Crowdfundingfor local authorities

how to...

part of our how to guide series on finance and local economic growth

IntroductionCrowdfunding has created a frenzy in the business community and the creative sector because of its ability to raise money quickly and flexibly, bypassing traditional sources of finance. But it has yet to become as widely adopted among local authorities. This is in large part down to the fact that councils are rightly cautious about new fads when it comes to handling public money. However, much of this caution comes from confusion about what exactly crowdfunding is, how it can be used in a local government context and how to weigh its risks and benefits. We hope to shed some light on this area so that people working in local government can make informed choices about if and how to get started.

There are three main types of crowdfunding: ● Donations-based crowdfunding ● Equity crowdfunding ● Peer-to-peer (P2P) lending

These work in different ways that are accessible to different organisations and groups. This guide will help you to unpick the different types of crowdfunding, their uses within and outside local government, and contains practical tips for those who wish to give crowdfunding a try.

While this is still new territory for local government, it is cheering to note that crowdfunding is already working well for many councils as we mention throughout the guide. It holds the potential to raise money for local charities and social projects, to earn higher interest on council savings, to plug funding gaps for services and to support local businesses and the economy. These opportunities will be different in each area so we will give ideas rather than instructions.

Please note: You must not rely on the information in this guide as an alternative to legal/financial advice from an appropriately qualified professional.

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What can councils use crowdfunding for?Donations-based crowdfunding

Equity crowdfunding

Peer-to-peer lending

Raising money for the council/council services

Depends on circumstances* No Yes

Investing council money in local businesses/social enterprises Yes Yes Yes

Investing council money in local charities Yes No No

Distributing council money to community projects Yes No No

Supporting the local economy by promoting local crowdfunding campaigns run by local businesses/social enterprises Yes Yes No

Encouraging individuals and organisations to donate to community projects Yes No No

Helping local businesses/social enterprises raise money through crowdfunding Yes Yes Yes

Helping community projects to raise money for projects through crowdfunding Yes No No

*Crowdfunding involves getting the public excited and engaged enough to support campaigns. If the council was running a campaign asking the public for direct donations, the public would most likely see it as giving the council more money, on top of council tax, and would be turned off by the prospect.

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Who can raise investment/borrow money through crowdfunding platforms?

Donations-based crowdfunding

Equity crowdfunding

Peer-to-peer lending

Local authorityDepends on circumstances* No Yes

Business Yes Yes Yes

Social enterprise Yes Yes No

Individual Yes No Yes

Community project Yes No No

Charity Yes No No

* As mentioned on the previous page, although local authorities are able to raise money for themselves through donations-based crowdfunding, it may not appeal to the public.

These tables are intended to give you an overview of the possibilities attached to each type of crowdfunding. However different platforms operate in different ways.

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Donations-based crowdfundingPlatforms include Spacehive, Kickstarter, Indiegogo and Crowdfunder

This type of funding involves people donating money towards a project, product or business. Unlike equity or debt funding, investors have no expectation of seeing that money again – it is comparable to donating to charity.

A range of people and organisations list on this type of platform – film students, museums, inventors, startups, charities, social enterprises, academics… There is a strong appeal in getting something for (essentially) nothing!

Many councils are already using this type of crowdfunding with great success for a variety of purposes. Some say that they have increased community engagement through running crowdfunding projects and are able to direct their support to the things that residents care about most. Instead of the council deciding which organisations need grant funding, the residents can decide themselves.

How does it work?A target funding amount is set by the individual or organisation that is raising money, and the campaign is listed online. Anyone can donate – individuals, organisations, local authorities, etc. – and they are able to contribute however much they feel like giving . The organisation must reach its target amount in order to receive any of the money. If the target total is reached by the deadline, the money is taken from those that have pledged; if not, no money is taken at all. The platform acts as an intermediary, handling the money.

