A little while ago we covered the benefits of equity crowdfunding from the perspective of the entrepreneur. It can be an excellent way for entrepreneurs to raise money, while at the same time gaining significant marketing exposure and solidifying customer loyalty. These reasons have contributed to equity crowdfunding gaining a high level of popularity among company founders. Though there is another important angle to explore: the investors.
Equity crowdfunding means that ordinary people can gain a stake in venture-capital-like opportunities, even if they don’t have a net worth in the millions. Wealthy investors have long known the diversification and potential upside that comes through including venture capital in their portfolios. However, until the early 2010’s the vast majority of the general public were legally excluded from investing in early-stage, non-listed companies. Equity crowdfunding has changed all that.
Changes In The Law
Prior to legal changes (which happened at different points in different countries), the law dictated that companies could only promote an investment to individuals who passed a “sophisticated investor” or “high-net-worth” test. The only way it was possible to promote to the general public was to go through an initial public offering (IPO). IPOs are extremely costly, due to all the input required from lawyers and investment bankers – none of whom are cheap. It was therefore simply unaffordable for startups whose capital needs were more modest, in the $250,000 – $2 million range.
Early-stage companies therefore needed to go to angel investors, venture capital and private equity for the funds they needed. But the aforementioned legal changes have resulted in a set of rules that make it possible to raise limited amounts of capital under a reduced level of disclosure, rather than have to prepare a full prospectus. Now, any investor is able to use equity crowdfunding to evaluate opportunities and be their own judge of which companies are worthy of their hard-earned money.
A Different Investing Model
Equity crowdfunding requires a fundamentally different approach than most of us are used to. Rather than a stable annual yield such as from real-estate or bond market investing, equity crowdfunding (and venture capital) is all about investments which might disproportionately increase in value by 20x, 100x, or 1,000x… or perhaps become worthless. Most startups fail. But that’s what it’s all about – gaining exposure to companies before their prospects are proven: trying to pick “the next big thing.”
Here’s how the investing math could potentially play out – invest in ten equity crowdfunding opportunities at $2,000 each – an outlay of $20,000 (not an unreasonably large sum in the context of the average retirement portfolio across a lifetime). Eight of these companies completely fail, one of them is a moderate success and doubles in value, one of them is a large success and increases in value by twenty times. This would see the portfolio rise in value to $44,000 – a return of more than twice the initial outlay, despite a failure rate of 80%. This is the sort of outcome venture capitalists (and equity crowdfunding investors) hope for when they invest in many companies, fully expecting most will fail, but that the successes will be large enough to make up for the failures. What counts is the accumulated payoff, not the proportion of right and wrong.
Choosing A Platform
Equity crowdfunding platforms provide a marketplace for companies to list and for investors to discover them. The wisest general advice for investors is to stick with the larger, more established platforms. This is because the bigger platforms usually have invested in a stronger investor user experience, better due diligence around their deals, and tend to be the sites where the most attractive companies decide to list themselves. The best investment opportunities cluster around the biggest platforms.
The choice over the exact platform that an investor ought to use is a question of geography. Equity crowdfunding is an offer of securities, so they are governed by securities’ law. The practical consequence of this is that cross-border platforms are rare and there is no single platform which operates everywhere. For example, Crowdcube and Seedrs are two of the largest in the United Kingdom, while WeFunder and StartEngine are big in the United States. Investors need to do their own research on platform selection, depending on where they are based.
A Crowd-Sourced Investing Culture
One of the most exciting things about investing through equity crowdfunding is that it gives young, innovative companies access to finance, while also allowing everyone – of almost any level of net worth – to participate in the upside as they build the economy of the future. By building a closer connection between crowd and company, it flips the old customer/provider relationship, to become one of crowdsourced co-creation.
It all points to a seismic shift in the investing culture. When the masses can achieve a direct shareholding in startups, it is bound to lead to people taking their financial future into their own hands. Rather than sitting on “passive” stock index funds managed by professional money-managers, anyone can take an active role in deciding how they want their money to be invested.
Keep a close watch on the initial public offerings of the coming years. With more equity crowdfunding “alumni” now having had the time to use the money from their past campaigns to grow and expand, there is a strong possibility that the next wave of companies to list on the public markets will be able to point to their origins from crowd-sourced finance.
Have you some experience of investing through equity crowdfunding you’d like to share with the Crowdsourcing Week community? Maybe you have some tips to offer, or words of warning?