Crowdfunding by non-accredited investors

As of May 16, 2016, anyone (not just qualified investors) can invest through the crowdfunding platform. This means that, in theory, ordinary individuals have the ability to invest in startups that were only angels and venture capitalists in the past. Of course, the restrictions apply, and the risks and potential rewards of early-stage companies are much greater.

Key points

  • Equity crowdfunding is a way for startups to raise funds by selling shares to a large number of individual investors.
  • Similarly, individuals can invest in real estate or directly participate in P2P lending.
  • As of 2016, the JOBS Act allows ordinary individuals to participate in equity crowdfunding, opening up early investment to angel investors and venture capitalists.
  • Restrictions still apply, and the risks associated with equity crowdfunding may be much greater than investing in more mature companies on regulated exchanges.

Equity Crowdfunding and Employment Act

The background is as follows: The 2012 Jumpstart Our Business Startups Act (JOBS) was passed, with the aim of making it easier for small businesses to raise funds, thereby stimulating economic growth by creating jobs. The third chapter of the bill specifically deals with crowdfunding.In October 2015, the U.S. Securities and Exchange Commission (SEC) finalized some key regulations related to allowing non-accredited investors to participate in such investments.

Many types of equity investments are only open to qualified investors. These include banks, insurance companies, employee benefit plans and trusts, as well as certain individuals who are considered wealthy enough and financially mature enough to reduce the need for certain protections. To qualify as a qualified investor, an individual must have an annual income of more than US$200,000 and a net worth of more than US$1 million, or be a general partner, executive officer, or director of a securities issuer.

For uncertified investors, investing through crowdfunding platforms is an uncharted territory, but understanding how different types of crowdfunding investments work can make it easier for you to navigate this waters.

Equity crowdfunding

Equity crowdfunding is the type of crowdfunding that the third chapter of the JOBS Act focuses on. Through this type of investment, multiple investors pool their funds into specific start-up companies in exchange for equity. This kind of crowdfunding is most often used by early-stage companies to raise seed capital.

For several reasons, stock investment may be attractive to unapproved investors. First of all, if the startup company you invest in ends up successfully going public, it is likely to get a substantial return. Once the company goes public, you can sell your stock and recover your initial investment and any profits. If you happen to invest in a startup that will eventually become the next Google, the rewards can be huge.

In addition, equity crowdfunding does not require a large amount of capital to start. Depending on the amount of financing the startup is seeking, you may only invest $1,000. This effectively balances the competitive environment between accredited and non-accredited investors.

The two biggest shortcomings associated with equity investment are its inherent risks and time frame. There is no guarantee that a new startup will succeed. If the company fails, your stock will be worthless. If the company does take off, it may take years for you to sell your stock. CrunchBase data shows that the average time to market is 8.25 years, which is a factor you need to consider in your exit strategy.

Real estate crowdfunding

Real estate is a great way to add diversification to your investment portfolio, and crowdfunding is an attractive alternative to real estate investment trusts (REITs) or direct ownership. With real estate crowdfunding, you basically have two investment options: debt or equity investment.

When you invest in debt, you invest in mortgage notes secured by commercial real estate. After repaying the loan, you will receive a portion of the interest. This type of investment is considered to be less risky than equity, but has a disadvantage because the return is limited based on the interest rate on the bill. On the other hand, it is best to directly own the ownership because you are not responsible for managing the property.

Investing in equity means that you obtain ownership of the property. In this case, the return is realized as a percentage of the rental income generated by the property. If the property is sold, you will also get part of the proceeds from the sale. In terms of profitability, equity investment can bring higher returns, but if rental income suddenly plummets, you will take more risks.

Like equity crowdfunding, the main advantage of real estate crowdfunding for non-certified investors is that it has such a low entry point. Many top platforms set a minimum investment of $5,000, which is much cheaper than the tens of thousands of dollars usually required to obtain private real estate transactions.Peer-to-peer lending

For non-accredited investors who would rather invest in individuals than companies or real estate, this type of loan may be an attractive option. Peer-to-peer lending platforms allow consumers to initiate fundraising activities for personal loans. Each borrower is assigned a risk rating based on his or her credit history. Then, investors can choose the loan they want to invest in based on the risks involved.

If you want to control the risks you take, this is a good thing. At the same time, it also allows you to gauge what kind of benefits you want to see from your investment. Generally speaking, the higher the borrower’s risk level, the higher the loan interest rate, which means the more money you have in your pocket.

Likewise, a lot of capital is not required to start this type of crowdfunding investment. If you have an additional $25.00, you can start funding the loan through Lending Club or Prosper, both of which open the door to uncertified investors.

Investment limit for non-accredited investors

Although the updated Title III regulations allow unauthorized investors to participate in crowdfunding investments, it is not free. The US Securities and Exchange Commission has chosen to limit the amount that non-accredited investors can invest within 12 months. Your personal limit depends on your net worth and income. Accredited investors have no such restrictions.

If your annual income is less than $107,000 or your net worth is less than that amount, you can invest up to $2,200 or 5% of your income or net worth, whichever is less. If your annual income and net worth exceed $107,000, you can invest up to 10% of your income or net worth, whichever is lower, and the total limit is $107,000.

The SEC imposed this restriction for a reason. The purpose is to reduce the risk of non-accredited investors who do not know much about crowdfunding or general investment. By limiting the amount you can invest, the US Securities and Exchange Commission also limits the amount you can lose if a particular investment fails.

Bottom line

One thing to remember for unaccredited investors is that even though Title III allows universal participation, not every crowdfunding platform may join. This may limit the types of investments you can participate in. When you compare different investment opportunities, please pay close attention to the fees charged by each platform, as these fees will affect your long-term returns.

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