Equity investment crowdfunding is a way to source money for a company or project by soliciting many backers, each investing a relatively small amount while typically using an online platform. In return, backers receive equity shares in the company.
Key Takeaways
- Companies or entrepreneurs can use investment crowdfunding to raise funds by soliciting many backers to invest a relatively small amount.
- Crowdfunding investing is unrestricted for accredited investors and has limits based on your income or net worth for those who aren't.
- The method can lower the barriers to entry for individual investors and is often through online platforms.
- Investments crowdfunded can include equities, real estate, and debt.
- Popular platforms for equity crowdfunding are the former StartEngine and FundersClub.
Understanding Investment Crowdfunding
Anyone can put money into a crowdfunding offering. Investment crowdfunding is unrestricted if you're an accredited investor and, if you're not, has limits on how much you can invest based on your income or net worth. In 2016, final rules issued by the Securities and Exchange Commission (SEC) for the Jumpstart Our Business Startups Act (JOBS Act) in the U.S. allowed for a wider scope of investors to invest via crowdfunding once the regulatory infrastructure was in place to do so.
Companies or entrepreneurs can solicit crowdfunding for equities, debt, and real estate investments. Risks include the potential loss of your whole investment, lack of liquidity since crowdfunded shares typically can't be resold easily, and the fact that your shares are relatively diluted and can be further watered down should more funding rounds occur.
Equity investment crowdfunding
You can use equity investment crowdfunding to put capital into companies, usually early-stage firms, and receive shares in them. Using online platforms, companies describe their business plans to capture your interest. You can spend a range of amounts, each with a gradation of percentage stake in the firm. As with regular stocks, the value of these shares goes up should the company do well. However, your equity interest comes with risk, given the relatively unpredictable prospects for startup firms.
Debt investment crowdfunding
Investment crowdfunding can also be done to exchange loans for equity stakes or interest income. You can engage with a large group who act as microloan providers in a debt investment. Through the platform you use, you'll review the purpose of the loan and the terms, including the interest rate, the loan's length, and the borrower's estimated credit rating.
Borrowers may seek this financing when traditional borrowing is too costly or not an option. Entrepreneurs typically have found seed money to start a new business by taking loans from banks, family, andfriends or offering equity ownership in return for investment from family and friends or angel and venture capital investors. Investment crowdfunding enables a startup to seek relatively small investments from many backers when other fundraising options are unavailable or cost too much. As a lender, you'll receive an interest rate typically higher than other debt instruments because of the credit risk of lending this way. You can, however, mitigate this risk by spreading your microloans across a range of entrepreneurs, projects, and companies.
Real estate crowdfunding
This method allows you to collectively pool money with many others in real estate projects through online portals. You contribute a smaller amount of money toward a property or development project and, in return, potentially earn a share of the profits from rental income or property sales. This approach allows non-accredited investors and those with less capital to participate in the real estate market, where investing traditionally requires a great amount of money or borrowing. This can also be a way to diversify your portfolio into real estate.
Popular Crowdfunding Platforms
One well-known platform for equity crowdfunding is FundersClub. The online platform supplies a curated list of equity crowdfunding investment opportunities. Typically, these are startups and early-stage companies. FundersClub says it vets each investment opportunity, with just 2% of those applying making it onto the site.
Another noteworthy platform is StartEngine, which in May 2023 acquired SeedInvest. The platform allows both accredited and non-accredited individuals to invest on its site.
Microlending platforms such as LendingClub and Prosper allow for crowdfunded debt financing where, instead of owning part of the company, as with some forms of debt crowdfunding, you become a creditor and receive regular interest payments until the loan is repaid.
Investment crowdfunding should be considered part of the riskier portion of any portfolio.
Investment Crowdfunding Benefits
Equity, debt, and real estate investment crowdfunding can be risky, but investors can diversify their money across numerous choices. It can be a way for individuals to support a startup they feel connected to, share their values, or simply look particularly promising. Since the buy-in can be very small for an equity stake (ordinarily, the company can set the terms), the barriers are low for individual investors. This can also be useful for learning about startup investing, debts, and real estate, depending on the platform you use.
The best investment crowdfunding offers several advantages and disadvantages for investors and those raising capital. For investors, benefits include starting with a small amount, potentially earning above-average returns, and gaining more investment transparency. Meanwhile, disadvantages are risks of failure, fraud, doubtful returns, and lack of liquidity.
For those raising capital, crowdfunding provides a quick way to raise financing with no upfront fees, helps test the market demand, and increases exposure. Potential disadvantages can include a low success rate, the time allocated to sourcing funds, and giving up equity in the project or firm.
Pros and Cons
Pros
Small initial investment and potential for high returns for investors
Often more transparency for investors than other investment vehicles
Quick method to raise funds for those sourcing capital
For those raising capital, crowdfunding can serve as market demand validation
Cons
High risk of failure for fraud for investors
Often lack of liquidity for investors
Generally low success rate and time-consuming for those raising capital
How to Get Started with Investment Crowdfunding
To get started with investment crowdfunding, first research the different platforms available. Choose a reliable crowdfunding platform that aligns with your investment interests. Create an account and thoroughly review the investment opportunities presented.
As an investor, it is vital to conduct due diligence. Understand the business model, management team, and risks involved. Decide on the amount you're comfortable investing, considering the annual limit based on your income and net worth for non-accredited investors.
Once you select a project, follow the platform's process to make your investment. Regularly review your investments and the company's progress. Remember, crowdfunding investments can be risky and illiquid, so it is vital to invest only what you can afford to lose.
Can I Trade My Crowdfunding Investment Shares?
No. Unlike traditional investors, crowdfund investors can't trade shares whenever they wish. These shares are often subject to holding period restrictions and may only be sold under certain conditions. The secondary market for them is not very developed, so finding a buyer can be a challenge.
How Does Real Estate Crowdfunding Work?
Real estate investing is a major part of the sector for investment crowdfunding and works like equity investment crowdfunding. Real estate crowdfunding enables many investors to pool their funds for property development or real estate projects. These projects may include different types of residential and commercial developments.
Can I Withdraw My Investment in a Crowdfunding Investment?
It depends on the platform's policies. Typically, though, once you invest in a crowdfunding campaign, it cannot be withdrawn.
The Bottom Line
Crowdfunding investing has grown significantly since 2016, when regulations lowered the bar for access. Noteworthy benefits include this lower barrier to entry for both businesses and investors, the potential for high returns, and enhanced market visibility. The cons are related to the risk of failure, the potential for fraud, and uncertain returns. As the sector evolves, stakeholders must balance these factors to make informed decisions.
