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The crowd moves on

It's the hottest place in the market right now but what does crowd funding really offer investors?
The crowd moves on

Records are being broken at a rapid rate in the crowd funding sphere. First, Nicola Horlick managed to raise £150,000 through Seedrs in just 22 hours, then a day later Crowdcube broke through the £10m threshold of funds raised on an equity crowd platform.

Crowd funding is where young companies pitch their funding requirements online to investors who decide whether or not to invest. Breaking records suggests a thriving market. In the UK the two main players, Crowdcube and Seedrs, continue to sign up new investor members and new businesses pitching for capital in small amounts. Both are now regulated by the Financial Conduct Authority, and unlike social-reward platforms, both are equity based: they secure equity stakes for the investors in the businesses they choose to back.

For companies seeking funding, these new platforms offer a less pressurised and lower cost way of raising development capital, along with the chance to build a loyal customer base who will be willing and enthusiastic ambassadors for the goods or services being sold. For investors, it's a chance to buy into an alternative asset class - the world of seed capital, start-ups and young companies - without having to invest large dollops of money. Tax breaks for investors are generous - if the business qualifies under Seed Enterprise Investment Scheme (SEIS) relief rules.

For some investors, part of the reward comes from being able to use the products and services of the companies they own a tiny portion of and flaunting them in front of friends, or seeing them on the shelves in supermarkets. "It's far more enjoyable, interesting and tangible than any other investing method that I am aware of," says one investor.

But the risks are real. The main risk is full loss of your investment, although SEIS relief can dull that pain considerably, or zero return on your locked-up capital - the opportunity cost. When your investments start to add up to several thousand pounds, or if SEIS relief doesn't apply, that risk shouldn't be brushed aside so easily. Another risk is being tempted to increase the amount you invest to make the potential rewards worthwhile. Crowdcube says the average amount invested through its platform is £2,700.

This is why it pays to do due diligence on all the businesses and to back a broad selection rather than just one or two. You should focus on judging the risk involved. Other safety precautions you can take include choosing businesses that are at different stages of development and to cap the total amount you allocate to this high-risk segment to no more than 5 per cent of your overall portfolio.

Jonathan Miller, a crowd funding investor who has invested around £20,000 in five businesses through Crowdcube, says his aim is to find businesses "that could generate 10 times my investment". Before getting involved in crowd funding, Mr Miller had considered becoming an angel investor but ruled it out on the grounds that the entry level investment, and therefore the risk, was too high.

He knows that small growth businesses are highly risky but is drawn to the sector for three reasons. The first is the financial incentive and the second is that crowd funding enables him to spread risk across a wide selection of companies. The third reason is the satisfaction of engaging with his investments. "I've always had a lot of respect for people who have the courage to quit permanent employment and embark upon setting up their own companies," he says.

Mr Miller uses his previous business and investment experience to select the right businesses with a bit of instinct thrown in. "Do I like the business idea, the people behind the company, the way they present themselves. Is it an interesting market?" he says.

But he's careful to ensure that he amount he invests in start-ups doesn't leave him exposed, and he stays in regular contact with the businesses for updates on progress.

Finally, investors need to remember that exiting the business - and realising profits - is out of their control and could take years.

Find out more about the crowd-funding opportunity in our interview with Luke Lang from Crowdcube: