Crowdfunding - Raising money in the 21st Century

Want to replace the church roof? Or pay for your grandad's open heart surgery? Or perhaps you're a band wanting touring funds, or then again you could be starting up a company. If your bank manager is unsympathetic you might choose to bypass him completely, and try the crowdfunding option.

Crowdfunding provides a way to source money from individuals by essentially putting your idea out there and asking people to support it financially. It's a variant of the crowdsourcing concept. In crowdsourcing a piece of work is farmed out to volunteers or paid workers who contribute their expertise in order to solve a problem. If you're the one sourcing it's a bit like commissioning work from a bunch of employees you've never met. It can be a powerful way to distribute pieces of a complex problem to many people, who by doing their bit individually help to create a total solution. Wikipedia is a good example of crowdsourcing. In the case of crowdfunding however, it's all about asking the crowd out there to solve your problem by opening their wallets.

Although the word 'crowdfunding' only came into use in 2006, the concept itself is nothing new. In 1884 the newspaper publisher Joseph Pulitzer asked the American public to donate money towards the completion of the Statue of Liberty when existing funds ran out. In six months he raised $100,000. But what is making crowdfunding so powerful a medium in the late 20th and early 21st centuries is the reach of the internet. One of the first examples of crowdfunding is the British band Marillion, who in 1997 raised $60,000 from their fan base to finance an American tour. The same concept applies to charity fundraising, with JustGiving being launched in 2000. Since then thousand of registered UK charities have benefited from the generosity of the public, raising in excess of £700 million.

Things became more sophisticated with the founding of Kiva in 2005, as a micro financing platform. This allowed people to lend their money to others in developing countries, where people often have no access to traditional bank loans. Since inception Kiva has lent in excess of $573,000,000 in 75 countries, with a repayment rate of 98.84%. A resounding success story. After Kiva the model evolved into what is now known as peer to peer lending, which operates on the same principles, but in developed countries. It's a simple way for individuals to lend money to each other without any bank involvement. An example of P2P lending is LendingClub, which started up in 2007. They've transacted more than $4 billion in loans since then. The beauty of the idea lies in the concept that you as a lender have the opportunity to invest in areas that genuinely interest you, and that you believe in. And you're paid interest too ... LendingClub cements its credibility by being registered with the Securities and Exchange Commission.

Then in 2008 IndieGoGo was born. This variation on the crowdfunding theme is about raising money through donations for creative ventures. Things like movie making, music, and technology ideas are funded by contributors who don't get anything as tangible as interest payments in return. Instead they may get product samples or concert tickets, or simply anything appropriate that's linked to the idea being sold. Kickstarter came along in 2009 and today these two sites are the leaders in this area of crowdfunding.

Only relatively recently, in 2010, the equity based model emerged. GrowVC is an alternative to traditional venture capital, aimed at technology startups who want to raise money. This was followed by CrowdCube in 2011, which offers investors the chance to fund start up companies in all business areas. You can lend to established businesses for a fixed return, or take an equity stake in startups yet to prove themselves.

The two dominant models operating today are the donation based and equity based models. Others may yet emerge. Let's look at some of the benefits and risks associated with crowdfunding.

The benefits for the initiator of a crowdfunding project are multifold. A good project can help to raise the profile of the person starting it, thereby boosting reputation. It's a chance to prove that there is a market for their proposal, and it provides an opportunity to communicate with their audience, who provide feedback. If your idea doesn't fit the criteria of traditional banking finance you can open it up to the 'wisdom of the crowd'. This wisdom is predicated on the concept that the collective commitment and judgement of the crowd is a good predictor of success.

On the flip side, your reputation as a project initiator can be damaged if you generate no interest or fail to reach your stated goal. Appealing to the same bunch of donors again for subsequent projects may produce donor fatigue, which can doom a project to failure. If you're a lender as part of the loan based model you run the risk of losing your money, though in defence of the concept LendingClub has an annual default rate of just 3%, which seems reasonable, depending on your point of view of course.

As far as equity crowdfunding is concerned the risks are obviously higher for investors in start ups. The failure rate for start up businesses is high, and in some cases potential investors let their hearts rule their heads. Although in the UK the Financial Conduct Authority (FCA) regulates loan based and equity based crowdfunding, their outlook on the subject is that the risks are high. They advise potential investors to do their due diligence on the business they're thinking of investing in, and to satisfy themselves that they can handle the level of risk they're taking on.

Crowdfunding as a 21st century phenomenon has been made possible through the rise of social media and the sharing economy that it encourages. In the late 90's people were more reluctant to participate, but as social media networks like Facebook gained popularity the whole 'sharing' concept gained acceptance. This has allowed crowdfunding to grow and prosper. The donation based model has the potential to help individuals realise creative visions that enrich our art and culture, and assists charities in furthering their work. The equity based model allows entrepreneurs and prospective investors the chance to come together and realise business based visions. This comes with a risk warning, but it also opens up a new avenue of financing and communication that your staid bank manager could never contemplate. It is to my mind a refreshing disruption to the status quo, and demonstrates yet another way that the web is changing our lives.

