Equity Crowdfunding 101: What You Should Know Before Investing

Equity crowdfunding is an underdiscussed way investors have to maximize returns on their hard-earned money. Grabbing a stake in private companies offers unique advantages and potential windfalls in comparison to traditional forms of investing. Equity crowdfunding allows investors to own a piece of a privately held startup company that is poised for explosive growth.

Diversifying your offerings is the best way to ensure you don’t lose your entire nest egg in one cratering corner of the market. We’re also big advocates of getting in on the ground floor of companies still on the starting line.

A bright green button on a keyboard that says Equity Crowdfunding. companies to invest in
Source: Shutterstock

Equity crowdfunding is an option for the retail investor with a little capital and a lot of desire to make money. But what is it?

Equity Crowdfunding Vs. Other Fundraising

The JOBS Act of 2012 changed federal regulations and opened the door for equity crowdfunding. That leveled the private investing playing field for nonaccredited investors who weren’t wealthy. Prior to the JOBS Act, only accredited investors – those who had a net worth of $1 million or more (not including your house) and/or an annual income of $200,000 – could participate in private investing.

Now, most anyone who meets some basic requirements can participate in equity crowdfunding and invest in privately held startup companies.

Startups use equity crowdfunding – also known as crowd investing or investment crowdfunding – to raise capital.

Since most startups have yet to turn a profit, the companies will raise money to stay in business while they work to bring their products to market.

A business might opt to fundraise with equity crowdfunding if it’s not approved for a loan or wants to avoid debt financing altogether. Companies can use the funds to build prototypes of its products, hire key people, or simply keep their operations going. (Usually the company will disclose why it is raising funds in the deal details.)

In exchange, as an investor, you get a stake in the company’s future success. Investors make money when a “trigger” or liquidity event occurs. That could mean the company going public via an initial public offering (IPO) or being acquired by a larger company. Your return depends on your investment, you’re you should realize that these events can take years to materialize – if they ever do.

Find Startups Here: Equity Crowdfunding Websites

You can invest in startup companies through a variety of equity crowdfunding platforms:

Some companies raise money through “reward” crowdfunding, which gives investors perks that range from social media shout-outs to discounts to free products.

If you’re interested in investing in a company that creates products and services you love, then reward crowdfunding on one of the following sites may be for you:

Keep in mind that the company you invest in may not succeed in raising the capital it needs, and even if it does, you likely will not get a return on your investment aside from those perks. These sites explicitly do not allow ownership in any company or product featured. And if the business falls short of its financial goals, then you likely won’t get your money back.

Equity Crowdfunding Rules

So you want to try your hand at investing via equity crowdfunding. Where should you start?

If you have a specific company in mind, then you can’t just show up on their doorstep with a check or put in an order with your broker. According to the U.S. Securities and Exchange Commission (SEC), you must use the online platform or app where the company is listed (see above) and open an account to conduct transactions. Portals must be listed with the SEC and be members of the Financial Industry Regulatory Authority, or FINRA.

As you set up an account on one (or more) of these platforms, you will need to include your income and assets. The SEC sets investing limits for nonaccredited investors based on net worth and income.

The SEC limits most nonaccredited investors to investing $2,200 or 5% of their annual income on private deals. Again, these deals are extremely risky and can take years to pay off, if they ever do, so safeguards are important.

Once you set up an account, you may start perusing potential opportunities. Private investors tend to follow current trends, looking for the most cutting-edge companies that could capitalize on fresh ideas, emerging technologies, or necessary products and services.

Start with the company’s location, valuation, and team. If you’re unable to find the most basic information about these details, then that may be a red flag and signal to take your business elsewhere.

Time Is on Your Side

Unlike other types of investing, once you sink funding into a private company, you’ll need to wait for that investment to pay off. Count on less liquidity than with investments that are more flexible with moving money.

The ways in which you might make money include the company going public or being acquired by a public company. Consider Oculus, which Meta Platforms Inc. (Nasdaq: FB) acquired in 2014 for $2 billion. The Oculus VR is a virtual reality gaming headset, and it raised nearly $2.5 million on Kickstarter. The Facebook acquisition was controversial, as early supporters of the company who invested just $300 stood to make nearly $20,000… if the investment had been made available on an equity crowdfunding platform. But because investors crowdfunded it, they only received free headsets and other swag.

You’ll want to look for opportunities that potentially can pay off like that when investing through equity crowdfunding. But expect your money to be tied up for some time. That’s not necessarily a bad thing.

As a VC investor, you’re investing in early-stage companies that will take several years to exit. While investments in the public markets struggle, you can rest assured that your private investments are working hard behind the scenes…

You should look at private investing should as a long-term investment – one that can pay off handsomely.

On this date of publication, Vanessa Rush did not have (either directly or indirectly) any positions in the securities mentioned in this article. Investing in startups through equity and real estate crowdfunding or asset tokenization requires a high degree of risk tolerance. Despite what individual companies may promise, there’s always the chance of losing a portion, or the entirety, of your investment. These risks include:

1) Greater chance of failure
2) Risk of fraudulent activity
3) Lack of liquidity
4) Economic downturns
5) Dearth of investor education

Read more: Private Investing Risks

Vanessa Rush is a former journalism instructor with more than 20 years of experience writing and editing in the trucking industry, health and fitness, law, B2B, and the financial industry.

Article printed from InvestorPlace Media, https://investorplace.com/2022/03/equity-crowdfunding-101-what-you-should-know-before-investing/.

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