DEFINITION of Investment Crowdfunding
Investment crowdfunding is a way to source money for a company by asking a large number of backers to each invest a relatively small amount in it. In return, backers receive equity shares of the company. Normally restricted to accredited investors, the 2012 Jobs Act in the United States allows for a greater scope of investors to invest via crowdfunding once better infrastructure is in place to do so.
Investment crowdfunding may also entail obtaining debt as well as equity stakes. Micro-loan providers are a source of debt investment whereby a large group of individuals may invest in a small piece of a larger loan. Lenders typically know the purpose of the loan and the terms including interest rate, length of the loan, and estimated credit rating of the borrower. Lenders receive an interest rate typically higher than other debt instruments due to the credit risk associated with borrowers; however, they can spread a large amount of money incrementally across a large number of loans. Borrowers may seek this sort of financing when traditional borrowing is too costly, or is not an option for them.
BREAKING DOWN Investment Crowdfunding
Entrepreneurs typically have found seed money to start a new business by taking loans from banks, family and friends, or by offering equity ownership in return for investment from family & friends or from angel and venture capital investors. Investment crowdfunding now allows a start-up to seek relatively small investments from a large number of backers when other fundraising options are not available or come with too much cost.
Backers receive shares of the new company commensurate with the amount invested. Popular platforms for equity crowdfunding are SeedInvest and FundersClub.
Micro-lending platforms such as LendingClub and Prosper allow for crowdfunded debt financing where a backer, instead of owning part of the company, becomes a creditor and receives regular interest payments until the loan is eventually paid back in full.
Investment Crowdfunding and New Opportunities for Individuals
Both equity and debt investment crowdfunding can be risky, but investors can diversify a sum of money across a wide range of choices. It can be an exciting and relatively low-risk way for individuals just beginning to learn about investing and/or who are particularly passionate about or want to support a startup that they feel connected to. Since the buy-in can be very small for an equity stake (often the company is able to set the terms) it lowers the barriers to entry for individual investors.
Crowdfunding insurance has been discussed as a way to mitigate a portion of the investment risk associated with crowdfunding in return for a premium payment.