Sometimes the person or organisation raising money will offer non-monetary rewards for the investment – such as preview screening tickets for a film, one of the first batch of products, keyrings, or your name in the acknowledgements. But for some investors, the satisfaction of having contributed to a worthwhile project or an improvement of their local area is enough. In Nesta’s 2014 report ‘Understanding Alternative Finance’, they found that “when choosing which campaigns to back, more than 60 per cent of backers valued the quality of the idea, the team and knowing their money was making a difference.”

Use in local authorities ● Councils can encourage residents to contribute to local projects run by charities,

community groups or individuals. They can also use their unique position of influence within the community to convene resource from other stakeholders, and make it available to project creators. Manchester City Council and 16 London Boroughs have done this with the help of Spacehive, a civic crowdfunding platform. Residents, businesses and councils can donate to ideas posted on the website. The public take ownership in delivering projects - reducing the burden on the local authority.

● Councils can leverage their existing funding streams by offering to match funding from the crowd for community projects. Some councils, including Dorset and Plymouth, have partnered with Crowdfunder to attract applications for community projects, with the promise of matched funding from the council if the crowd contributes.

● Councils can also look for ideas about where to put their resources by looking at local projects that have been successfully crowdfunded. This gives the council a good idea of what issues and projects matter to their residents. For instance, in response to Liverpool

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People donate money to a project they believe in, which is listed on a crowdfunding website, eg new play equipment for their local park

If the project raises its target funding amount it goes ahead. In this case new play equipment is purchased for local children to enjoy!

Sometimes the project organiser will offer non-monetary ‘rewards’ for people who donate money, such as VIP passes to the opening of a film they have funded

City Council’s proposal to remove an abandoned flyover, the local community crowdfunded over £40,000 to pay for a feasibility study looking at creating an elevated park instead.

Top tipsRaising money

● There is little financial risk involved for councils wishing to raise money from the crowd through this type of platform. The main consideration is how the community will respond. Depending on what the council is raising money for it is possible that residents may perceive your fundraising efforts as an additional tax for services they already expect from their council. However if the project is developed alongside the community, you have a much better chance of achieving buy-in to the idea and therefore raising money.

● According to councils that have tried raising money through donations-based crowdfunding, smaller localised projects seem to work well. Encouraging residents to donate to projects that are less fun, accessible or personal, like infrastructure or on-going maintenance costs, is likely to be quite a hard sell. In general, donations-based crowdfunding is good for augmenting existing council spending, but shouldn’t be used to fully replace it for most services.

● It may be preferable to use existing crowdfunding platforms than to design your own. When spending money online, people tend to prefer a familiar site as a reassurance that their money is safe. Moreover, the design of crowdfunding platforms is rapidly evolving to maximise the user experience and maintaining your own to the same standard would be very difficult.

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Investing money

● When donating to a project, or encouraging others to do so, you should do some background research on the individual or organisation behind it to make sure they are credible, contactable and are really doing what they say they are doing. If necessary, ask your financial advisor to conduct due diligence to uncover any past bankruptcies or fraud convictions.

● It’s worth bearing in mind that there is no guarantee that the project will be completed, will be a success or that the people listing it intend to work on it at all. Platforms are trying to crack down on this (for example by requiring those listing on the platform to sign a contract saying they will deliver their project, as Spacehive does) and doing your own research will also help minimise the risk.

● You should take the usual sensible precautions when investing council money into external projects. As with any other type of grant funding, you may wish to offer the money in tranches upon reaching certain milestones, or to ensure that projects commit to delivering defined goals.

Case Study: Lewisham Council“We see Spacehive being used as a way to make the local voluntary and community sector more sustainable by building their skills and capacity as well as diversifying their fundraising strategies.”

Winston Castello, Community Enterprise Manager, Lewisham Council

When the London Borough of Lewisham adopted civic crowdfunding in 2015 as a way to distribute their grants, they were not just looking to address reduced resources but were also working towards creating a more sustainable funding model for community projects as well as building the skills and capacity of local organisations.

Using an existing funding pot of £100,000, the council invited local groups to upload their project ideas to Spacehive and demonstrate community support through attracting pledges. The council then pledged up to £10,000 towards the most popular projects.