Do You Trust Your Financial Adviser?

Many people who want to invest their money have little or no knowledge about what can often seem a bewildering array of products on offer. They have two choices: - either learn about the investment world themselves, or consult a professional adviser.

The perception of financial advisers in the UK is somewhat variable, ranging from the view that they exist only to enrich themselves at your expense, or that they provide a valuable service which allows their clients to make the best choices.

A survey conducted by Vanguard Asset Management in May 2013, asking 1163 people for their opinions on their interactions with financial advisers, came back with an overall 'average' score. Of the participants, 65%  had worked with a financial adviser, and the remainder gave their thoughts on the value they believed FA's provide. Around 41% of the total group thought that FA's provide good value, and 33% thought the opposite. What the other 26% thought remains unclear. What was clear for all those surveyed though, was both the quality of their relationship with their adviser, and the advice received.

Those who rate their advisers highly are more likely to understand what they're being offered and how it's being paid for. If you decide to visit a financial adviser, there are a few things you need to know.

1. What sort of adviser is he/she?

Financial advisers fall into two camps - independent and restricted. The independent adviser (IFA) can consider all products on offer in the market in order to help you meet your financial objectives. A restricted adviser on the other hand, is limited to recommending a certain number of products, or products from certain providers. It's important that you understand this distinction going in. A restricted adviser may recommend something that meets your needs, but in doing so disregards other market offerings that could be more advantageous. And there may be certain types of product the adviser doesn't advise on. So if you talk to a restricted adviser, make sure you understand just how restricted they are.

There's also the issue of guidance as opposed to advice. If your adviser talks to you in general terms about products - how they work for example, and perhaps terms and conditions attached, and he makes no specific recommendation, then you are receiving guidance. This is a non-advisory service, which leaves the decision on which product you actually buy down to you. This may reduce your costs, but makes it harder to appeal to the ombudsman if it all goes wrong. It would seem that independent advisers are the obvious option, but remember that some advisers are restricted because they specialise in a certain area, and from that perspective they may offer good value.

2. What qualifications does he/she have?

They should have as a minimum a diploma in financial planning that's recognised by the Financial Conduct Authority. And they should be regulated by the FCA.

3. What does he/she actually advise on?

Advisers are there to help you meet your financial objectives in the most efficient manner possible. The kinds of things they can talk about, that will reflect any investor's concerns regardless of where they are on the investment journey, include:

• Annuities - this is what you buy with your pension. It gives you an annual payment for the rest of your life.
• Protection products - income protection, life assurance and critical illness policies
• Mortgages - many varieties on offer, so good advice can be very useful
• Tax planning - the best way to minimize your tax bill on your investments
• Investments - products including stocks, ETFs, mutual funds etc. Finding the right mix to effectively build a portfolio

4. What will you pay?

On 31 December, 2012, a ruling known as the Retail Distribution Review came into effect. This means that commission payable to advisers on new product sales no longer applies. Instead the adviser levies an advice charge to his client. The idea is that all charges are now upfront and transparent. In the past clients paid commission, but it was often a stealthier form known as trail commission, that was paid to the adviser as a percentage of your investment on an annual basis. Because of this, clients were often blissfully unaware of just how much the product was costing them. It also gave the adviser an incentive to recommend products with the highest commission rates.

Make sure you clearly understand all the charges. General Insurance and mortgage products aren't covered by the Retail Distribution Review. However, in most cases you shouldn't be asked to pay for these, as the adviser takes an introductory fee from the product provider.

Charges can come in the form of a fixed fee, an hourly rate, or a percentage of your investment. If you want the adviser to review your investment periodically there will be an ongoing advice charge, which is usually a percentage of your portfolio value.

The whole rationale of the new advice charge is about transparency. It also removes the conflict of interest inherent in the old commission system. Transparency and advice charging = 'Trust'.

An adviser should be asking you about your family commitments, what investments you've currently got, what you're aiming for financially, and your attitude to risk. This is the beginning of the portfolio managment process. If you do find an adviser with whom you can build a good ongoing relationship, then there are some distinct benefits you can expect:

• He or she should keep you on track. As you can be your own worst enemy when it comes to porfolio managment, it's always good to have a knowledgeable sounding board available
• You will get expert assistance with your investments in the form of asset allocation and rebalancing advice
• Your adviser should be able to put together the most tax efficient strategy when it comes to taking the fruits of your investments

So the bottom line seems to be: - if you're clear and happy about what it will cost, and you're confident in the advice you're receiving, then there is no reason not to trust your financial adviser. When you first meet with that person though, be sure to ask all the right questions before committing yourself.

Darren Winters