The world of crowdfunding is being opened up over the last few years as the government is easing the restrictions to allow non-accredited investors. What was once available to only the rich few is now opened up to the masses. There are now crowdfunding investments and businesses that were not available until recently.
And though there are still certain contribution limits, now determined by each state, most of the states only limit the amount you can invest to a small percentage typically 5-15% of your income. However, most middle-classed investors have a hard enough time putting away 10% of their income for the limits to be too much of a concern.
Crowdfunding basics – Pooling Funds
The idea of a crowdfunding investment is a way to pool funds. People get together and bring in a portion of the funds, then with the funds, they split the profits and receive shares of the company or get a return on their money.
For example, if a company is currently worth $1,000,000 and they decide to sell half of the shares then he can gather 500 people to bring $1000 and each person would own $1000 worth of the $1,000,000 company. Now if they continue to grow the business and it gets bought out by someone for $10,000,000 then your $1000 share now became $10,000.
The idea mirrors traditional investments where you provide money in exchange for stock or provide money in exchange for a debt note or bond. The biggest difference is that the market is private and there are limited options to liquidate your share.
Become a Venture Capitalist – Invest at the beginning
By allowing you to invest at the beginning you can become a Venture Capitalist and share similarly in the large risk as well as large reward. There was a reason that accredited investors were the ones who were allowed to become Venture Capitalists, it’s because they could afford to lose. Any amount they invested was at high risk of the company just closing up shop and leaving them with nothing of value.
That may be one of the reasons why non-accredited investors are only limited to invest a small amount each year, for if they lose that money they should still be able to provide everyday essentials.
To help the process of finding legitimate investments, brokers are set up and go through underwriting and auditing of the companies to help provide the most accurate information. It’s not like you’re just going to be investing in someone’s grand idea. Most of these companies already have sales and are in the growth phase as well as they have been in business for a few years to show they are fairly stable.
Invest in Startups – Help Grow the Business
Though non-accredited investors are now allowed to invest there are still a number of places that require accredited investor status. The biggest name that focuses on crowdfunding business startups is Republic. Republic is formed by alumni of AngelList. AngelList is one of the world’s largest investment platforms to help accredited investors find investments for them. They are already in the habit of finding these venture capital companies ready to be grown.
Most companies are between $1,000,000 and $15,000,000 have working products, big-name investors, and a track record of increasing revenue. With the initial slow years of starting a new company behind them, they are in the accelerated growth phase where they can make the most impact.
Republic is unique in that is allows investors from all over the world to invest, not just US-based investors. Investment minimums are determined by the company but typically range between $50-$250 and come with no fees. Companies come looking to receive between $25,000 and $1,000,000 which they sell as potential shares of their stock. Some companies have specific time frames while others have not current time frame of when they’ll sell off or prepare to go public. But most of them provide incentives (similar to Kickstarter) for higher investment tiers.
Here’s how it works
There are typically 2 ways that an investor can make money during a triggering event-when your money converts into stock- either when the company take their stock public – an IPO – or being acquired by another company. If the company can allow a discount or a max valuation or both. If they offer a discount then when the company goes public they will take the amount and buy your shares at the discounted rate. If they offer a max valuation, your shares are pegged at that valuation and if the company continues to grow you are acquired then they are still valued at the max valuation. Or if the companies offer both then you get the better of the 2 options.
Let’s see how this works in action. If you invested $500 into company XYZ and they offered both a discount of 20% and a max valuation of $10,000,000. If they go public then with the discount you would earn $500 worth of stock 20% cheaper than face value (1/(1-.2) * $500) for a $625 total. With the max valuation once the company hits $10,000,000 then your $500 is pegged to that $10,000,000 value. If the company is acquired for $50,000,000 or hits an IPO at $50,000,000 then your $500 investment converts into $2500. And if the company offers both then you get the better of the two, $625 or $2500.
Now how long it takes to reach that valuation is anyone’s guess so consider these long-term investments and diversify accordingly so you can see your profits spread across a handful of companies and not waiting for that one to go public decades later.
Do you wish you could have invested just a few hundred dollars in Microsoft, Apple, Google, Amazon, Facebook, while they were small? Think about this, if you had invested $1000 in Amazon at their IPO you would have over a $1 million and at the time of their IPO, Amazon was valued at almost $500 million. What if you could have invested when the valuation was $50 million or $5 million? You would have $10 or $100 million respectively based on that small $1000 investment.
We’re not saying to invest because the next company will become as big as Amazon more likely is that they’ll be bought out by these larger companies. The best part of Republic is that you are in control, you can evaluate the companies you like and which ones you choose to back and invest in and spread out your investments across a diversified basket of companies.
Crowdfunding investments are becoming more and more common, think of the possibilities. You could crowdfund a real estate project, or fund a business, or pool together an assortment of investments. We’re glad that these options are not becoming mainstream and available to the everyday investor to allow them to diversify their alternative investments and get in early on the success of startup companies.