Since the Council’s fund launched on Spacehive, 36 projects have been successfully crowdfunded, raising £323,000 from more than 1,300 backers. Following Lewisham Council’s lead, other local organisations including Lewisham Homes, idverde UK, GLL, Lendlease, Veolia and the Esmée Fairbairn Foundation have since set up their own matched funds on Spacehive, meaning the ecosystem of match funding available for Lewisham projects has now more than trebled to £350,000.

The success of the initiative has encouraged the council to begin exploring the role civic crowdfunding could play in their wider regeneration plans. What started off as one funding pot has catalysed the growth of a vibrant ecology of ideas and funding. Residents are empowered to become change-makers within the community through creating and delivering projects that matter to them.

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Equity crowdfundingPlatforms include Crowdcube, Seedrs and Syndicate Room

Equity crowdfunding is mainly used by young, high-growth businesses looking for money to grow. It falls into the broader category of equity investment, which includes venture capital and private equity firms. Equity crowdfunding platforms take the equity investment process online and open it up to a wider pool of potential investors – the ‘crowd’.

Equity investment involves the company raising money from investors, who then own shares in the company. At some point in the future, if the company has grown well, the investors can sell their shares for a much higher price than they paid for them. However, if the company fails, they will not receive any of their money back. It is high-risk for investors but if they bet on the right horse, they can earn several times their initial investment. However with equity investment there is no guarantee that you’ll see your money again if the business fails, so investors must be prepared to lose all the money they invest. Equity investment is popular with young companies that are too risky for banks and other lenders because they aren’t yet profitable or don’t have any assets to borrow against.

Until crowdfunding platforms came along, equity investment was the domain of venture capital funds, pension funds, and professional investors called ‘business angels’, who can commit large amounts. With equity crowdfunding, ordinary investors with less money to invest can get involved too – the online platforms allow lots of people to give smaller amounts, without a huge administrative burden for the company.

How does it work?Only private companies with share capital can raise money through equity crowdfunding platforms (i.e. not charities, companies limited by guarantee or public bodies). This is because they must be able to give away legal ownership of part of the organisation, so councils would not be able to raise money this way.

Equity crowdfunding is usually facilitated by an online platform which acts as an intermediary between the company raising money and the investors. The crowdfunding platform is responsible for finding suitable companies to list on their website and conducting some background research on them. Once they have been vetted, the company profile is listed on the crowdfunding platform, along with a target fundraising amount and how much of the company they are giving away (in the diagram, Drinks co. is raising £30 and giving away 10 per cent of its shares).

Individuals browse through the companies listed on the crowdfunding website and can invest any amount they choose in companies they like the sound of. If the company’s target amount is reached by their deadline, the investment is allowed to move forward – the company takes the money and the investors receive their shares. If the total isn’t reached, the money will be returned to the crowd and the investment will not go ahead.

Unlike on the public stock market, there is currently no simple way of re-selling shares in private (unlisted) companies once you have invested. This means that your money is effectively tied up until the company ‘exits’ (e.g. by listing on a stock exchange or being bought out). This usually takes between 5 and 10 years, depending on the sector of the business and the point at which you invest, but will be dependent on circumstances and is not a fixed date unlike with bank loans.

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A company decides to raise money by selling some of its shares through a crowd funding website

In this example Drinks Co. is selling 10% of its shares at a price pf £30.Crowd investors can choose how much they want to invest and therefore how many shares they buy.

However if the company has not been successful, crowd investors will not be able to sell their shares and will not receive any of their original money.

After a few years, if the company has been successful, crowd investors will be able to sell their shares for much more than they were bought for originally. In this example the investors have increased their money tenfold.

OR

Use in local authorities ● Councils could invest into any local companies that have been listed on equity

crowdfunding platforms, with the aim of supporting local economic growth. Lancashire County Council became the first council to try this when they invested in local businesses via the Crowdcube platform in August 2016.

● As part of their Treasury management, councils could invest their reserves in businesses through equity crowdfunding platforms as a way of earning a higher return on the council savings. It’s worth remembering that this should be part of a diversified portfolio of investments including some with a lower risk profile.

