Crowdfunding and Its Use as an Investment Opportunity
By Nick Mango
The advancement of the Internet, and particularly the advent of crowdfunding, has truly opened up what was once a distant frontier for investors. Today, more private-equity-driven opportunities are open than ever before, and perhaps surprisingly, select crowdfunding investments offer potential returns that trounce the measly yields investors have (sadly) come to expect from more traditional investments like bonds and fixed-income vehicles.
Before diving in, however, it’s important for interested investors to understand what crowdfunding is, the risks and benefits to investing, and the proper role that crowdfunding might play in a well-balanced and diversified investment portfolio.
What Is Crowdfunding?
By definition, crowdfunding raises capital through the (often small or modest) monetary contributions of a large number of people. Now conducted predominantly online using popular sites like Kickstarter, GoFundMe, Indiegogo, Prosper, and others, it’s been estimated that crowdfunding raised over $53 billion worldwide in 2015 alone. Depending on the platform and individual campaign, crowdfunding investors may contribute as little as $10 or $25 dollars at one time, or as much as $100,000 in a 12-month span, as governed by the JOBS Act, which was implemented by the SEC to regulate crowdfunding activities in the US.
For campaign creators, crowdfunding makes it possible to finance their unique vision, everything from art and science applications, to business and philanthropic ventures, and yes, new product development and startup companies like those often featured on ABC’s “Shark Tank.”
Not every crowdfunding campaign is investment quality, though. One Kickstarter campaign back in 2014 generated more than $55,000 from over 6,900 funders for—get this—an Ohio man’s batch of potato salad! That’s why, for investment purposes, interested parties might confine their searches to only encompass equity, debt-based, and real estate crowdfunding campaigns, for only those predictably offer monetary return on investment.
In large part, crowdfunding helps leverage the power, reach, and convenience of the Internet to connect entrepreneurs with willing funders. And as an investment tool, crowdfunding can empower self-directed investors through the entire process of locating, properly vetting and comparing individual opportunities, and buying in with ease and confidence.
Risks to Crowdfunded Investing
Just like with any equity, bond, or alternative investment, the foremost risk within the realm of crowdfunding is that of financial loss, and the biggest challenge, finding transparency and making informed decisions based on veritable facts.
Particularly with debt- and real-estate-based crowdfunding campaigns, credit risk and potential rate of return can be more transparent than with other opportunities. That’s because, in what is a most powerful feature, some crowdfunding platforms like Prosper provide investors the ability to browse available loans, the credit score(s) of the borrower(s), and the rating and term info to make more informed choices about the particular loans in which to invest.
For equity-based campaigns, because the value of your securities, and thus, return on investment, may depend on the success of the product and/or company, prospective funders need a deeper understanding. So beyond just creating a “cool” product, for example, can that company deliver a compelling marketing message that reaches its target demographic(s), does it have an efficient and sustainable supply chain solution, and what about future growth potential?
Lingering questions like those require deeper insight into the company, information that can be elusive for many investors. This lends to the idea that the key risks and challenges for crowdfunders, much like with mainstream equity investors, involve making decisions based on incomplete information, a condition that’s often called information asymmetry.
- Information asymmetry
- Conducting due diligence
Crowdfunding Benefits over Traditional Investments
Traditionally, to promote portfolio diversification, or when looking to put some risk capital to work in outlying areas of the market, investors have gravitated toward vehicles like REITs, hedge funds, managed futures, derivatives, and commodities, all sectors with a reputation for a relatively high cost basis, particularly when considering what usually amounts to modest performance.
The combination of a reduced cost basis, far more investment choices, and fewer barriers to investing has helped tip the benefit scale in favor of crowdfunding in recent years. And from a performance standpoint, while crowdfunding investment rates of return are about as widely varied as one might expect, with one study showing a 40% rate of return alongside a 40% failure rate, early stats suggest that crowdfunded investments do deliver a positive rate of return overall.
The key—again, just like with mainstream investing—is to buy quality and diversify your “portfolio” of crowdfunded assets so as not to have too much exposure to, say, tech startups, high-risk personal loans, or real estate in only one, concentrated locale.
- Reduces investing costs
- Expanded access to investments
- Accessible without a broker
- Favorable tax implications
- Positive overall performance
Conclusion & Next Steps
Crowdfunding has given newfound breadth to the private equity space, and when considering how today’s Internet-based crowdfunding platforms have facilitated low-cost, open access for investors, what’s happening is a venerable (veritable?) revolution across the alternative investment asset class.
Quality crowdfunding opportunities can represent compelling alternative investments that were once inaccessible to self-directed investors. But perhaps best of all, select crowdfunded investments offer the promise of more lucrative returns than investors get with run-of-the-mill Treasuries and other fixed-income investments, as well as less potential risk and broader selection than aggressive growth investors will find among volatile marijuana and/or biotech stocks.
Just remember that the same rules and standards for investing apply to crowdfunding opportunities as well, so you mustn’t contribute to campaigns and/or terms that you don’t fully understand, nor use anything other than purely speculative capital to invest.
In other words, don’t bet your retirement or the kids’ college funds on it, but consider crowdfunding an alternative investment option. Now here are a few helpful sources for relevant information:
About the Author
Nick Mango is a freelance writer and editor whose work in the investing, trading, and financial communities spans more than 12 years. He’s co-author of the book, Traders at Work (Apress, 2013), and has consistently published content across major media outlets and the Web’s most well-known and respected financial portals, including OTAcademy.com.