Crowd funding: a realistic alternative to bank lending?

People holding a piggy bankAccess to bank credit can prove tricky for most start-ups and small firms. With conditions still changeable in the short term, where else can you turn? Crowd funding is one solution, but is it a viable option for small firms?

The Bank of England has stated that restricted bank credit has pushed some small firms to look for new solutions to boost their working capital.

Whilst figures from the Forum of Private Business show that awareness is still relatively low, crowd funding is one alternative that is providing finance to a small, but growing number of businesses.

Standing out from the crowd

Crowd funding allows individual investors to pool their money together, usually online, to support a business or project. Typically, people can invest as little as £10 in return for a small stake, other monetary reward or perk.

UK crowd funding providers aimed at small firms include companies such as Funding Circle, which bypasses the banks and provides loans of up to £1 million through a network of private investors; and Crowdcube, which offers investment in return for an equity stake. Funding Circle was launched in 2010, and has so far made approximately loans totalling in excess of £235 million. Crowdcube has successfully funded over 100 small firms so far, with the help of over 60,000 registered investors.

Clearly, crowd funding is still a relatively new concept and few businesses have obtained finance using it to date. But, as awareness of crowd funding has grown, it has become a serious alternative to a bank loan.

Phil McCabe“The downside for business owners with companies such as Crowdcube is that they have to give up a stake in their firm,” says Forum of Private Business senior policy adviser Phil McCabe. “But next to not being able to get the growth finance they need, there are few disadvantages to using reputable alternative funding platforms.

“There is a growing appetite among small firms for alternative funding models,” he adds.

So how does Crowdcube work?

Crowdcube logo“Banks aren’t lending at the moment and angel networks are reticent to part with their money, so Crowdcube was developed to provide an alternative to entrepreneurs in the UK,” says Crowdcube co-founder Luke Lang.

“Banks are starting to refer customers to us now. Some business owners have been turned down for a traditional bank loan and their bank has suggested they try us instead.

“For too long, entrepreneurs with good ideas have had to go cap in hand to wealthy individuals. We wanted to enable anyone above 18 in the UK to invest in businesses.

“There are two main reasons why people would invest on Crowdcube. Firstly, return on investment, and secondly we think that people will want to engage on a higher level with a business they particularly like. Also, businesses can offer ‘rewards’ to investors — such as free samples or discounted products. These are designed to act as an additional incentive and give a sense of return faster for more modest investors.

Luke Lang“Businesses from all sectors can pitch for investment. We give those with a good business plan and financial forecasts an opportunity to showcase their investment opportunity to a broader range of investors and take control of their fundraising. Crowdcube also provides start-ups with a method of formalising investment from friends and family.

“Start-ups and small firms seeking investment decide what stake they want to give away and the size of investment they’re after. The minimum amount individuals can invest in businesses on the site is £10, but there is no upper limit. We operate a policy of all or nothing funding, so if you’re after £20k to start your business and you only attract £2k, you don’t get the funding. You have to hit the target. We only make money when businesses hit their targets — at which point we charge a 5% success fee.

“Crowdcube is a private platform and details of investment pitches are only revealed to members. However, as it’s free to become a member we advise that entrepreneurs take all the usual precautions to protect their IP [intellectual property]. If you are not protected thoroughly and you cannot communicate the essence of your business without giving away your IP, then we may not be right for you.” 

So what can go wrong?

  • A lot can go wrong when seeking investment in general, not just with crowd funding. Ensure you are prepared before seeking investment or start-up funding.
  • With some crowd funding providers, if you don’t hit your target investment, you don’t get any cash.
  • Disclosing the details of your business plan to the public can leave you vulnerable to competitors using your ideas and perhaps infringing your IP rights. Find out how to protect your IP.
  • Crowd funding is new and the regulation is a grey area, so check if the provider is authorised by the Financial Conduct Authority (FCA). If you obtain finance from a lender or investor that isn’t registered by the FCA, you won’t be eligible for compensation in the event it proves to be a scam or if the provider is forced to close down.
  • For investors, one has to assume that the risk of investing their money in businesses which may have already been turned down by their bank is high. Legally too, it’s a complex area when it comes to the rights of minority shareholders — rights which may turn out to be toothless in real-life disputes between shareholders.

Related articles