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Crowdfunding Is Growing Up: Here's What You Need to Know

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Just six months ago, equity crowdfunding was not yet legal in the U.S. Today, there are close to 1,000 crowdfunding sites in existence -- at last count, Crowdsourcing.org included 995 crowdfunding sites in its directory.

Despite its incredible growth, many think of crowdfunding strictly in terms of donation-based and reward-based platforms, such as sites like Kickstarter and Indiegogo. But as a result of the Jumpstart Our Business Startups (JOBS) Act, the definition of crowdfunding has expanded.

Thanks to the JOBS Act, small businesses and startups now have greater access to capital. The legislation allows entrepreneurs to publicly seek funding and makes it possible for individuals to become investors, a combination that has led to the emergence of equity crowdfunding -- a new opportunity for investors.

What is equity crowdfunding?

With equity crowdfunding, accredited investors provide funding to a private company in exchange for an equity stake in the business. Or they can choose to invest in real estate, whether it's a commercial property, development project or mortgage. Title III of the JOBS Act would extend the opportunity to unaccredited investors but that piece of legislation is not yet enacted.

In comparison, reward-based crowdfunding offers investors a tangible product or service, often a sample of what the funds are being used to create, as a reward for their contribution. With the donation-based model, investors give to a charitable cause, and under the lending-based form, the individual or company repays investors over time.

A recent report found that companies have raised an average of $178,790 through successful equity campaigns and in the process, sold between 5 and 50 percent of their companies, with an average of 15 percent.

A number of equity-based crowdfunding sites have already helped small businesses and startups find the capital they need. CircleUp, which has raised more than $20 million for businesses, provides consumer and retail companies with access to accredited investors, as well as partners like General Mills and Procter & Gamble. Crowdfunder connects entrepreneurs with investors, resulting in almost $62 million in deals to date. And RockThePost has helped innovative startups raise over $23 million and counting.

From a real estate perspective, American Homeowner Preservation has raised more than $4.6 million in distressed mortgage investments, which has helped 440 homeowners and extinguished almost $49 million in negative equity. Other sites like Crowdstreet are making commercial real estate opportunities available to investors.

These sites only scratch the surface of the many options for equity crowdfunding, but the numbers speak for themselves. Many of the top crowdfunding sites are also working to foster crowdfunding legislation and provide more education, in order to cultivate more opportunities for individuals and businesses.

Benefits of equity crowdfunding

When investors make equity crowdfunding a part of their portfolio, they gain both financial and social benefits. By investing in a company, investors earn a share in a property or a company's success, which can yield monetary returns over time. Returns vary based on the nature of the deal, the amount of equity it affords, and the success of the startup or real estate investment. But there is potential for a strong return: the average company that has raised money on CircleUp has seen its revenue grow at 80 percent per year since raising money on the site and its gross margins expand from 34 to 39 percent. On the American Homeowner Preservation site, investors can choose among opportunities with returns of 9 percent, 10.2 percent or 12 percent, depending on the duration of the investment.

And the returns go beyond the financial. On a larger scale, investors are also contributing to job creation and boosting the economy through new business development and real estate growth. With crowdfunding, investors have more opportunities to invest in organizations that have a social impact or support a cause they believe in. They can engage in crowdfunding for social good, putting their dollars to use in a meaningful way that contributes to positive change in their communities.

Potential risks of equity crowdfunding

As with any type of investing, equity crowdfunding involves risks. By nature, equity crowdfunding is a unique type of investment. Because the investments are not part of a public market, investors would likely have difficulty selling their shares if they wanted to do so in the future. Startups are not required to pay dividends, usually choosing to reinvest profits into the business, and they could end up issuing additional shares, diluting value for existing investors.

Even after a company, property development team, or homeowner receives capital through an equity crowdfunding campaign, there is no guarantee they will succeed. Investors may not have a good sense of a company's operations or growth. And though it will hopefully be rare, fraud is always a possibility.

To help reduce risk, do your research. Check into the security measures of the crowdfunding platform before investing and understand the requirements companies must meet in order to solicit funding. Make sure you feel comfortable with the site as well as the specific startup.

As with any investment, be realistic about what you can afford to lose and diversify to minimize risk. When it comes to real estate crowdfunding specifically, look for platforms that allow you to diversify your investments across a number of properties to further reduce your risk.

How to get involved

Despite the risks of equity crowdfunding, the rewards can be great. If you're ready to make this type of investment a part of your portfolio, investigate your options by browsing the directories at Crowdsourcing.org or Crowdfundinsider.com and learn more about the top equity crowdfunding sites. With all of the opportunities out there, you're sure to find one that is a match for you and your portfolio.