Investing through Crowdfunding Sites
When a company is just starting out, founders will often borrow money from family, friends, and banks, but they also may seek out investors. This is known as “seed funding”. The investors provide capital in exchange for equity in the new business. Uber (UBER) and Beyond Meat (BYND) are two start-ups that recently went public and made their seed investors very, very rich.
Investing in a start-up is extremely risky. Even the most seasoned investors fail big and often, but when they strike gold, there can be a huge payout. Most investors were not allowed by law to participate in these start-ups until very recently.
In the past, you needed to be an accredited investor to invest in a private company. To be considered an accredited investor, you need to earn income that exceeds $200,000, or $300,000 together with a spouse, in each of the prior two years, or have net worth over $1M, either alone or with a spouse, excluding your primary residence. This accredited investor requirement was dropped during the last financial crisis in 2008. Congress passed the Jumpstart Our Business Startups Act (JOBS Act) with bipartisan support.
Now that you can invest in private companies, should you?
The Risks
Market Risk
Public companies are held to a much higher standard than private companies in terms of disclosure requirements, transparency, and regulation. The fast and furious WeWork disaster highlights this. Shortly after WeWork filed paperwork related to its upcoming IPO in August 2019, the company faced scrutiny over the validity of its valuations and business practices. This is a company that secured round after round of financing from investors with no problem. Ultimately, the company never went public and its valuation dropped from $47B to $10B. Early stage businesses are extremely risky and many will fail. Very few win, and even fewer win big like Uber and Beyond Meat.
Liquidity Risk
Liquidity is the ability to buy and sell an investment quickly and cheaply. While you can easily log in and sell your shares of a public company, such as Apple, that is not the case with a private company. You will be limited in your ability to sell your investment in the first year, and potentially longer than that.
How crowdfunding investing works
You are limited in the amount you can invest.
According to the FINRA investor alert on Crowdfunding, this is the dollar amount that you can invest.
If either your annual income or your net worth is less than $107,000, then during any 12-month period, you can invest up to the greater of either $2,200 or five percent of the lesser of your annual income or net worth (not including your primary residence).
If both your annual income and your net worth are equal to or more than $107,000 then, during any 12-month period, you can invest up to 10 percent of your annual income or net worth (not including your primary residence), whichever is less, but not to exceed $107,000.
Companies cannot raise money from you directly.
You need to go through an online broker-dealer or a funding portal. Here is a list of the funding portals that FINRA regulates. Realize that the website names may be listed as the “other name”, such as Republic. Crowdfunding portals register with the SEC and are members of FINRA, just as your financial advisor should be.
How to incorporate crowdfunding into your strategy
Consider it as part of your “play account” or charitable giving.
As you review the crowdfunding sites, you will see that for as little as $100, you can participate in many investments. Decide on the total amount you want to invest - perhaps $500 per year for 5 different companies. Check with your partner or spouse, if applicable, and your financial advisor to ensure the amount contributed will not affect your ability to meet your financial goals.
Take advantage of the ability to support local, small businesses.
This is really the only way that many people can invest in local businesses that you want to help thrive. Most crowdfunding sites offer a way to identify businesses in your local area that are running a crowdfunding campaign.
Learn More
When I am building a portfolio for a client, it is composed of broad, diversified, low-cost index funds. I do not recommend start-ups. That does not mean that crowdfunding sites, such as Honeycomb Credit, Small Change, Steward, Republic, and Wefunder, don’t have a role. For those that want to support a healthy, financially strong, diverse community, investing in local businesses through crowdfunding sites can help you do that. As long as you limit your total investment to an amount that you are able and willing to lose, these crowdfunding portals can open up an entirely new way for you to magnify your impact.
Learn more by listening to the Investing Forward Podcast, Investing in your local community.
Linda Rogers, CFP®, EA, MSBA is a virtual financial advisor and the owner of Planning Within Reach, LLC (PWR). Originally from New Jersey, Linda services clients nationwide (based in San Diego) and expats worldwide. She leads the design of PWR's investment portfolios which integrate environmentally, socially, and governance (ESG) factors. She focuses on impact investing and can be followed on Twitter.