Crowdfunding for Non-Accredited Investors

Key Takeaways

• Equity crowdfunding is a way for start-ups to raise capital by selling shares to a large number of individual investors.

• Similarly, individuals can invest in pieces of real estate property or engage in direct P2P lending.

• As of 2016, the JOBS Act allows ordinary individuals to take part in equity crowdfunding, opening up early-round investing to more than just angel investors and venture capitalists.

• Limits still apply, and the risks associated with equity crowdfunding can be quite a bit larger than investing in more mature companies on regulated exchanges.

Equity Crowdfunding and the JOBS Act

Here's the background: The 2012 Jumpstart Our Business Startups Act (JOBS) was passed to make it easier for small businesses to raise capital and, in turn, spur economic growth through job creation. Title III of the act deals specifically with crowdfunding. In October 2015, the U.S. Securities and Exchange Commission (SEC) finalized some key provisions relating to permitting non-accredited investors to participate in this type of investment.

Many types of equity investments are only open to accredited investors. These include banks, insurance companies, employee benefit plans and trusts, plus certain individuals considered affluent and financially sophisticated enough to have a reduced need for certain protections. To qualify as an accredited investor, an individual must earn more than $200,000 per year, have a net worth exceeding $1 million, or be a general partner, executive officer or director for the issuer of the security.3

Investing through crowdfunding platforms is uncharted territory for non-accredited investors, but understanding how the different types of crowdfunded investments work can make navigating the waters easier.

Equity Crowdfunding

Equity crowdfunding is the type of crowdfunding with which Title III of the JOBS Act is primarily concerned. With this type of investment, multiple investors pool money into a specific startup in exchange for equity shares. This kind of crowdfunding is most often used by early-stage companies to raise seed funding.

Equity investments may be attractive to non-accredited investors for a couple of reasons. First, there’s the potential for a solid return if the startup you’re investing in eventually has a successful IPO. Once the company goes public, you can then sell your equity shares and recover your initial investment, along with any profits. If you happen to luck out and invest in a startup that ends up being the next Google, the payoff could be huge.

Aside from that, equity crowdfunding doesn’t require a substantial amount of money to get started. Depending on how large the funding round is that a startup is seeking, you may be able to invest as little as $1,000. That effectively levels the playing field between accredited and non-accredited investors.

The two biggest drawbacks associated with equity investments are their inherent risk and the timeframe. There’s no guarantee a new startup will succeed, and if the company fails, your equity shares would be worthless. If the company does take off, it may be years before you can sell your shares. Data from CrunchBase has shown that the average time to go public is 8.25 years, which is something you would need to factor into your exit strategy.4

Real Estate Crowdfunding

Real estate can be an excellent way to add diversification to your portfolio, and crowdfunding is an attractive alternative to a real estate investment trust (REIT) or direct ownership. With real estate crowdfunding, you essentially have two options for investing: debt or equity investments.

When you invest in debt, you’re investing in a mortgage note secured by a commercial property. As the loan is paid back, you receive a share of the interest. This type of investment is considered lower risk than equity, but there is a drawback because returns are limited according to the interest rate on the note. On the other hand, it’s preferable to direct ownership because you’re not responsible for managing the property.

Investing in equity means you receive an ownership stake in the property. In this scenario, returns are realized as a percentage of the rental income the property generates. If the property is sold, you would also receive a portion of any gains from the sale. In terms of profitability, equity investments can lead to higher returns, but you’re taking on more risk if the rental income takes a sudden nosedive.

Like equity crowdfunding, the primary advantage real estate crowdfunding offers to non-accredited investors is it has such a low entry point. Many of the top platforms set the minimum investment at $5,000, which is much more affordable than the tens of thousands of dollars often required to gain access to private real estate deals. Peer-to-Peer Lending

This type of lending may be an appealing option to non-accredited investors who would rather invest in individuals than in companies or real estate. Peer-to-peer lending platforms allow consumers to create fundraising campaigns for personal loans. Each borrower is assigned a risk rating based on his or her credit history. Investors can then choose which loans they want to invest in based on how much risk is involved.

That’s a good thing if you want some control over how much risk you’re taking on. At the same time, it also allows you to gauge what kind of earnings you stand to see on the investment. Generally, the higher the borrower's risk level, the higher the interest rate on the loan, which means more money in your pocket.

Again, it doesn’t take a huge bankroll to get started with this type of crowdfunded investment. If you’ve got an extra $25.00, you can start funding loans through Lending Club or Prosper, both of which open their doors to non-accredited investors.56

Investment Limits for Non-Accredited Investors

While the updated Title III regulations allow non-accredited investors to participate in crowdfunded investments, it’s not a free-for-all. The SEC has opted to place restrictions on how much non-accredited investors can invest over a 12-month period. Your individual limit is based on your net worth and income. Accredited investors have no such restrictions.

If you make less than $107,000 per year or your net worth is below that amount, you can invest up to either the greater of $2,200 or the lesser of 5% of your income or net worth. If your annual income and your net worth exceed $107,000, you can invest up to 10% of your income or net worth, whichever is less, up to a total limit of $107,000.1

The SEC imposes this limit for a reason. The purpose is to curtail the risk to non-accredited investors who may not be as knowledgeable about crowdfunding or investing in general. By limiting how much you can invest, the SEC is also limiting how much you could lose if a particular investment falls flat.

The Bottom Line

One thing for non-accredited investors to keep in mind is even though Title III allows universal participation, not every crowdfunding platform is likely to jump on board. That may limit the kinds of investments you’re able to take part in. And as you’re comparing different investment opportunities, pay close attention to the fees each platform charges since these can impact your returns over the long-term.