Is crowdfunding worthy to invest?

Equity has been found to be a trendy investment option and a large number of investors have invested in this instrument with an objective of earning a high rate of return on investment. But the critical question remains: one will be left wondering: is it really worth it?

Understanding Crowdfunding

Crowdfunding, also called micropatronage in Spanish, is a collective financing of a project on emergent property for altruism, for a reward, or to participate in the project. In most cases conducted through the internet, crowdfunding involves setting a financing target and a time of expiry. If the target is not reached, funds are generally given back to the shareholders. That being the case, in the event that the investment objectives are realized, the investment goes forward.

Crowdfunding is a way to raise funds for different initiatives, starting from an individual’s charitable pursuit and ending with business activities for financial profit.

According to the Spanish Crowdfunding Association, it can be classified into four types:

• Investment-Based: Shareholders get a stake in a company or their rights on surety on its earnings.
• Loan-Based: Borrowers return the loan with some extra amount called an interest.
• Donation-Based: They do not get paid most of the time, it is common to find a donor funding a humanitarian cause.

The Nature and Development of Crowdfunding within its Historical Framework

The idea of grouping together in order to raise money to cater for a common cause is one that has been used in the past. Some of the examples of historical analogous financial structures are war bonds during active military conflict and various community initiatives funded by people’s donations.

These platforms enabled a host of projects, ranging from creative such as films, music albums, and the arts, to innovation that is products and technology. Crowdfunding made the investment easy and opened the market, making it possible for anybody and everybody to be part of the entrepreneurship ventures.

Aspects that Make Crowdfunding Attractive to Investors

Accessibility and Inclusivity

Through crowdfunding, small investors have their chance in the market, which earlier was conducive only for individuals with fat pockets. It can accommodate funding in new and innovative firms and areas, while dream chasers get to chase their dreams, and investors could get immense profits.

Crowdfunding attracts people because it is easy, and there would be high revenues earned from it. As opposed to common types of investment instruments, crowdfunding services may demand less amount of investment compared to a standard starting pack. This has opened up the market to many different people, and they come with different skills and funds.

Supporting Innovation and Entrepreneurship

Secondly, crowdfunding offers investors a means to fund worthy and viable projects that they would like to see implemented in society. Whether it is a new technology to change the world or a business that focuses on the welfare of its stakeholders or the community, art, and creations, investors can select projects that can inspire them. The given emotional bond can add value to the investment and make the experience more ends than the material one.

Democratization of Investment Opportunities

In the same regard, a major strength of crowdfunding is that it makes capital accessible to the masses. Generally, say, investing in startups or other high-potential markets was possible only when there was a considerable amount of money and that was P2P only for the elite or large companies. Due to these reasons, crowdfunding has eliminated this barrier where one can invest with a small amount of money.

In this way, this democratization opens the opportunity to increase the number of people to contribute to the growth and success of innovative companies.

Thus, it has the possibility of encouraging the spread of creativity and innovation by acting as a source of funding that is separate from bank loans or venture capital. This freedom has definitely benefited many creative projects as well as technological developments that have come to existence more than they would have otherwise.

To the entrepreneurs, crowdfunding provides much more than financing. It acts as a means of proof of concept, gathering feedback on an idea, and getting a base of early adopters. Crowdfunding also has the potential of attracting the attention of the media and other investors into projects when a crowdfunding campaign marketing strategy is successful.

Advantages of Crowdfunding Investments

Fractions are made available to markets that demand high early investments through the use of crowdfunding. It also helps in diversification of investments as one is able to make an array of choices from the various categories listed in the crowdfunding platforms. Most notably, crowdfunding can provide high revenues, that is why these investments are rather interesting.

Accessibility and Inclusivity

As a result of the above-stated uses, crowdfunding platforms have eased the entrance to investors. Since the minimum quantities of funding can be as low as a few dollars, virtually anybody can contribute to crowdfunding projects. This has proved to make investing more inclusive and any individual can support a project they would like to fund.

Diversification of Investment Portfolio

Business crowdfunding opportunities therefore help investors to diversify their investment portfolios. This way, investors can lower the risk of investments and at the same time get high returns from different fields and projects. Another factor, which is actually more important in the case of high-risk investments, is diversification; whereby investment in different areas is organized in such a way that when one investment performs dismally, another may perform exceedingly well.

