a “good thing”, and that “crowdfunding would become less of an alternative financial market.” He thought that the “FCA regulation would formalise the industry, would reduce the number of people working within the industry, would allow crowdfunding platforms to become standardised and better established, in addition to offering better protection for consumers”.
Does crowdfunding present an ethical investment alternative?
Although great for democratising the financial world, crowdfunding does not necessarily present an ethical investment alternative. Some crowdfunding platforms such as Crowdcube have created forums where you can question a business about their credentials and ethics before you provide a loan or invest in them. Although this could potentially provide some social and environmental performance information, the borrower’s answers are not necessarily independently verified.
However, many niche crowdfunding platforms have developed for specialised sectors, allowing consumers and investors to find causes they believe in. This allows for rudimentary ethics screening based on the work a project or business does, but does not screen the firm behind a project. For example, Unbound offers rewards-based crowdfunding and specialises in publishing. Authors pitch their ideas and you can help bring their ideas to life by donating money in return for a reward.
Four crowdfunding platforms: Abundance Energy, Lend With Care, Kiva and Buzzbnk, appear in our ‘Choosing Direct Ethical Investment’ listing.