Is Crowdfunding Worth the Investment?
In recent years, crowdfunding has taken centre stage in the world of finance, presenting an innovative alternative for businesses seeking capital and for investors looking to diversify their portfolios. But is it a smart move to put your hard-earned cash into crowdfunded businesses?
The global crowdfunding market was valued at approximately £894 million in 2023, and experts predict that figure could double by 2028. With growth like this, many are asking: Should you be investing in crowdfunded ventures? Let’s explore the pros, cons, and what to keep in mind before you dive into the world of crowdfunding. Martin Clapson, Managing Director at Price Bailey, weighs in on the opportunities and challenges of this evolving investment model.
What Exactly Is a Crowdfunded Business?
Crowdfunding is all about levelling the playing field. Rather than relying on traditional investment avenues such as banks or venture capital, businesses seeking funding can now appeal to the masses. Individuals, everyday people like you and me, can chip in small amounts, which are pooled together to fund these ventures.
In return, investors may receive a share in the business, exclusive early access to products, or other perks. Crowdfunding essentially opens doors for companies that might not otherwise attract big-ticket investors, while also giving the average person a chance to get in on the action—whether it’s a cutting-edge tech start-up, an eco-friendly business, or the latest craft gin distillery.
Early-Stage Investment Opportunities
One of the biggest draws of crowdfunding is the opportunity to invest in a business during its infancy. Early-stage investments offer the potential for higher returns, as companies are just starting out and have a long road ahead.
“Crowdfunding allows investors to access start-ups and early-stage businesses that might not be available through traditional channels,” says Clapson. The earlier you invest, the bigger the potential payoff if the business succeeds.
Access to Diverse Sectors
Crowdfunded ventures span a wide range of industries. Investors can choose to support businesses in tech, finance, food and drink, mobile apps, and more. In fact, the most popular sectors for crowdfunded businesses include:
- Internet platforms (19%)
- Mobile apps (18%)
- Food and drink producers (14%)
- SaaS (10%)
- Consumer banking and financial services (8%)
This variety provides a unique opportunity to diversify your investments across multiple industries, reducing risk while broadening exposure to different markets.
Lower Investment Thresholds
Unlike traditional investment avenues that often require large sums of money, crowdfunding allows people to invest smaller amounts. “The average crowdfunding investment round falls between £909k and £1.5 million,” Clapson explains.
This makes it accessible to a wider audience, allowing individuals to dip their toes into the investment world without a massive upfront financial commitment.
Potential for High Returns
If a crowdfunded business performs well, investors stand to reap significant rewards. There have been numerous cases of companies raising their valuations after successful crowdfunding campaigns.
Some businesses have even gone on to achieve impressive exit valuations, meaning they were acquired or went public, rewarding their early investors handsomely.
Community Engagement
Crowdfunding also creates a strong sense of community. Investors often feel personally connected to the businesses they support. Many campaigns offer perks or early access to products, fostering a deeper connection between investors and the company.
This engagement can be especially fulfilling for those who enjoy supporting innovative ideas or socially responsible businesses.
Portfolio Diversification
Adding crowdfunded businesses to your investment portfolio can help with diversification, particularly in industries and sectors that don’t always correlate with traditional markets like stocks or bonds.
For investors looking to balance risk and reward, crowdfunding offers an appealing way to hedge against more conventional investments.
Higher Risk of Failure
While the potential for high returns exists, investing in crowdfunded businesses comes with considerable risk. “Crowdfunded companies often have a higher failure rate compared to those backed by private equity or venture capital,” Clapson warns.
Data suggests that about 30% of crowdfunded businesses struggle to secure additional funding, which can stifle growth and lead to failure. Without proper backing, many businesses stall, becoming so-called “zombie companies” that operate without real growth potential.
Overvaluation Concerns
Another issue investors should be wary of is overvaluation. Crowdfunded businesses sometimes enter their funding rounds with inflated valuations, which don’t always reflect the company’s true financial health.
“This can create problems down the line when businesses seek further funding from professional investors,” says Clapson. When valuations are out of sync with the company’s performance, raising additional capital can be challenging, putting both the business and its investors at risk.
Illiquid Investments
Crowdfunding often locks your money in for the long haul. Unlike publicly traded stocks that you can sell at any time, crowdfunded investments are usually illiquid. In other words, you might not be able to sell your shares until the company goes public or is acquired, which could take several years.
Investors should be prepared for a long-term commitment, and potentially limited flexibility in accessing their funds.
Lower Exit Rates
It’s important to note that crowdfunded businesses have lower exit rates compared to those backed by private equity or venture capital. Only 7% of crowdfunded companies manage to exit in a given year, compared to 12% of their PE/VC-backed counterparts.
This lower exit rate may dampen the chances of seeing a return on your investment within a reasonable timeframe.
Limited Professional Oversight
Crowdfunded businesses often lack the rigorous due diligence and oversight that comes with private equity or venture capital investments. Without the involvement of experienced investors, these companies might have weaker governance structures and financial planning.
This increases the risk for crowdfunders, who may be investing in companies without the benefit of expert guidance.
Balancing Risk and Reward
Investing in crowdfunded businesses is not for the faint-hearted. It requires a keen understanding of the risks involved, a willingness to ride out potential volatility, and a long-term investment horizon. As Clapson points out: “Investors should carefully weigh the potential returns against their financial goals and risk tolerance.”
However, for those who are willing to do their research and take calculated risks, crowdfunding offers an exciting way to engage with early-stage companies and support innovative ideas. Clapson notes that companies with higher-than-average valuations before crowdfunding tend to outperform, raising 67% more capital and selling for 23% more. While this can present an opportunity for savvy investors, it’s crucial to understand the risks associated with premium valuations.
A Bright Future for Crowdfunding
As the global crowdfunding market continues to grow, so too do the opportunities for investors. Whether you’re looking to support a local craft brewery or invest in the next big tech start-up, crowdfunding presents an accessible and potentially lucrative way to diversify your portfolio.
However, as with any investment, careful consideration is key. Investors should do their due diligence, seek professional advice where necessary, and always be aware of the inherent risks. Crowdfunding can be an exciting frontier in the world of finance, but it requires a measured, informed approach.
