So you have heard about crowdfunding, the strategy that allows entrepreneurs to raise money from the public. It sure has led to some interesting ideas and concepts, with some of them a “bit out there.” So how does the investor benefit? Are investors looking to hit that home run when they become a crowdfunder? Many crowdfunding projects are finding success and now a lot of publicity, yet the payout for an investor is not much: maybe a commemorative T-shirt, a special gadget, etc.; that is, if you’re lucky.
Photo by flickr user photologue_np.
Crowdfunding still hasn’t taken root as a real equity-investment vehicle — at least not publicly yet. What are the expectations for a return on your “small” investment? It’s not much, but the public part of the crowdfunding investment is about to change. While a crowdfunded company might not be in your portfolio yet, you might see advertisements on TV soon. In September, the Securities and Exchange Commission (SEC) lifted a ban on this type of solicitation, which will allow all types of crowdfunded projects to legally ask the general public for funding.
Entrepreneurs can now easily reach a wider pool of investors to pitch their ideas or projects. They can place an ad at a local coffee shop, or pitch the investment opportunity online. But even though they can fundraise in public, not everyone can participate, not yet anyway. According to current regulations, only accredited investors can buy an equity stake through crowdfunding. If you have an income over $200,000 for two consecutive years or a net worth of $1 million, you can buy into your favorite start-up. If not, you’ll have to wait until crowdfunding is introduced to the rest of the 97% of Americans. As a result, we now have crowdfunding, minus the crowd. But that could change as soon as next year.
The lift on advertising to high-net-worth individuals is just the first step in introducing the equity-crowdfunding concept. Since this is new, the goal is to test the waters before rolling out to the general public. One of the primary challenges associated with crowdfunding will be managing investor expectations. During the past few years, crowdfunding has gained exposure primarily through rewards-based sites such as Kickstarter or IndieGogo. These sites have introduced a wide variety of projects but a financial return is not on their priority list. For example, Kickstarter start-ups offer rewards for donations in place of ownership or financial gain: like a T-shirt, game, or signed movie poster, which might be considered as their so-called ‘return.’
While we all like to help people, don’t most investors want the promise of some type of financial reward when making an investment? So what should an investor expect from a crowdfunded project? First, investors need to be aware of the riskiness of investing in start-ups. They fail quite often as the Harvard Business School found out: 30%-40% of start-ups lose all of their investors’ money, while 90%-95% of them fail to meet declared projected goals. Investments typically fall into three categories: equity, lending and royalty-based. Each investment option offers a different risk/reward outcome and it is crucial that investors consider their objectives from the outset, including the pros and cons of crowdfunding.
By removing the ban on general solicitation, the SEC will bring a wealth of crowdfunding advertisements to cities across America. While currently only a fraction of Americans will have the opportunity to invest, the rest of us will be able to evaluate the projects and watch this new fundraising platform develop over time. As it continues to take root, the tool that emerged as a fundraising platform for free merchandise could cause quite a stir in the investing industry in the years to come. Stay tuned. If you would like to learn more about crowdfunding or have an extraordinary business challenge contact me at mlewis@simmonswhite.com or (504) 905-4646. Here is to your success…