What You Need to Know Before Investment Crowdfunding

Key Takeaways

• The Jumpstart Our Business Startups (JOBS) Act of 2012 created the regulatory system for letting companies find investors through crowdfunding sites.

• Laws prevent investors from investing more than 5% of their annual income through crowdfunding sites (or $2,200, if 5% of their annual income is less than $2,200).

• Investment crowdfunding sites are similar to peer-to-peer lending sites.

• Unlike traditional investors using a brokerage account, crowdfund investors aren't able to trade shares whenever they want.

What Is Investment Crowdfunding?

You’ve heard of crowdfunding. It’s sending money to someone to help them with a goal. It might be to raise money for medical treatment. Maybe it’s to help someone publish a book. Perhaps the person is creating a product, and your contribution will help them found a business venture. No matter the reason, you send the money, and you don’t expect anything back, except a thank-you note and maybe an early sample.

Investment (sometimes called "equity") crowdfunding is different. It was introduced as part of the Jumpstart Our Business Startups (JOBS) Act in 2012. The Act required the Securities and Exchange Commission (SEC) to come up with rules for investment crowdfunding, allowing for different regulations for startups and small and medium-sized businesses to raise capital without being hedged about by some of the red tape that comes with issuing shares and providing returns for stakeholders.

There are still rules and red tape, but investment crowdfunding makes it easier for businesses to raise capital by allowing others to invest. At first, only accredited investors were allowed to get involved. However, in 2016, anyone could start accessing platforms to invest in new business, thanks to so-called Title III rules.1 Now, you can take $100 to an investment crowdfunding platform and invest money in the hopes that you will see a return.

How Do You Invest on an Equity Crowdfunding Website?

Crowdfunding websites have been popping up since the introduction of the JOBS Act. Sites like Kickfurther, SeedInvest, and Wefunder all provide you with access to startups or expanding companies looking for capital. To sign up, you have to jump through the same hoops as you would in signing up for any other investment website. You need personal information and bank account information.

Once you have opened your investment account with a reputable investment crowdfunding platform, you’re ready to invest. Different platforms come with various minimums.

In any case, your investment is still much smaller than you might need to invest in similar organizations in the past. To be a venture capitalist or angel investor before investment crowdfunding, you needed millions of dollars to invest on the ground floor. Before real estate investment crowdfunding, you might need anywhere between $100,000 and $2 million to join an investment club and access some of the projects you can buy into for a fraction of that amount today.

Before You Risk Your Money

Just like any other investment, it’s important to make sure you do your due diligence. It’s an investment, so there’s a chance you might lose out.

Some of the platforms that allow you to invest in companies work similarly to P2P lending websites. You make your investment as part of a round of funding, and you are paid back when the company starts earning profits. If the company doesn’t turn a profit or goes bust, you might not even see partial repayment. You could lose all of your money.

Other considerations include:

• What companies are these websites? Remember: many of these companies are on investment crowdfunding websites because they couldn’t attract other forms of funding, either from venture capitalists or through small business loans. While there’s a chance that you can find a solid choice—or even a unicorn—the reality is that you aren’t likely to find the next billion-dollar company on one of these websites.

• Can you handle illiquidity? You can’t just pull your money when you want. It’s not like buying and selling shares with a more traditional broker. You have to wait until the company starts making payments out of its profits. There is no selling at a loss to get some of your capital back in a pinch.

• Do you meet the requirements? The SEC isn’t just letting you risk everything. If either your annual income or your net worth are $107,000 or less, you can invest up to the greater of either $2,200 or 5% of the lesser of your annual income or net worth. If both your annual income and your net worth are equal to or greater than $107,000, you can invest up to 10% of annual income or net worth, whichever is lesser, but not more than $107,000.2 That limitation means that some willing investors simply won’t be participating in a real estate crowdfunding website.

Investment crowdfunding offers opportunities to grow your wealth in unconventional ways. Before you move forward, though, it’s up to you to consider your situation and to decide whether or not you have the risk tolerance for it.