Investing Through Crowdfunding: What You Need To Know

Crowdfunding3The Jumpstart Our Business Startups Act (JOBS Act) Title III came into power on May 16th – expanding the investment opportunities to non-accredited investors, who have been historically excluded from this process. Every American will have access to invest in startups and small businesses and share in their financial success. If you are thinking to put your money in a startup, here are some things you need to know.

What’s the difference between investment crowdfunding & rewards-based crowdfunding?
Equity or investment crowdfunding enables investors to invest in companies fundraising on online portals and gain ownership, or a promise of future returns while in rewards-based crowdfunding you will only receive a “reward” for your contribution to the company.

The risk of failure.
Like all private investments, crowdfunding is high-risk. An early equity-based investment could result in a big return, but many of the companies could end up not being successful – and therefore you need to be ready to lose your money. The potential upside for investors is that they will be able to review a large number of alternative investments through crowdfunding portals and hopefully fund the ones that will be successful. Spread out investment risk – you need to spread the risk across more than one company.

Keep your eyes open.
Online platforms are ideally suited for equity crowdfunding because they offer wide reach, scalability, convenience and ease of recordkeeping but this also makes it a target for fraudsters to set up dubious ventures to attract equity crowdfunding from gullible investors. Even though the platforms are required to take measures to prevent fraud, investors who have not had the patience to conduct due diligence before investing may end up losing their entire investment to fraudulent crowdfunded schemes.

Returns may take years to materialize.
An investor who invests through equity crowdfunding has an expectation of some return on investment in the future – however, it may take many years to materialize. In many cases, equity may not ever accrue to the investor. Management may deviate from the business plan, or could be out of its depth when trying to scale up the company. You may have to wait several years before a startup company goes public and you can sell your shares on a stock exchange. Usually, investors wait for 5-10 years on the return.

Investing through equity crowdfunding has the potential for huge returns, although the odds of hitting a home run on such investments are quite low. Remember the story of Facebook’s $2-billion acquisition of crowdfunded virtual reality headset maker Oculus Rift in 2014? Oculus Rift raised $2.4 million on donation-based crowdfunding portal Kickstarter from 9,500 donors. Unfortunately, however, since these backers were donors and not investors, they did not receive any payout from Facebook’s acquisition. Had Oculus Rift raised its initial capital through equity crowdfunding, the Facebook buyout would have generated an estimated return of between 145 times and 200 times the original investment, which means that an average $250 investment would have resulted in proceeds of $36,000 to $50,000.

Greater degree of satisfaction.
Investing through equity crowdfunding can give the investor a greater degree of personal satisfaction than investing in a blue-chip or large-cap company. This is because the investor can choose to focus on businesses or ideas that resonate with him or her, or that are involved with causes in which the investor has a deep belief. The real reward for crowdfunding investors isn’t financial but the opportunity to participate. Helping entrepreneurs achieve their dreams, and being a part of a company that changes its industry – or maybe even the world. Everyone should have the freedom to make a difference with their dollars.

Equity crowdfunding is rapidly gaining in popularity. According to the research firm Massolution, equity crowdfunding platforms raised $1.1 billion for business owners in 2014, an 182% increase from the previous year (2015 CF – Crowdfunding Industry Report). Investing through equity crowdfunding carries risks but it also offers rewards like the potential for huge returns, a greater degree of personal satisfaction, the opportunity to invest like accredited investors, and the prospect of stimulating the economy through business and job creation.