● Councils could get involved with equity crowdfunding as a facilitator rather than an investor, by brokering relationships between local businesses that need finance and the platforms themselves.

● Remember, councils cannot raise money for themselves through equity crowdfunding platforms – because they do not have any shares to sell!

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Top tips ● Equity crowdfunding is still a very young industry (roughly six-years-old) and because it

takes several years to tell if an equity investment has been successful, it’s very difficult to judge how risky equity crowdfunding is – both compared with regular equity investing and with other forms of investment.

● Remember that you must be prepared to lose the whole amount of your investment and that you cannot rely on the money being returned to you by any specific time.

● Always seek independent financial advice. Advisors will be able to tell you if you’re getting good value for money by looking at factors such as the stage of the company’s growth, the sector it’s in and the company’s financial history. Although platforms usually conduct their own background research, the extent and rigour varies between platforms so you should always seek independent reassurance.

● Ask your lawyer to check the investment terms. In many cases, ‘crowd’ investors will receive non-preference shares, which means that they will be at the bottom of the pile if the company fails and any assets are divided up between investors.

● Ask your lawyer to check for non-dilution clauses. Dilution of your investment value is a danger with equity investing if the contract isn’t watertight, and may lead to your shares being worth much less than you anticipated. For example, you might buy 100 shares which comprise 10 per cent of the company’s 1000 shares. Then in a year’s time the company raises another investment and creates 1000 new shares to divvy up among new investors, making 2000 shares in total. Suddenly your 100 shares are only worth 5 per cent of the company. You need to check you have a non-dilution clause to prevent this from happening.

● Do your research about any equity crowdfunding platform you plan to invest through. Do they also invest in the company themselves, proving their commitment to the business plan? Do they manage your shares for you? Have they been in any hot water over their methods? How long have they been operating? How many companies have successfully raised funding through their platform? And how many failures have there been (always remembering that failures could take a few years to appear)?

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Peer-to-Peer (P2P) lendingPlatforms include Funding Circle, Ratesetter, Thincats and Zopa

Peer-to-peer lending is a funding method that bypasses banks, by matching a borrower directly with an individual or organisation with money to lend. The idea is that, by cutting out the middle man, the lender will earn higher returns on their money compared with putting it in a standard bank account, and the borrower will benefit from a faster, more flexible process and competitive interest rates.

Peer-to-peer lending is often used by businesses (e.g. through Funding Circle and ThinCats), but in theory any type of borrower can use this form of funding. People have been known to borrow for personal mortgages, student loans and more (e.g. through Zopa and Ratesetter).

Typically businesses that seek debt finance are more established, profitable and have assets such as property and equipment to borrow against, as opposed to young startups which often seek equity. This can go some way to reducing the risk that the borrower will be unable to repay the loan. However, most platforms offer an indication of each borrower’s level of risk.

How does it work?Peer-to-peer lending can work in different ways depending on who is lending and who is borrowing, and which platform is being used.

Typically, lenders can pick and choose from the selection of borrowers listed on the website, according to how much they want to invest and how much risk they want to take on. So as a lender you would see a list of companies, alongside information including: how much they are asking for; what interest rate they will be paying based on risk and how long they need the money for. Once the funding has been distributed, the borrower will then make monthly repayments, along with interest, that is distributed to the lenders.

From the borrowers’ perspective, they can apply for a loan online in as little as 10 minutes, and receive a decision within 48 hours. After a credit assessment, the loan is given a risk band (indicating how much interest investors will earn) and then listed on the platform.

On some platforms there is a secondary market, where you can buy and sell parts of existing loans before the repayment date, allowing investors to access their money before the end of the loan term (if they are able to find a buyer, of course).

A number of local authorities now use peer-to-peer lending platforms. Some use their economic development funds as a means of lending to local small businesses, whilst others use treasury funds to lend across the UK as a way of earning attractive returns. When using economic development funding, local authorities use platforms to directly target small businesses in their region; the platform sources the borrower and carries out a credit assessment of each one. Funds are then allocated from the local authority based on their lending criteria. Platforms take care of all payments, thus reducing the administrative burden on the government body while helping them to meet their economic growth aims.

