The Power of Crowdfund Investing - dummies

By Consumer Dummies

Crowdfunding has many applications: from raising funding for disaster relief and philanthropic causes to supporting creative endeavors by musicians, artists, and others; to supporting research and scientific breakthroughs; and more. Crowdfund investing occurs when early-stage or start-up businesses raise capital by selling small amounts of equity or debt to many investors.

Prior to the 2012 JOBS Act, businesses were forbidden by law to solicit capital through advertisements. The fear was that, due to the nature of these investments, only accredited (read “rich”) investors could safely assume the risk. In addition, people who raised the money could not legally give back any financial return, including even giving back the original investment. What they could give, however, were perks. If an artist wanted to raise money to make a new music album, he might give people a sticker for a $5 contribution, a digital copy of the completed album for a $10 contribution, and so on. The JOBS Act, however, changed these rules. All the great benefits of crowdfunding still exist, but the perks that investors stand to receive now also include financial gain.

Here’s why this change is so important:

  • The legalization of equity- and debt-based crowdfund investing has broken down the barriers for the small investor, who can now invest in start-up companies. You now have the choice to be an active participant in the growth of a business, to reap rewards for doing so, or to see your returns tied in with those of entrepreneurs over the long term.

  • As an investor, you can find businesses that people in your social networks are launching and can support them with your dollars and your expertise. We all like being part of something that’s bigger than ourselves, and crowdfund investing allows you to do exactly that. From the comfort of your own living room, you can help your nephew or former roommate or coworker get a new company off the ground.

Investing in a start-up company is very risky. Your risky investments should occupy only a small portion of your overall portfolio, and your crowdfunded investments should be considered some of your riskiest investments. The chances of your investing in the next Facebook are very slim, but at least you now have the opportunity to make investments that were previously reserved for only the wealthiest Americans. With that opportunity comes a great deal of responsibility to be a well-informed investor.

Spotting the business beneficiaries

The types of businesses most likely to benefit from crowdfund investing include start-ups, small businesses (including technology companies, bricks-and-mortar retail shops, and service companies), and anyone else who doesn’t easily qualify for traditional financing. The term used in the JOBS Act for such entities is emerging growth companies.

These businesses benefit from more than just the capital they can raise through crowdfunding. Entrepreneurs and small business owners also need the support of as many people as possible to be successful. Whereas large, publicly traded companies have the support of many successful people (they have vast resources to pay experienced people to help guide them), start-up businesses, especially those that are actively seeking capital, generally lack the resources to spend on top-notch talent. But crowdfund investors offer growing companies and entrepreneurs both financial support and expertise.

Crowdfund investing should be an active investment. If you buy stock in Apple or General Motors, all you give is your money. But when you engage in a crowdfund investing campaign, you can also support a company with your knowledge and skills. The collective knowledge of the crowd is much greater than the knowledge of any group of experts.

Finding businesses to invest in

Prior to the passage of the JOBS Act in 2012, it was difficult or even impossible for businesses needing funding to find willing investors. The laws governing how private businesses could seek capital from individual investors, written in the height of the Great Depression, were set up to protect people from scams and rip-off schemes. The JOBS Act permits private companies to generally solicit for equity and debt offerings, meaning they can publically advertise and discuss such offerings (subject to certain restrictions). Also, it makes crowdfund investing possible by enabling business owners to communicate with anyone via their social networks (such as LinkedIn, Facebook, and Twitter) to find potential investors for their business or start-up ideas.

Companies can position themselves to find crowdfund investors by crafting excellent business plans and by posting their offerings on SEC-registered online funding portals. As a potential investor, you should shop for campaigns only via SEC-approved funding portals.