Potential for High Returns

Another extraordinary motive of funding through crowdfunding is that of high returns. Hence while not all projects are likely to be very profitable, those that are once developed can represent astronomical returns as opposed to other forms of investment. For instance, early investors in some of the successful new companies like Oculus VR and Pebble received their investments’ good yields.

Emotional and Social Rewards

Apart from the pecuniary quantity, the investments in crowdfunding can give some emotional and social quantity. That is why investors will be satisfied and fulfilled as they join fund schemes to finance projects of interest and in line with their values. Moreover, it can be stated that being in a social environment that supports backers can help create a shared identity.

Disadvantages of Crowdfunding Investments

Nonetheless, crowdfunding investments include several demerits even with the numerous advantages it has. The greatest one is risk because the organization is associated with high risks bearing in mind that there are no guaranteed profits. For instance, investing in a startup is associated with a potential loss in the company’s operations but it could be somewhat profitable.

High Risk and Uncertainty

Investments in crowdfunding are inherently risky, which usually proves to be rather costly for those who invest in them. Most projects, especially those considered startups, have rather high failure rates. As could be expected, some would become very popular and make almost incredible promises, and their products turn out to be stupendous flops that investors lose their money on. This is a big issue because compared to companies which have well-developed and stable records of performance, the identity of a crowdfunding project is very often questionable, and its experience, therefore it is tough to judge its credibility.

Illiquidity of Investments

The other disadvantage associated with such investments is the challenge that accompanies the process of liquidation of such an investment. Unlike the shares in the stock market that can be sold and purchased in the public domain, the shares in crowdfunding investment may be few in numbers if profitability is not high. Thus, invested capital is locked into the business for the medium to long term, and there is a possibility of losing the invested amount in case of unsuccessful business.

Limited Regulatory Oversight

As we have seen, laws governing crowdfunding are still being developed, and in any case, the market for crowdfunding is not as mature as, for example, financial markets, where specific rules and sharper control are already in place. This lack of regulation can put the investors at risk of fraud or being given bad management altogether. These risks should however be dealt with by investors by simply ensuring they conduct their analysis on the various platforms and projects that they intend to invest in adequately.

Potential for Dilution

The first one is equity-based crowdfunding in which there is a possibility of the shareholders’ dilution. In case the company needs to go for additional funding in the future, more shares may be created diluting the value of the earlier issued shares. This can lower the absolute returns for backers-investors in the early stages.

Complexity and Time Commitment

Crowdfunding investments hence call for extensive studies on the investment. Investors should also be fully aware of the details of the projects including the model of business, the market possibilities, and the challenges. This process may take a lot of time and may at times, need skills that every investor may lack.

Precautions Before Investing

Crowdfunding is mostly focused on real estate and businesses. In real estate funding is employed to purchase, lease out, or sell properties in order to make a profit. Additionally, P2P also entails offering funds to the creators (crowdlending) for new projects, where the initiator has to pay interest to the lender. In the business world, crowdfunding helps stakeholders such as individuals, establish their companies or innovative products through people who invest in the companies through the acquisition of stakes in them.

Trading in these markets ought to be well thought-out. Here are some precautions to take when investing through crowdfunding:

• Verify Platform Legitimacy: Make sure the crowdfunding is legal, reliable, and has prior practice. Perform CNMV checks for the company.
• Study Each Investment: When it comes to reading any documents, there should be certain advantages and disadvantages which should be taken into consideration.
• Understand the Investment: One of the most heinous mistakes that an investor makes is putting their money in something they have no clue about.

Assessing Platform Credibility

The crowdfunding platform should also be properly researched before investors invest in it, it involves committing some of their money. This entails the examining of the ability and capability of the platform in relationship to the past performance, experience, and of past users. That way, fraud or unprofessional management can be prevented since the platform has to be compliant with regulatory requirements for the sector.

Detailed Project Analysis

This implies that upon entering into a project, analysts and investors should take their time and conduct a thorough analysis of the project so that they are well informed on the prevailing circumstances. This includes the business proposition the firm executes, the target market, the competitors in the market, among others, and possible profitability. Reporting on the same also reveals how successful the project team has been and in that way understanding how successful the project will be if left to the team.

