Founded in 2016, Ceteris Paribus is A student-led economics and finance publication at Davidson College.

Equity Crowdfunding: A New Way to Invest

by Ezan Karim

 

In 2013, over three thousand New Yorkers donated to a Kickstarter page launched by two design studios pushing an initiative to build a unique way to experience swimming outdoors in the city. A couple months and over five hundred thousand dollars later, Family and PlayLab introduced the +POOL project—a floating, filtered tile swimming pool that floats on the East River between Manhattan and Brooklyn—a nearly-completed project which will open to the public this summer.

Since the introduction of the JOBS Act in 2012, crowdfunding has been rapidly gaining traction. Online donations for entrepreneurs and small companies have skyrocketed from $1.5 billion to $34 billion from 2011 to 2015, along with an expected increase in 2016. The widespread popularity of crowdfunding has made it possible for anyone, regardless of his or her financial standing, to send a contribution and join others in funding a project that they all want to support.

Crowdfunding refers to the practice of funding a project or venture by generating monetary donations from a large group of people. Some Davidson students have taken advantage of this form of alternative finance, using crowdfunding platforms such as GoFundMe and Kickstarter to help raise money for their academic endeavors.

For others, such as musician Amanda Palmer, Kickstarter allowed her to release a studio album after she successfully raised a whopping $1,192,793 in her one-month campaign. Engineer and entrepreneur Debbie Sterling brought her Kickstarter dream to life when GoldieBlox, her toy and book campaign for young girls, raised over two hundred thousand dollars. As a result of her impressive crowdfunding effort, GoldieBlox gained attention in The New York Times and NBC’s Today show and is now sold in Toys-R-Us stores nationwide.

But unfortunately for Sterling’s investors, her donors were unable to benefit monetarily from GoldieBlox’s success. As of now, if a business idea or project takes off, the only financial beneficiaries are the creator of the project and the crowdfunding platform (such as Kickstarter or GoFundMe).

In eleven days, that will all change.

What if any ordinary individual, someone like you or me, wanted to actually invest in a business idea that could potentially become profitable? Until recently, only venture capitalists, bankers, and ‘accredited investors’ (high-net-worth individuals) could buy stock in a private company.

Title III, a new proposal from the Securities and Exchanges Committee (SEC), will go into action on May 16, 2016. When “Regulation Crowdfunding” takes effect, the SEC will approve the sale of all securities through crowdfunding, and American individuals will be entitled to an opportunity investors have enjoyed for years — they can buy stock in startups. This new investment concept, coined “equity crowdfunding”, allows you to invest in privately held companies via brokers or through special platforms registered by the Financial Industry Regulatory Authority to become an equity shareholder. In two weeks, any willing individual will be able to join other investors in funding startups and small businesses with the potential to earn a return on your investment. The investment amount has been capped by the SEC at 5% of your income if you are making less than $100K per year, and 10% if you are making more than $100K.

Not everyone, however, is enthusiastic about the SEC’s new policy. Jacqueline Benson, a partner at Moye White LLP, expresses unease with the implementation of Title III. “The major concern about crowdfunding is that unsophisticated, unaccredited investors may not understand the true risk of investing in early-stage companies. Not to be all Debbie Downer about early-stage investments, but most early-stage companies do not achieve the level of success that they anticipate on the timeline they estimate.”  

While Benson may be unsure of unaccredited investors’ ability to judge the potential of a small company or startup, others seem enthusiastic. Todd Crosland, a broker currently working with crowdfunding-type equity raises, believes that the SEC passing Title III will mark a watershed moment for startups and investors.

With all of this being said, the question remains: to invest, or not to invest?

Benson, though perhaps a tad pessimistic, isn’t wrong; equity crowdfunding involves privately investing in early stage companies, a concept that carries enough risk within itself. This fear probably arises as a result of over 90% of startups failing, and is likely the reason that only three percent of current accredited investors choose to invest in startup companies.

If you’re still not convinced that investing in startups is risky business, a simple Google search will provide the logistics of the idiosyncratic risks in private equity caused by its illiquidity and infrequent cash flows. Not to mention the miniscule percentage of companies that survive in the fierce startup market, or the lack of usable information presented for an individual to attempt to monitor or value the startup. 

To sum it up, yes, investing in a startup is risky.

But with high risk, comes high reward.

With a little financial guidance, a little research, and a little luck — it is possible to win big with a sizable return on your investment. Equity crowdfunding puts Main Street on the same playing field as elite venture capitalists, providing non-accredited investors with valuable opportunities to invest in small businesses before their profits skyrocket.

Some crowdfunding sites, such as CircleUp, have been adjusting in light of the SEC’s new policy to support small investors. CircleUp now provides an in-depth evaluation of the companies that seek funding through their platform, allowing more naïve investors the chance to thoroughly research the company before investing. Many other crowdfunding sites are beginning to follow suit; for non-accredited investors, this could be a way to avoid some of the risks of investing in private equity. 

Not only will Title III help ordinary investors, small businesses and startups also reap benefits from the new regulation. Equity crowdfunding significantly improves the way private companies can raise capital. The efficiency of crowdfunding will allow companies to gain both the support and investment from the general public. Companies with a firm business plan that can present their platform well are now exposed to a much larger pool of investors.

The online presence of equity crowdfunding platforms will also provide additional exposure to startups and small businesses that may have otherwise remained under the radar of accredited investors. This could expand the scope of the startup landscape and allow companies with unrecognized potential to take advantage of increased access to funds.

If equity crowdfunding sounds appealing to you, sites like CircleUp, WeFunder, LocalStake, Indiegogo, EquityNet, and SeedEquity are among some popular equity crowdfunding platforms to start with. As of now, less than a third of Americans are informed about equity crowdfunding. Market experts predict investments through equity crowdfunding will yield tremendous profits in the first couple months of Title III’s implementation. Clifford Holekamp, director of the entrepreneurship platform at Washington University in St. Louis, points out that the monetary possibilities only tell part of the story.

“The real reward for crowdfunding investors isn’t financial,” Holekamp says. “It’s the opportunity to participate. Helping an entrepreneur achieve their dreams, and being a part of a company that changes its industry – or maybe even the world – is exciting and personally rewarding. Everyone should have the freedom to make a difference with their dollars.”

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