The internet’s ability to connect people and share ideas has evolved and given rise to a new type of investing called crowdfunding. In 2015 alone, the total equity invested in crowdfunding worldwide reached $2.56 billion dollars, according to the Massolution Crowdfunding Industry Report[i].
In this blog post, you will learn more about crowdfunding, how it works as an investment tool, and get tips on how to leverage it as part of your investment portfolio.
What Is Crowdfunding?
Research in the Journal of Business Venturing defines crowdfunding, or equity crowdfunding, as a method for entrepreneurs and startup companies to fund their ventures through small contributions submitted online from many people[ii]. It essentially expands investment opportunities once limited to venture capital groups or wealthy individuals. Ordinary people have a chance to invest in early stage startups solely based on a product idea or service concept and marketed on dedicated crowdfunding websites such as Kickstarter.
How Does Crowdfunding Work as an Investment Tool?
The 2012 JOBS Act signed by President Obama legalized equity crowdfunding to be used as an investing opportunity as noted in research published in the Journal of Business Venturing[iii]. Just as stocks give individuals an equity stake in a company, equity crowdfunding promises individual investors a share of the business or future project sales. However, unlike stocks, there is no “market price” for crowdfunding pledges. Interested individuals simply invest an amount they can afford in the company or idea. The crowdfunding site only collects the money pledged to the project by the collective investors if the full capital goal is raised. However, only one in nine projects ever gets fully funded through crowdfunding, according to research published by Harvard Business School[iv].
If the business or project takes off, investors will see a positive return on their investment. If the opposite happens, investors lose their money.
One unique aspect of crowdfunding investing is that there is a high level of transparency between the entrepreneur and investors. Once the required funds are raised, entrepreneurs communicate timelines for product or concept delivery and often communicate updates in bringing the product or concept to life. Based on these launch timelines and considering product adoption rates, it is important to view any crowdfunding participation as a long-term investment.
The federal government now acknowledges the popularity of crowdfunding and has implemented new regulations around this collaborative investment practice. The U.S. Securities and Exchange Commission (SEC) even has a complete section on the topic.
Recently updated SEC guidelines indicate that “because of the risks involved with this type of investing, you are limited in how much you can invest during any 12-month period in these transactions.[v]” For a complete list of 12-month limits based on annual income levels, visit the SEC website here: https://www.sec.gov/oiea/investor-alerts-and-bulletins/ib_crowdfundingincrease.
Crowdfunding Investment Tips
Now that you are more familiar with crowdfunding and how it works, here are some simple tips to help guide participation in it as part of your investment portfolio:
- Do your research. Much like participating in the stock market, crowdfunding investment opportunities are like hedging a bet. You should spend time researching the startup company that is seeking investments, as well as the idea being proposed. Researching won’t make your investment a sure bet, but you can feel more confident in the entrepreneur and the idea.
- Consult with a certified investment advisor. He or she can work with you to review your comprehensive investment portfolio and weigh the benefits and risks before participating in crowdfunding investing. Also, an advisor can help with the research and analysis to determine how much you should invest through crowdfunding.
- Wade through the crowd. The openness of crowdfunding platforms like Kickstarter allows you to see who else is investing in startup companies. Following notable angel investors and VC firms is one way to help you navigate the flood of ideas offered on crowdfunding websites. You should still perform your own research, but watching other investors can narrow your crowdfunding investment options.
[i] 2015 Crowdfunding Industry Report. Massolution. http://reports.crowdsourcing.org/index.php?route=product/category&path=20.
[ii] Mollick, Ethan. “The dynamics of crowdfunding: An exploratory study.” Journal of Business Venturing. Vol. 29. 2014. https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2088298&http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2088298.
[iii] Mollick, Ethan. “The dynamics of crowdfunding: An exploratory study.” Journal of Business Venturing. Vol. 29. 2014. https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2088298&http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2088298.
[iv] Mollick, Ethan and Ramana Nanda. “Wisdom or Madness? Comparing Crowds with Expert Funding in the Arts.” Harvard Business School. August 2015. https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2443114.
[v] “Investor Bulletin: Crowdfunding Investment Limits Increase.” U.S. Securities and Exchange Commission. May 2017. https://www.sec.gov/oiea/investor-alerts-and-bulletins/ib_crowdfundingincrease.