If you’re considering equity crowdfunding as a serious investment opportunity, you’ll want to understand federal regulations and identify potential risks so you can make informed decisions.
The industry is growing rapidly and in 2015, Goldman Sachs released a report on the future of finance in which they stated that crowdfunding could “potentially be the most disruptive of all the new models in finance.”
Equity crowdfunding is still fairly new to the industry and there some important things you need to know before making an investment.
An Overview of Equity Crowdfunding
Becoming familiar with equity crowdfunding regulations is something that all investors should take the time to understand. Specifically, Title III of the JOBS Act. Title III allowed crowdfunding to become an accepted form of investing and gave all citizens the ability to invest in startup companies.
According to an official press release from the U.S. Securities and Exchange Commission (SEC), “Title III of the JOBS Act created a federal exemption under the securities laws so that this type of funding method can be used to offer and sell securities.”
This created an opportunity for startups to raise much-needed capital using crowdfunding platforms. .
Essentially, the JOBS Act made it easier for early-stage companies and startups to access capital by modifying certain rules and restrictions.
If you’re interested in startup investing, there are three things you need to know about investor requirements:
- The maximum aggregate amount of funds a company can raise through crowdfunding offerings in a 12-month period is $1.07 million
- The maximum amount an individual can invest in crowdfunding offerings over a 12-month period is:
- If their annual income or net worth is less than $107,000 than the greater of:
- $2,200 or 5% of the lessor of their annual income or net worth
- If the investor’s annual income and net worth are equal to or more than $107,000 then 10% of the lesser of their annual income or net worth
- During the 12-month period, the aggregate amount of security sold to an investor through all crowdfunding offerings cannot be greater than $107,000
If you meet the individual investor requirements, you can take part in equity crowdfunding opportunities. While equity crowdfunding can be a high-risk venture, the industry is also experiencing significant growth which can lead to potentially lucrative investment opportunities.
In 2017, offerings for Regulation Crowdfunding (Reg C) increased 267% over 2016 while total investments grew from $24 million to $49 million during the same period.
What’s even more impressive than that?
The average success rate of issuers to raise money for regulation crowdfunding offerings in 2017 was 66.7%.
Addressing the Risks of Crowdfunding Investments
Risk is unavoidable in any investment and equity crowdfunding is no different. Equity crowdfunding offers investors an option to diversify their investments in a rapidly growing industry that—like any other investment—has the potential to provide strong or non-existent returns.
The SEC lists eight main risks of crowdfunding that potential investors should recognize before investing:
- Startup investments are speculative and 90% of new businesses ultimately end up failing.
- Selling your crowdfunding holdings can be complex because they cannot be sold or transferred in the first year of ownership. In some cases, you may have to hold your investment indefinitely.
- Canceling your investment must be done up to 48 hours before the end of the offering deadline. Any later than that and your investment will be final with no option to cancel.
- The valuation of your investment is difficult to gauge, and you run the risk of overpaying for your equity stake because crowdfunding investments are not valued according to market-driven stock prices.
- An early-stage company may offer limited disclosure because they might not have a fully developed business plan in place. Also—unlike publicly listed businesses—early-stage companies are not required to file annual or quarterly reports.
- Use of funding can sometimes go towards compensating employees in startups and early-stage companies. Make sure to ask how the funds will be allocated when researching an equity crowdfunding opportunity.
- There is no guarantee against fraud as with any other type of investment, so you should review the SEC’s recommendations on what you can do to avoid investment fraud.
- An early-stage company may lack professional guidance that angel investors and board members provide to venture capital firms.
There is always the possibility that you could lose some—or all—of your crowdfunding investment. You should know the potential risks before investing. Risks can range from uncertainty about the company’s ability to manage rapid growth or a disruption of operations, to bankruptcy or inability to secure intellectual property rights. It all depends on the individual investment opportunity.
The Investment Process Under Regulation Crowdfunding (Reg CF)
Investing in a crowdfunded offering can be done through an online portal. MicroVentures, for example, has partnered with Indiegogo to provide First Democracy VC, a registered funding portal that allows individuals to invest in startups and early-stage, innovative companies.
To start the investing process for an offering under Reg CF with First Democracy VC, just click Crowdfunding on MicroVentures’ homepage and you’ll be able to browse each of our offerings:
When you click on an offering you’ll be provided with more extensive investment details, including the number of days left to invest, the amount raised to date, and information on the offering’s performance, history, and roadmap.
In addition, you’ll also be able to access key documents–like the offering statement and company summary–and the offering’s pitch deck:
Investing through an online funding portal is designed to be an easy, intuitive process.
The Benefits of Equity Crowdfunding Investments
While the risks associated with crowdfunding investments can be high, equity crowdfunding is on the upswing and potential investors may be able to take advantage of these potential benefits:
- The equity crowdfunding industry has a projected compounded annual growth rate (CAGR) of 5%
- The total value of equity crowdfunding investments is projected to grow from its current total of $1.7 billion annually to $5 billion in 2022
- Returns sometimes have the potential to be larger than returns from bonds, publicly quoted shares, and other assets
- Equity crowdfunding investments can help diversify a portfolio
- Some countries offer tax benefits to investors on certain crowdfunds
Equity crowdfunding can provide many benefits to investors looking for new opportunities.
While growth is no guarantee of a successful venture, it can be a factor in making an investment decision. Just remember, it’s important to study the industry and offering, and analyze the risks before making an equity crowdfunding investment decision.