Technology is constantly evolving. It’s amazing to experience the new creations and ideas that we once never thought were possible. We can communicate with anyone across the world, instantly. The first computer ever made was 1800 square feet. Now computers that are much more powerful can fit inside of our pockets. Every day we see new improvements in technology. But every once in awhile, something new comes along and changes everything. In the investment world, a recent event has occurred that will transform our idea of investing, forever. It’s name is crowdfunding.
What is Crowdfunding?
Crowdfunding is the practice of raising capital from a large group of people to fund a new venture, project, or idea. The concept of crowdfunding has been around for centuries. It wasn't a viable investment until recently, though. When most people think about crowdfunding, they usually think of donation campaigns funded through companies such as Kickstarter and Indiegogo. Through these sites, anyone is able to donate money to a campaign. The problem is that the most they can receive in return is a gift, free sample, or possibly just a ‘thank you’. For a long time, this was basically the only use for crowdfunding.
In 2012, though, everything changed. On April 5th, 2012, President Obama passed the Jumpstart Our Business Startups Act, also known as the JOBS Act. The JOBS Act significantly changed a number of laws and regulations and made it much easier for companies to raise money. Some of these changes involved creating new exemptions for crowdfunding, which opened up a whole new realm of possibilities.
After the passing of the JOBS Act, crowdfunding companies are now able to raise money from investors in exchange for ownership (equity) in the company without having to register with the SEC. Registering with the SEC can cost hundreds of thousands (or even millions) of dollars, which made it nearly impossible for small businesses to raise money from investors. Many small businesses need more capital in order to scale and grow their businesses. The problem is that they have been limited on their options to raise money. Venture capitalists reject around 98% of all business plans that are brought to them, and bank loans are becoming more and more difficult to obtain since the financial crisis. The JOBS Act has created an opportunity for companies to raise money from investors in a much more efficient and effective way.
Why is this a big deal?
This is a HUGE deal, for a couple of reasons. Small businesses now have much more access to capital. This enables them to expand and reach more customers much faster. These small businesses are now able to use these new exemptions in order to advertise to investors and raise money to fund their projects and new ventures. In fact, any business now has easier access to capital. This will have a substantial impact on the growth of all businesses. The biggest impact of these new regulations, though, is what they will do to the investment world.
Crowdfunding has been growing exponentially since the JOBS Act. According to a report done by Massolution, the global crowdfunding industry grew from $6.1 billion in 2013 to $16.2 billion in 2014, then to $34.4 billion in 2015. This growth is staggering, and there have been no signs of slowing down any time soon. Actually, many people believe that crowdfunding has only scratched the surface of its potential (myself included).
The Benefits of Crowdfunding
- The entire process can be handled online
Since everything can be handled online, companies are able to eliminate some major expenses. For example, they can eliminate rent for office space and overhead costs. It also enables the company to cut out the middlemen and have their investors invest directly through the company. The company can then pass on those savings to their investors by charging lower fees, reinvesting in the business, or by paying out dividends/distributions.
- The minimum investment is very low
Most crowdfunding investments have low minimum investment requirements (the range is usually anywhere from $1,000 to $10,000). Investors can now start investing much sooner. It doesn’t require them to break the bank in order to invest, either.
- Crowdfunding can provide instant diversification
Some crowdfunding investments (such as the real estate sector) provide instant diversification. This is accomplished by investing in multiple properties or projects in the same investment offering. This reduces the risk of the investment and allows the investor’s funds to be spread across multiple asset classes without being charged multiple commissions or fees. You can find out more on how much you should diversify in this article.
The Biggest Benefit of All
The reason crowdfunding will change the future of investing, though, is because it opens up the world of private equity investing to everyone. This means that everyone now has the ability to invest and share in the ownership and growth of private companies. Have you ever come across a company that you knew would be the next big thing, but you couldn’t invest because they weren’t a public company? I know I have.
Crowdfunding provides the opportunity to invest in some of these companies before they become big corporations and get listed on the stock exchange. The best part is, these companies won’t be affected by the crazy emotional fluctuations of the stock market. These companies will be valued based on factors such as their financial condition and growth potential rather than worries about the next presidential candidate or the next terrorist attack.
As with any investment, there are risks involved in crowdfunding. For example, investing in private companies is riskier than investing in public companies. Private companies aren’t held to the same regulations and standards as public companies. This means there is less transparency with private companies. This makes it easier for private companies to hide important information from their investors or to report misleading information on their financial statements. Another disadvantage with crowdfunding is that the investment is usually a lot less liquid. With a public company, you can sell your shares on the open market and get your capital back almost immediately. It’s not nearly as easy with private equity investments. Most crowdfunding investments require you to stay invested for a year or longer. It's important to understand the differences between each investment and decide which investment vehicle is right for you.
This is just a brief overview of crowdfunding and the impact it can have on investing. Anyone interested in crowdfunding should do plenty of research and due diligence on that investment. Every investment is different, and each investment comes with its own advantages and disadvantages. No one can predict what the future has in store for us. But, it will be exciting to see how everything plays out!