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This article has been updated to reflect the Securities and Exchange Commission’s new regulations affecting non-accredited investors and equity crowdfunding that went into effect via the JOBS Act (Title III) on March 16, 2016.
What is crowdfunding?
Crowdfunding as a broad subject can perhaps best be described as “raising money via relatively small contributions from a large number of individuals.” Widespread adoption of social media and general internet use made crowdfunding a viable way to raise money in the early 2000s, and the concept really roared into the public view with the advent of companies like Kickstarter raising millions, then billions, for various “projects”—anything from somewhat laughable “projects” like making a potato salad or pirate pancakes to worthwhile ideas like a refugee-led radio station.
What’s the Difference Between Crowdfunding on Kickstarter and Equity Crowdfunding?
The mechanism of equity crowdfunding is basically just as simple as that of the more widespread crowdfunding seen on Kickstarter. Similar in many ways to Kickstarter, a platform such as RealtyShares finds investors who need to raise capital for various projects. RealtyShares then provides a description of the project, pro formas, and other relevant information, and numerous investors get to decide whether or not they want to back that particular project. (To learn more about RealtyShares, click here.)
There is only one significant difference between equity crowdfunding and the type of crowdfunding you see on Kickstarter:
Individuals who back equity crowdfunding projects expect a return on their investment, while individuals that back projects on Kickstarter expect at most a small “reward” when the project is completed.
If you were one of the folks who donated to the potato salad project on Kickstarter, you probably weren’t expecting to get that money back—and you definitely weren’t expecting to get any interest. There is an obviously different expectation from the investor who puts $5,000 into a commercial real estate deal through a crowdfunding platform. The former is just looking for a bite of potato salad, while the latter is seeking financial gain.
As with any investment, investing in crowdfunding comes with a level of risk. Investors should never bank on a certain level of return—and should never invest more than they can spare to lose. In fact, the SEC has put certain regulations on how much money non-accredited investors can place into equity crowdfunding to protect these investors. (Read more about regulations here.)
What Are the Benefits and Risks of Equity Crowdfunding?
Crowdfunding is not some new mode of investing that will magically produce outsized returns from your living room. It requires knowledge and research just like any other form of investing, and it includes risks just like any other form of investing.
Crowdfunding does, however, offer some significant advantages over other forms of real estate investing:
- Crowdfunding is a great resource for investors looking to diversify in several real estate projects, as they can go through dozens of deals and invest relatively small amounts of money in each. Assuming the investor has done their due diligence on the crowdfunding portal and can trust the information provided, they can screen deals in minutes. Outside of crowdfunding, it’s fairly difficult to invest small amounts of money (amounts between $5,000 and $25,000) in dozens of real estate projects.
- Crowdfunding also helps the investor who needs to raise capital. The guy who is looking to raise $1 million in equity financing previously would have had to approach wealthy investors one by one and try to get large contributions from each. Through crowdfunding, the capital seeker can give the financials and other relevant information to a crowdfunding platform just once and have hundreds or thousands of investors exposed to the investment.
With these advantages come a few disadvantages:
- Equity crowdfunding projects are subject to fees. The structure of these fees varies from company to company, but it is important to understand that the investors will pay in some form or other for the collection and presentation of pertinent financial data from those seeking to raise money, while the individual seeking to raise capital will pay for the platform’s access to investors. These fees in their varying forms will absolutely need to be factored into analysis contributing to any decision to invest or to raise money via crowdfunding.
- The concept of equity crowdfunding is still relatively new. Often, successful and experienced commercial real estate developers will repeatedly go back to their same sources of private funding over and over again to raise money for their projects. These experienced investors might have little trouble raising capital due to their excellent track records and have little need for new platforms like crowdfunding. This could potentially result in some less experienced investors being among the early adopters who use equity crowdfunding to raise money.
It’s up to individual investors to weigh these pros and cons when making the decision to invest or raise money via crowdfunding. It is also important to note that risk comes with putting your money into any investment, crowdfunding included. While many investors enjoy solid returns from crowdfunding, experiencing losses and preparing for potential downturns in the market are simply realities of real estate (or any other type of) investing.
Who Can Use Crowdfunding Right Now?
In the spring of 2016, the Securities and Exchange Commission (SEC) put new regulations in effect, opening up a whole new world of investments to non-accredited investors. Signed into legislation in 2012, the JOBS Act required the SEC to write new rules, and the equity crowdfunding portion of the act applying to non-accredited investors (Title III) became effective March 16, 2016.
Previously, only accredited investors were granted reasonable access to equity crowdfunding. It is estimated that accredited investors (generally those with an annual income of $200,000/year for the past two years or a net worth of $1 million or more, excluding primary residence) make up less than 10 percent of the population, meaning the vast majority of ordinary people were excluded from any equity crowdfunding investments.
With the advent of Title III, more investors can enter the crowdfunding (and real estate) space. Investing in most commercial property usually involves a very large amount of money. These amounts are so large that I would feel the need to put in an enormous amount of research, preparation, networking, and legal background work before I could commit to buying an apartment complex or large mixed use building, even if I could get great seller financing terms. While the crowdfunding market is still far from a free-for-all marketplace, new changes allow investors have the opportunity to put attainable amounts of money—often as little as $5,000—into equity crowdfunding investments, including commercial real estate.
Use the comments section to weigh in:
- Have you used equity crowdfunding?
- Would you be interested in pursuing the option?
- Do you see any other advantages or drawbacks to crowdfunding that I didn’t mention here?
Let me know your thoughts, and let’s discuss!