There are plenty of options for businesses that are looking to secure capital. Sadly, there’s no easy way of gaining funding for your business, and all avenues can be arduous.
Sharing your idea with friends and family, selling your service before you’ve even made a prototype, discovering networking connections to exploit and pitching your business to venture capital firms can be extremely time-consuming and there’s no guarantee that all of your hard work will eventually pay off.
Sometimes, if business owners have enough faith in their ideas being loved by the public, they can turn to external sources for the raising of capital.
Traditionally, it’s been difficult to establish businesses away from the confines of bootstrapping or VC funding, but equity crowdfunding has opened the door for more opportunities in getting a company up and running without having to wait for the blessing of an affluent investor.
Essentially, equity crowdfunding helps to raise capital directly from the individuals who would like to see the product or service succeed the most. Businesses typically leverage this through the sale of securities like shares, debt and revenue shares in a private company.
(Market size of crowdfunding. Image: Statista)
Now the world’s getting smaller and it’s becoming increasingly easy to share ideas on the internet, equity crowdfunding has become a highly viable way of securing the future of a company through the piecemeal funding of interested investors. Let’s take a deeper look into the world of equity crowdfunding and weigh up the investment method’s individual pros and cons.
Equity Crowdfunding in a Nutshell
Equity crowdfunding is a method for businesses to raise capital by asking a large pool of different people for smaller volumes of money in return for some shares or a tangible stake in the company. If the investment round is successful, the value of the shares held will increase. Whereas if they’re not, the value will fall.
Technology has made it possible for equity crowdfunding to take place online, and can really act as a timesaving measure for businesses. Websites like Seedrs and Crowdcube are particularly popular places for businesses to seek funding.
The Mechanics Behind Equity Crowdfunding
While traditional forms of crowdfunding focus on special gifts and prospective discounts in the product or service, equity crowdfunding is more focused on investing in a business for future profits.
The equity crowdfunding is a process that takes place entirely online through dedicated platforms. On said platforms, startups have the freedom to express the amount of money it’s aiming to raise in return for a percentage of the company.
The percentage of the business owned will be proportionate to the size of the investment being made. If a startup doesn’t reach its target by the end of a predetermined deadline, the money is returned to the various micro investors in full.
Why is Equity Crowdfunding Becoming so Popular?
The beauty of equity crowdfunding is that investors are given the chance to financially support small businesses.
There’s also a significant chance that an investor could see a handsome return on the money they’ve pledged to a business – depending on its levels of subsequent success.
Financing small businesses through equity crowdfunding is a great way of holding a stake in local or interesting startups. If an investor sees a business model that they’re confident could be a success, their investment could offer significant returns, too.
Are There Any Drawbacks Associated With Equity Crowdfunding?
There are certainly risks involved with equity crowdfunding – even if a project or business successfully raises all the funds it’s looking for.
Firstly, it may take investors an uncomfortably long time to see enough of an increase in their investment’s value in order to ultimately sell their shares on. It’s also likely that investors won’t see any dividends paid out on investments, due to the fact that the startups are unlikely to quickly scale to the point where they can distribute profits to shareholders.
It can be difficult to sell shares on in a company even if it’s performing rather well. Unfortunately, there are rarely any secondary markets in which investors can re-sell their shares and find willing buyers should they be looking to get their money back.
Finally, some companies engage in equity crowdfunding multiple times in order to raise additional funds. However, this process can ultimately dilute the value of existing shares within the company – causing a drop in the value of individual stakes.
Understanding Seed Investments
The Seed Enterprise Investment Scheme (SEIS) exists to boost the investments in small startups by offering income tax relief on any shares bought via crowdfunding platforms. This scheme helps to promote the benefits of holding money in crowdfunded startups without the necessity of seeing returns hampered by taxation.
Through the SEIS scheme, investors need to be holding their shares for at least three years to qualify, otherwise, tax relief can be limited or withdrawn entirely. If an investor sells their shares in a SEIS-qualified company after holding them for three years, their returns will be entirely tax-free.
Among the various tax benefits associated with SEIS schemes, investors can enjoy income tax relief where 45% of initial investment can be claimed back on the part of the investor when they take out their holdings. Capital gains exemptions also mean that any shares sold will be 100% exempt from capital gains tax.
Furthermore, there is also capital gains tax reinvestment relief for investors looking to cash out their holdings and reinvest funds elsewhere, with the reinvested funds eligible for a 50% reduction in tax.
Impressively, there are also loss relief measures that can be actioned if the SEIS business invested in goes bust – leaving investors empty-handed. Here, the loss relief will be offset at an investor’s highest income tax rate.
Finally, there’s also inheritance tax relief available at a rate of 100% should shares be passed down two years after their initial purchase date. Investors can claim for tax relief by filing a self-assessment tax return. It’s important to note that investors who don’t invest in a SEIS business will still need to declare their earnings, including any bonus payments that could’ve occurred.
Weighing Up an Enterprise Investment Scheme Purchase
Aside from the Seed Enterprise Investment Scheme, the Enterprise Investment Scheme (EIS) focuses on providing tax breaks for investors in small-scale, high-risk trading businesses. The scheme itself can bring investors as much as 30% income tax relief on investments that range up to £1m.
Likewise with Seed Enterprise Investment Schemes, investors will need to be holding their shares for at least three years to qualify. Investors in EIS businesses that run out of money are capable of offsetting their losses against income. It’s possible to make a claim on tax relief as part of a self-assessment tax return.
Investors who haven’t bought into an EIS business will still be required to declare their earnings, including any bonus payments made.
Overall, equity crowdfunding has been made a success for small businesses thanks to the ever-shrinking world of today. Where funding could have been hard to find in the past, now the internet can but startups in the shop window for investors who either wish to support small businesses or cash in on a good idea early on. Fundamentally, with benefits to be had for both business and investor alike, equity crowdfunding makes for a very viable funding method for entrepreneurs wherever they may be in the world.