Crowdfunding: A hot topic in investment circles

July 11, 2013

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That buzzing you hear might be excited chatter about the investment world’s latest hot topic -- crowdfunding.

 

Crowdfunding is when many different people pool their money, typically via the Internet, to finance some venture or activity. It began in 1997 when fans of the British rock band Marillion initiated an online campaign to raise money for a U.S. tour by the band. It was a success, and the idea caught on. Today small entrepreneurs have gotten in on the act by using crowdfunding to finance business ventures. While those who donate money currently receive no equity or profit share in return, they might receive prizes, formal recognition or other perks, depending on the project.

 

But soon, thanks to the April 2012 JOBS (Jumpstart Our Business Startups) Act, that will change, and that’s what the buzz is about.

 

Once the regulations envisioned by the JOBS Act are fully implemented by the SEC (which may happen by early 2014), crowdfunding sites will be allowed to issue equity to a project’s “donors,” who will then become “investors” in their chosen project(s).

 

The potential benefits to investors are nothing to sneeze at. This is the democratization of the venture capital market. And by promising to bring entrepreneurship to the masses, it is a very American idea.

 

It is also, potentially, a very successful one. Many hugely successful businesses were once fledgling start-ups backed only by good timing, quality people and seed capital. For instance, both Apple and Google famously began in family garages. Facebook got its start in a college dorm room. The spectacular early-stage returns of such companies can leave those on the outside fantasizing about what life would have been like had they been one of the “ground floor” investors.   

 

Now, through crowdfunding, early-stage investment opportunities are available with a click of the mouse. While crowdfunding may not be for everyone, familiarizing yourself with this brave new investing world is definitely worthwhile.

  

The 3 R’s of crowdfund investing  

  

  • Risks: In venture capital markets, many projects fail, even those that receive strong financial backing. This is likely to be even more common in crowdfund investment markets, where barriers to entry will be lower. Anyone considering investing should therefore be willing to accept the risk of losing their entire investment. Lack of liquidity must also be considered. And while disclosure requirements being formulated by the SEC will make it harder for entrepreneurs to (intentionally or not) mislead investors, they provide no guarantee.

 

  • Rewards: In addition to the possibility of outsized early-stage returns, with crowdfunding you can invest in projects – whether business, artistic, or charitable -- that align with your personal beliefs and passions. You may feel more “a part of” such a venture than is the case with a stock or mutual fund.

 

  • Recommendations: Investors should tread carefully in the crowdfund space. Disclosure requirements will provide a way to evaluate alternative projects. Anyone considering investing should take advantage and perform as much investigation and due diligence as possible, but also realize that there is no guarantee against loss. At PartnersInWealth, we feel that crowdfund investing has potential for rewards both tangible and intangible. But due to the risks, we recommend that no more than 10% of your portfolio be placed in crowdfund projects. For those who are interested, a good way to start might be as a “donor” in the current crowdfund market, where equity is not issued.

 

We’ve linked to a few crowdfunding sites below. As always, we are available to be your unbiased sounding board on this topic. For more information, helpful guidance or professional assistance, please contact Jim Waters, CFP®, at PARTNERSINWEALTH, 713.964.4028 or jrw@partnersinwealth.com.

Some popular crowdfunding sites: