Here are some reasons why I believe investing is becoming more attainable:
One development though I am particularly excited about is the rise of crowdfunding. You may be familiar with the concept of crowdfunding through charitable giving platforms like GoFundMe or funding for creative projects like Kickstarter. Over the past eight years though, crowdfunding has also unlocked many investment opportunities for retail investors that were previously only accessible to institutional investors and high net worth individuals.
What Exactly is Investment Crowdfunding?
Investment crowdfunding (also sometimes called equity crowdfunding) is a way for private companies (i.e. companies that are not listed on a stock exchange) to raise capital across a large pool of investors in exchange for part ownership in the company or offering. Private companies can raise capital for a variety of deals and ventures including real estate, seed investments, and agriculture.
Capital is raised through the sale of securities (shares, convertible note, debt, revenue share, etc.) and investors gain to share in the profits of a successful investment. The sponsor or company of a crowdfunding deal dictate the terms of the offering and typically leverage a crowdfunding platform to solicit the deal, raise capital from investors, and pay out distributions.
Investors can source and invest in deals through a variety of crowdfunding platforms online. Some crowdfunding platforms will have a greater hand in facilitating and vetting investments whereas others serve purely as a marketplace.
Investors typically earn profits through regular cash flow such as dividends or appreciation from the sale of an asset.
The global crowdfunding market was valued at $10.2 billion in 2018 and is expected to reach $28.8 billion by 2025.
How Did Crowdfunding Start?
Crowdfunding emerged as a result of the JOBS (Jumpstart Our Business Startups) Act that passed in 2012. The JOBS Act was passed after the financial crisis to encourage economic growth by easing securities regulations around the private funding of small businesses in the US. This made it easier for small businesses to raise capital by expanding the pool of investors that could participate in capital contributions and private funding.
The JOBS Act made crowdfunding possible by allowing public advertising for participation in a securities offering. As a result, many crowdfunding platforms have emerged to more easily connect businesses with investors on private offerings.
Two of the most notable industries that have leveraged crowdfunding are commercial real estate and agriculture. There are many other business types that have benefitted from crowdfunding as well including startups, fine art, and even wine!
Crowdfunding opens the door for retail investors to take advantage of alternative investments, many of which are more recession-resistant or counter-cyclical to the market. Therefore, it can be a great way to diversify your portfolio and build long-term wealth.
As a relatively new sector though, there are some additional risks and considerations, both in the investment offerings and the crowdfunding platforms themselves. If crowdfunding sounds like an intriguing venture to you, it is important to weigh in all of these factors.
Benefits & Risks of Crowdfunding
Below are some of the benefits, risks, and considerations associated with investing in private offerings through crowdfunding platforms.
1. Added diversification
Crowdfunding provides the opportunity to invest in asset-backed securities and alternative investments that are not typically available in traditional markets. Agricultural crowdfunding, for example, provides opportunities to invest in emerging farm technologies such as vertical farming or hydroponics. Investments backed by hard assets can provide greater security in comparison to stocks, which can disappear overnight. Real estate and farming in particular are desirable assets because everyone needs shelter and food.
2. Income-generating assets
Crowdfunding is a great way to create a passive income stream that can supplement your regular cash flow. Many equity and debt offerings are structured to provide monthly, quarterly or annual distributions, plus the opportunity for capital appreciation. An investment in a multi-family development through a real estate crowdfunding platform, for example, may offer quarterly distributions from rental income in addition to capital gains from the eventual sale of the asset. Several commercial real estate crowdfunding platforms offer investments in funds (i.e. portfolios of multiple assets) that provide regular distributions as well.
3. Recession-resistant or counter-cyclical assets
There are many private offerings through crowdfunding platforms that can withstand recessions particularly well or are counter-cyclical to economic cycles. Self-storage properties, for example, perform very well during economic downturns due to changes in life events, relocation, and downsizing. Investing in assets that do not follow the markets can help create a more defensive portfolio that can better withstand economic headwinds.
4. Low-touch investment
One of the great things about crowdfunding investments is that they are generally passive. While you’ll want to do a little vetting upfront, crowdfunding deals are generally low-touch investments that require minimal involvement once the deal is funded.
Risks & Considerations
There are two types of risks and considerations when evaluating crowdfunding opportunities - the investments and the crowdfunding platforms themselves. I will break them down into these two categories below.
Investment Risks & Considerations
1. Illiquid Investments
One of the biggest considerations when considering a crowdfunding deal is liquidity. Crowdfunding investments are generally illiquid investments, which means your money is tied up in the investment until the deal is completed. Most deals last up to a few years, if not longer.