Central government is also using platforms to inject funding into UK small businesses. Most notably, the Government-owned British Business Bank (BBB) has lent millions through platforms like Funding Circle, MarketInvoice and Ratesetter. This enables the Government to lend to thousands of businesses across the UK, whilst also earning reliable returns.

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Peer-to-peer loans are like normal bank loans, except without the bank being involved. They can be used to fund all the same types of things - businesses, property, buying a new car, etc. The platforms link lenders directly with borrowers.

After an agreed amount of time, the borrower must repay the load, plus interest, to the lender.

Use in local authorities ● Councils can use P2P lending platforms as a way of managing their investments into local

businesses they have identified as needing support. This is already being done by many councils including Camden and Lambeth.

● Equally, councils could in theory invest in social enterprises, local charities or other organisations in a similar manner, but not through the more established platforms.

● As part of their Treasury management, councils could invest their reserves through P2P lending platforms, if the investment options available suit their risk appetite. Equally, they could apply to borrow money for bigger projects themselves. For instance, Warrington Council has set up its own P2P lending platform which facilitates lending between public sector organisations.

● Councils could get involved with P2P lending as a facilitator rather than an investor, by brokering relationships between local organisations needing finance and the platforms themselves.

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Top tips ● Peer-to-peer lending is still a relatively young industry (roughly 10 years old), but the

industry’s largest platforms set up a self-regulatory body in 2011 called the Peer-to-Peer Finance Association (P2PFA), which promotes high standards of conduct and consumer protection on top of the full set of regulations set by the Financial Conduct Authority - so these are a good place to start.

● Whilst some platforms have had some issues recently, debt crowdfunding is a more developed market than equity crowdfunding and lending is usually much lower risk than equity investing in general. Make sure you research the platform you intend to work with.

● Whilst platforms carry out thorough credit assessment checks on all borrowers before they are listed on the platform, the best way to mitigate risk as an investor is to diversify your investment across as many borrowers as possible. Investors should expect borrowers to default as this is a very normal part of lending, but by spreading your investment across as many borrowers as possible, you reduce the impact of bad debt on your portfolio.

● Platforms provide credit checking of borrowers but your investment is not covered by the Financial Services Compensation Scheme. Some platforms offer a ‘bad debt guarantee’, where losses are offset by a ‘provision fund’ that is funded by investors when they first start lending. A stated priority in the FCA’s regulation of the sector is that platforms have full wind down plans in place so that investors still receive loan repayments in the event of a platform ceasing to trade. Even so, it is worth checking what might happen to your money if the platform itself shuts down.

● Remember that lending through these platforms is an investment, so your capital is at risk and returns are never guaranteed – regardless of any bad debt provision funds. You must be prepared to lose the whole amount of your investment.

● A large majority of lending through platforms is unsecured with a personal guarantee, so you should use platforms’ historical loss rates as a good indication of a platforms’ credit assessment capabilities. These can all be found on the P2PFA’s website.

● Most platforms offer a secondary market so you can sell your loans if you choose to leave the platform before the loan matures so bear this in mind when choosing a platform.

● Always seek independent financial advice. Whilst an adviser won’t advise you on each and every £20 investment you make through a platform; they will be able to guide you towards a suitable platform based on the type of lending you want on your portfolio i.e. business, consumer or property lending.

● Always consult with a lawyer. Ask them to check the investment terms. Whether you are borrowing or lending, what will happen in the event the borrower cannot repay the loan? Do some investors have a preferential agreement? What happens to the loan agreement in the event that the platform closes down?

● Do your research about any P2P lending platform you plan to invest through. Start with members of the P2PFA, who adhere to rigorous self-imposed standards to ensure consumer protection. Have they been in any hot water over their methods? How long have they been operating? What is the default rate of businesses listed on their platform (always remembering that these could take a few years to appear)? How do they conduct their due diligence? Will they cover your investment if the borrower defaults?

