What You Need to Know Before Investment Crowdfunding

Money raining down on a happy man and woman.

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In recent years, one of the most exciting developments in the world of investing has been the development of investment crowdfunding. With this new type of investing, there is a chance that you could make money from startups, expanding businesses, and even real estate in a way that you haven’t been able to in the past.

However, before you dedicate money to investment crowdfunding, it’s important to evaluate the situation to see if it’s right for you—as you would with any other type of investment.

What Is Investment Crowdfunding?

You’ve heard of crowdfunding. It’s when you agree to send money to someone to help 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 SMBs to raise capital without being hedged about by some of the red tape required to issue shares and provide 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.

Now, you can take $100 to an investment crowdfunding platform and invest money in the hopes that you will see a return to beat the stock market.

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 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. A platform like Kickfurther might only require a minimum investment of $20 in a brand or company. However, if you use a real estate investment crowdfunding platform like RealtyShares or Fundrise, you might need a bigger initial investment, on the order of $5,000 or $10,000.

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 only see partial repayment—or no repayment at all. You could lose 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 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 you make less than $100,000 per year, you can only invest $2,000 or 5 percent of your annual income, whichever is greater. If you make between $100,000 and $200,000 a year, the cap becomes up to 10 percent of your income. For some investors, that limitation means you won’t be participating in a real estate crowdfunding website, even if you want to.

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 decide whether or not you have the risk tolerance for it.

The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk, including the possible loss of principal.