Very rarely do private offerings have secondary markets where you can find a buyer to sell your shares. There are some funds, however, that may offer limited secondary offerings so be sure to check the terms and conditions.
If you are considering an investment through a crowdfunding platform, it is crucial to understand the deal’s time frame, exit strategy, and early exit options. If you think you will need your money before the target date, it’s best to explore a more liquid investment option.
2. Investor requirements
While crowdfunding platforms have leveled the playing field for retail investors, private offerings still fall under different regulations under the JOBS Act, which determine investor eligibility. Some offerings will require all investors or a subset of investors to be accredited. To be an accredited investor, you must have a net worth of $1,000,000, excluding the value of your primary residence, or have an income of at least $200,000 per year ($300,000 combined if you are married). Always verify the investor requirements before attempting to participate in a deal.
3. Limited control
While crowdfunding deals allow you to kick back and relax while as you rake in passive income, the downside is that you have limited control over the investment. The sponsor or business may choose to exit early or extend their end date. You could get lower than projected returns. Or the deal may cease completely.
As with any investment, private offerings come with some amount of risk. It is a good idea to refrain from investing any funds that are critical to meet your other financial obligations in case the deal goes south. When investing in a private offering, make sure you understand all of the terms and risks associated with the deal.
Crowdfunding Platform Risks
1. Limited track record
Since crowdfunding platforms have only emerged in the past 8 years, there is limited information around a platform's experience and overall performance, especially during a market downturn or economic recession. Many platforms boast strong returns of their investments and funds, but it is important to keep the backdrop of a particularly strong bull market in mind.
These next few years will be critical in understanding how various sectors weather economic headwinds. If crowdfunding remains a sustainable trend, we’ll have a more realistic picture of what expected returns can look like based on broader historical data.
2. Early-stage companies
Most crowdfunding platforms have only been around for a few years and are early stage companies. As mainly private companies, they are not obligated to publicly share their financials or balance sheet. Given that many crowdfunded investments are multi-year deals, there is always the possibility that the crowdfunding platform itself may go belly-up during that time period.
RealtyShares, for example, was a successful real-estate crowdfunding platform with over $870 million invested across more than 1,000 projects. It unfortunately had to close its doors after 5 years though because it was not able to secure the financing needed to continue their own business.
Even if the crowdfunding platform you invested through does go south, that does not mean the deal you invested in (or your money) suddenly disappears. What will most likely happen is that the deal is transitioned to a new manager or administrator to see through the remainder of the transaction. Ensuring a smooth transition and relationship with this new party might just require a bit of extra work.
If you are considering a crowdfunded investment, research as much as you can about the platform and account for some hiccups along the way in case the company ceases its operations.
3. Success breeds competition
Crowdfunding is becoming an increasingly popular way to raise capital across many sectors. And with increased success comes increased competition. I’m continually finding new platforms that offer similar investment types and deals. While it’s great to have options as an investor, it becomes increasingly harder for companies to get a piece of the pie.
I believe crowdfunding will become a longer term trend, but there may eventually be some consolidation of platforms in the process. When investing in a deal, be prepared for management, operations, or business models to change over time. Being flexible, open, and aware, are key to staying sane throughout your crowdfunding journey.
4. Laws can change
Crowdfunding is a byproduct of government legislation, of which can easily change at any point in time. With the country currently starving for economic activity and a high motivation to restore economic growth though, I personally feel that provisions will continue to heavily lean towards the side of investors. The U.S. Department of Labor, for example, recently opened the door for 401(K) sponsors to include private equity funds to their retirement plans which vastly expanded their pool of investors. The more ways there are to raise sound capital, the more opportunities there are for economic development.
While crowdfunding may not be going anywhere in the short term, there’s always a possibility that the government administration could pull the plug. Take advantage while you can, but keep other alternatives in your back pocket in case you need to change course.
I truly believe that crowdfunding is creating a new pathway for younger investors with longer time horizons to build long-term wealth.
There are of course several risks and considerations both at the investment and company level, but if you’ve done your due diligence and are able to assume the risks, it is a great way to create passive income, diversify your assets, and ultimately build greater financial security.
As an emerging sector, crowdfunding is continually evolving with new developments, trends, and options. In future posts, I’ll dive into different crowdfunding platforms that I've used or explored and talk more about industry trends.
Staying open, curious, and informed will help you navigate the world of private funding and crowdfunding. Until then, keep calm and invest on!