Risk Management Strategies

Thus, the risks of crowdfunding investments should be managed and the investors should implement the following risk management strategies. This comprises diversification of their investment, limitation of the amount of money to be invested in each project, and regular evaluation of their investment.

Legal and Tax Implications

Before investors go out to invest in the various enterprises, they should be aware of the laws and taxes that are in place for the same. The rules governing crowdfunding also differ from one place to another, therefore one needs to consult specific rules of the place. Such issues must be discussed with legal and financial experts to get a better understanding of them.

Crowdfunding Legislation

Spain’s extraordinary law 5/2015 prescribes the maximum quantity of money that an investor could place into crowdfunding if accredited or otherwise. An accredited investor has no restrictions while the restricted investor can invest up to €3,000 in a single project and in any % of other projects of €10,000 in total through one or more distinct platforms in any 12-month period.

To become an accredited investor, individuals must meet one of the following criteria:

• Professional advice on investments.

International Regulatory Landscape

Eventually, the legal structures in relation to crowdfunding are a bit different from one country to another. While some of the jurisdictions may have set very much detailed and elaborate laws meant to protect investors, others may lack adequate laws in as much as investor protection is concerned. Regulating authorities and investors should be aware of legal requirements in the investor’s country and the country of the crowdfunding platform.

Investor Protection Measures

To prevent harm to investors, the measures including investment restrictions, reporting rules, and the requirements for the platform have been put in place in many countries. They are intended to enhance the level of transparency and decrease the possibility of fraudulent activity. The investor needs to learn of these protections and just as importantly make sure that the platforms that they are using are meeting these protections.

Popular Crowdfunding Platforms

There are more and more platforms that include this type of fundraising. Hence, it happens to be very important that such marketplaces can be considered to be reliable, financially sound, and experienced before they begin to invest on their services.

Market Leaders

It is also important to note that some of the most popular crowdfunding sites today are Kickstarter, Indiegogo, GoFundMe, and Seedrs among others. Each platform has its unique focus and strengths:

• Kickstarter: Popular for artistic works ranging from movies, music, and entertainment like games.
• Indiegogo: It is involved in diverse projects; Technology and design projects.
• GoFundMe: Mainly applicable for individual and non-profit organizations’ solicitation of funds.
• Seedrs: Specifically aims at equity funding where it gives investors an opportunity to invest in a startup by acquiring stakes.

Platform Selection Criteria

The investors should consider some key variables when selecting a crowdfunding platform among them being the reputation of the crowdfunding platform, the costs of the crowdfunding platform, and the selection criteria and investor protection of the crowdfunding platform. It is also possible to establish the effectiveness of the thinking platform by reinvestigating case studies and success stories.

Emerging Trends in Crowdfunding

One has to mention that the industry of crowdfunding is rather young and it is experiencing significant changes right now as it is forming new trends and implementing new technologies. For instance, the latest and popular development in the financial market is the appearance of the contract, which has given birth to decentralized crowding platforms that intend to raise the level of transparency as well as contract the cost of the operation. This is because it is important that investors should develop awareness about these trends so as to note fresh opportunities and avoid or minimize risks.

Conclusion

There is enormous potential for profits in crowdfunding as a financial investment if initial investigation is carried out properly. It brings the markets closer to the people whereby any small investor can engage in the markets that previously were for the rich only. However, due to the higher risks and possible illiquidity, investing is a precise process, which requires separate planning. Thus, knowing the specifics of crowdfunding, an investor is capable of getting good returns on his decision.

The investors should, therefore, be very careful when investing in crowdfunding investments so that they can determine the benefits that can result from the investment and the pitfalls that come with the same. Although the opportunity to get high revenue and an ability to finance fresh projects are rather alluring, the threats and risks that would be faced are not to be overlooked. This paper, therefore, concludes that understanding the market and the intricacies of the legal structure is crucial when investing in equity-based crowdfunding and that a number of practices such as doing your homework, diversifying your investments, and being aware are key to success in equity-based crowdfunding.