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What next?The first step is to assess your own council’s strategic priorities and work out if crowdfunding can help to achieve any of these; there is no sense in adopting crowdfunding for the sake of it! At the very least it makes sense for those working in local government to educate themselves about their options with regards to crowdfunding, to be able to make informed decisions and construct persuasive business cases if the time comes.

As funding cuts continue to put a strain on both statutory and discretionary services alike, increasing public engagement with community services will become even more essential. Asking the community to prioritise and fund their own projects could have the threefold benefit of involving residents, continuing important services and reducing the financial burden on the council.

Equally, in the context of 100% business rate retention being implemented in the next few years, councils may increasingly be looking for ways to attract and retain businesses in their region, and crowdfunding may be a way of achieving this.

This guide is part of LGiU’s local government finance programme for 2017. We will be exploring innovative ways for councils to support their local economy and bolster public service delivery, such as using social impact bonds, supporting entrepreneur hubs, and leveraging council savings in new ways.

We are really keen to hear how you get on so please get in touch with any thoughts, advice and examples of crowdfunding working (or not working) so we can keep sharing best practice within local government.

Get in touch by email: jennifer.glover@lgiu.org.uk

Join our LinkedIn Group: linkedin.com/groups/LGiU-Policy-8588500/about

Sign up to our monthly Finance policy update: www.lgiu.org.uk/policy-theme/finance

Speak to Spacehive: partner@spacehive.com

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LinksPlymouth City Council: https://www.plymouth.ac.uk/news/plymouth-university-welcomes-the-launch-of-crowdfund-plymouth-which-will-provide-_60000-to-local-projects

Dorset County Council: http://www.dorsetecho.co.uk/news/14562293.Dorset_County_Council_to_crowdfund_youth_projects/?ref=rss

http://www.crowdfundinsider.com/2016/06/86961-crowdfunder-uk-teams-up-with-dorset-county-council-to-offer-crowdfunding-youth-projects-200000/

Warrington Council: http://www.socialhousing.co.uk/council-and-funding-adviser-launch-peer-to-peer-lending-platform/7014362.article

London Borough of Lambeth: https://www.fundingcircle.com/blog/press-release/lambeth-council-to-finance-local-business-growth-through-funding-circle/

London Borough of Camden: https://www.fundingcircle.com/blog/press-release/camden-first-london-council-finance-local-business-growth-funding-circle/

Liverpool City Council: http://www.independent.co.uk/news/uk/crowdfunding-gets-liverpool-s-elevated-park-off-the-ground-9318140.html

General

http://www.nesta.org.uk/blog/big-and-small-funders-learning-play-together

https://www.nesta.org.uk/sites/default/files/understanding-alternative-finance-2014.pdf

https://www.theguardian.com/local-government-network/2013/may/29/crowdfunding-way-forward-for-councils

http://p2pfa.info/

LGiUThird Floor, 251 Pentonville Road, London N1 9NG 020 7554 2800 info@lgiu.org.uk www.lgiu.org.uk

© LGiU March 2017

LGiU is an award winning think-tank and local authority membership organisation. Our mission is to strengthen local democracy to put citizens in control of their own lives, communities and local services. We work with local councils and other public services providers, along with a wider network of public, private and third sector organisations.

Spacehive is an award-winning crowdfunding platform for civic projects, designed in the UK with the help of thousands of citizens, government, businesses and grant-makers. The platform aims to make it as easy as possible for people with ideas for improving their local area to attract the support and funding they need to deliver them.

To do this, Spacehive has streamlined key processes involved in proposing, funding and delivering projects – from checking the viability of ideas to identifying and applying for funding from grant-makers and the “crowd” at the same time, and reporting back on the impact they make.

Cities are rich with creativity and resource. Spacehive allows collaboration across silos like never before, empowering changemakers to create vibrant civic spaces that boost quality of life and the local economy. It’s a model that works for community change-makers and works for cities.

Author: Jennifer Glover, LGiU