There’s been a lot of coverage about crowdfunding and though it isn’t new, it got a nice shot in the arm in 2012 when Congress passed the JOBS Act. JOBS is actually an acronym for Jumpstart Our Business Startups. Among other things, it advanced the cause for crowdfunding for investment purposes, and that’s why it’s been generating so much excitement. Here’s how to think outside the traditional investing box with crowdfunding.
Crowdfunding is a way of raising money without going through traditional banks, although banks are actually beginning to participate in the practice.
It works when various investors put their money together, generally for the purpose of providing investment capital — for a certain return — for small businesses. It’s thought the advancement of crowdfunding through the JOBS Act will generate a considerable amount of future economic activity.
How Crowdfunding Works
Crowdfunding has been practiced in Third World countries for decades. Since traditional banks are scarce in many of these areas, individuals pool together small amounts of money to make available to individuals for small business loans.
More recently, it has been a practice in the U.S. and other Western countries, primarily among nonprofit agencies. Now that the practice is becoming more formalized, it will extend to providing investment capital to small and upstart businesses.
Crowdfunding is mainly being handled through websites. This is the best way to attract both investors and small businesses needing loans, since it creates an informal environment where the two can come together. The sites represent small business venture capital sources.
Under the JOBS Act, there will be specific limits on the amount of money a business will be able to raise, or even an investor will be able to provide. Right now, the maximum dollar amount of securities a business can offer is $1 million per year.
In addition, whenever a business requests capital in excess of $100,000 they are required to provide an independent financial statement reviewed by a CPA. Above $500,000, fully audited statements are required.
Investors meanwhile are limited to investing no more than $100,000 in any given year. However, there are also various limits relating to an investor’s financial ability, and those are still largely in a state of flux, since crowdfunding is only being rolled out now.
Crowdfunding and the Economy
In many circles, it’s thought that crowdfunding will not only be a boom to small businesses, but also to the economy in general. It will enable an entrepreneur to go into the market and raise capital, in much the same way large, registered public companies do in the financial markets. Only it will remove the filing and regulatory requirements typically associated with large capital raising ventures.
The small business owner will be able to showcase his business or venture through the various crowdfunding websites. Interested investors will be able to weigh out the pros and cons of the security offering, and make a personal decision whether or not to invest in it.
This is very unlike traditional venture capital as well. Rather than pitching an idea to a single venture capital firm, who will either support or reject the venture, the entrepreneur is able to secure funds from multiple small investors. A single loan or stock offering may be funded by dozens or even hundreds of investors.
This will also create a wave of fresh investment opportunities for investors looking for potentially higher returns. Small investors will be able to take positions in multiple upstart businesses deemed by the investor to have great potential.
If this potential is realized, the investor stands to gain substantially more than might be possible in publicly listed stocks. In addition, a small investor will have an opportunity to invest in small business ideas that may not be available in the traditional financial markets.
Crowdfunding holds potential to not only grow a very large number of small businesses, but also to create what will collectively be enormous investment opportunities. If it works as hoped, it can cause the economy to grow at levels not seen in decades.
How Can You Participate in Crowd Funding?
In order to participate in crowdfunding, you will visit websites that exist specifically for this purpose. The websites can be both convenient and easy for small businesses and investors to connect with one another, and to create new investment opportunities.
Some of the more popular crowdfunding websites at the moment include:
- Go Fund Me, which bills itself as “The World’s #1 Personal Fundraising Websites”
Like with all investments, proceed with caution before investing in crowdfunding sites, and don’t be quick to exit the traditional stock markets! This is an industry in its infancy, so it may take some time before it develops into a viable investment option, particularly for small investors.
All of the risks normally associated with investing in stocks also exist when it comes to crowdfunding. But because crowdfunding involves investing money in small and often brand-new businesses, the potential risks are even greater.
The small businesses are not regulated by the SEC or other government agencies. It’s a good bet there will be a significant number of scams, especially in the early years.
The best thing for small investors may be to allocate a small amount of your portfolio to what you believe to be the most promising opportunities available. It would have to be money you can afford to lose, but in the hope that a small number of the investment opportunities will turn into very lucrative situations.
Readers: Have you had any experience with crowdfunding so far? Would you recommend it to others who are considering it, either to raise capital for business or for investment purposes?