Investing through crowdfunding sites is growing increasingly popular around the world. In Spain alone there are more than 10 platforms focusing on equity investments. If you’re thinking about investing through crowdfunding, here are some key points to consider.
1. With risk there’s reward:
Investing in early stage businesses has the potential for great returns. NESTA, a UK-based nonprofit focused on supporting innovation, identified British business angels as having an overall return of 2.2 times the capital invested.
This kind of investing does, however, place your capital at risk. While reputable crowdfunding sites carry out due diligence on the investment opportunities they present, it’s vital that you do your own and only invest what you can afford to lose. So ask questions and join in on conversations – see what the crowd thinks. Many sites have forums or other ways of asking questions of the entrepreneurs and other investors. These are a great way of figuring out what you need to know before making the decision to invest. Crowdfunding has opened up investment to a whole new group of people so make the most of their skills and insight.
2. Generous tax breaks and investment incentives
There are some very generous tax breaks available to investors in Spain.
When investing in companies that are less than three years old, investors in Spain are entitled to an income tax write-off of 20% of their investment.
Many autonomous communities offer additional incentives to their residents and startups. For example, in Cataluña investors receive a supplementary 30% break, which means that if you live in Cadaqués and invest in a new Barcelona startup, you can write off 50% of that investment on your income tax returns at the end of the year. You can check out a full description of the tax breaks, as well as a rundown total tax breaks by autonomous community here.
These tax brakes aren’t the only incentives that Spain has put into place to encourage investing in early stage companies. In addition:
- Upon divestment in a company in which you invested during its first three years of existence (even if we’re in, say, year 5), all profit that you make is not taxable, so long as it is re-invested in early-stage companies.
- If a company (less than three years old) in which you have invested fails, you can recoup your investment by writing off your capital gains tax for up to four years.
3. Choose the right platform for you:
Some platforms are open to everyone – from investment novices to Venture Capitalists. Others are restricted to networks of Business Angels and/or funds. The minimum investment amount also varies drastically site to site, ranging from €10 to more than €1,000.
If you’re new to investing and want to start small, look towards the sites that have minimum investments of less than €100. Since the Spanish Government has not yet finalized its regulation of the crowdfunding industry, investors need to be vigilant and self-regulatory about how much they invest. The crowdfunding community is eagerly awaiting the Spanish crowdfunding legislation, as it will help protect individual investors and help them make smarter decisions.
4. Investor fees:
If you make a profit from your investments some platforms will take a slice of your money despite not taking any of the risk. It’s worth checking which platforms charge investors and those that don’t. A commonly used phrase is a ‘carry’.
5. Shareholder Rights and Dilution:
Before investing, it is important to understand the rights that your shares afford you, and what will happen to those shares (and their value) as the company grows.
Some platforms offer the option to emit voting (Class A) and/or non-voting (Class B) shares during their campaigns. Make sure you are fully aware of the rights that your shares afford you – and what kind of position you want to play in the company – before investing.
Dilution occurs when a company issues more shares and affects every existing shareholder who does not buy any of the new shares being issued. As a result an existing shareholder still holds the same number of shares, which may have increased in value, but their proportionate shareholding of the company is reduced, or ‘diluted’.
In relation to dilution, you may see the phrase ‘pre-emption rights’. In essence, this means that if you have pre-emption rights and the business wants to sell more equity they usually have to give you the option to buy some first and stop your share from being diluted. The key point here is that you have to invest more money to stop dilution occurring. It’s you parting with more money that stops dilution, not pre-emption rights per se.
Some equity crowdfunding sites, like Crowdcube España, offer additional investor rights, like Tag Along and Drag Along clauses. Tag Along rights mean that if some shareholders decide to sell their stake in the company for a certain price, all shareholders have the option to share at that same price. Drag Along means that if a majority shareholder decides to sell the company, they can require that all shareholders sell, again at the same price.
When thinking about when and where to invest, it is important to consider how you will make a return. Generally equity investments have higher risk than other forms of investment, but can also result in greater returns. Given the riskiness of investments, it is always a good idea to diversify your portfolio of invested companies. Here are some common ways startups could exit and if the company is successful, how you could earn a return on your investment:
- Dividends, which are cash payments to investors taken from a company’s retained earnings, allow shareholders to see cash returns earlier than other liquidity events.
- When a company is sold to another company, shareholders are entitled to their share of this liquidity event.
- Some companies choose to buy back investors shares for a multiple of what investors paid.
Through crowdfunding, anyone can participate in the world of investments. They can feel the satisfaction of helping a great idea get off the ground, the stress of witnessing firsthand the ups and downs, the delays, and the struggles that come with starting a business, and they can experience the thrill of seeing an idea that they believed in turn into a successful company. And with equity crowdfunding, investors also have the potential for upside. Articles like this make it fun to dream about the potential returns we could all experience with some smart investments with the crowd.
Hopefully these points will give you some of the information you need to decide if investing via a crowdfunding platform is right for you. Just remember that your capital will be at risk and ensure you aware of the risks involved before investing.
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