What is equity crowdfunding?
Equity crowdfunding is the process whereby people (i.e. the ‘crowd’) invest in an early-stage unlisted company (a company that is not listed on a stock market) in exchange for shares in that company. A shareholder has partial ownership of a company and stands to profit should the company do well. The opposite is also true, so if the company fails investors can lose some, or all, of their investment.
Previously only wealthy individuals, venture capitalists, and business angels could invest in startups. Equity crowdfunding platforms have helped democratise the investment process by opening the door to a larger pool of potential investors dubbed “the crowd”. Watch an introduction to equity crowdfunding in the video below.
Investment tax reliefs
To offset some of the risk involved with investing in early-stage companies, the UK government offers tax reliefs on eligible opportunities in the form of the Enterprise Investment Scheme (EIS) and the Seed Enterprise Investment Scheme (SEIS). These are some of the most generous tax incentives in the world, offering 30% and 50% income tax relief respectively for eligble investors.
More about EIS tax relief
More about SEIS tax relief
Who can invest?
That depends on the investment platform. Equity crowdfunding tends to take place online via equity investment platforms, which can offer individual investment opportunities as well as EIS investment funds. The criteria for investment varies from platform to platform, so make sure to do your research before you invest.
While some platforms require very few checks to register as an investor, others are more stringent in their guidelines. Self-certification is often used as a method of telling an investment platform you have the appropriate level of experience, risk awareness and means to invest in early-stage businesses.
What are the risks?
Equity crowdfunding for startups is risky by nature, so there are a number of things you need to be aware of if you're considering investing.
It can take years to see a return
It may take a long time for your shares to increase in value, which in turn impacts on your ability to make a return if you sell them on.
You're unlikely to receive dividends
Startups normally don't make enough profit to be able to pay dividends to their investors, meaning that you're unlikely to see any return or profit until you are able to sell your shares, which can take years if it happens at all.
Any equity crowdfunding investment you make will be highly illiquid as there's no secondary market where you can easily sell on your shares. This means you will most likely have to hold on to your shares until the company you invested in exits or floats on an exchange.
Risk of dilution
If the company you invested in raising more capital at a later date (and it's almost certain that it will), new shares will be issued to the new investors and so your percentage shareholding within the company will be reduced (or 'diluted'). These new shares might also come with certain preferential rights that might work to your disadvantage if exercised.
You can guard against dilution by making sure certain investor protections are in place before you invest.