According to the World Bank, crowdfunding investments is set to reach $90 billion before the end of 2017 in the US alone. Even in China where the regulations are rather unfavorable to equity crowdfunding, the sector is predicted to exceed $50 billion by 2025. Crowdfunding has become a useful alternative source of credit to small businesses that are usually turned away by venture capitalists and angel investors who fund only 1 percent of the proposals that they receive.
How Crowdfunding Works
Donations or investments are channeled through an online platform. The administrator of the platform is in charge of coordinating the contributions and administering the fund. You only give or invest what you can afford or are ready to contribute. It may be as little as $5 or as much as $200,000. There is no fixed amount that you should contribute.
Crowdfunded projects may be purely community-based with no intention of making a profit or sophisticated portfolio-picking with the sole aim of making profits.
The UK Crowdfunding Association classifies crowdfunding into three categories.
- Donation crowdfunding
Donors are usually motivated by social or personal considerations as opposed to monetary gain. Usually, only people who believe in the cause will donate funds towards it. Donors could receive acknowledgements such as regular updates on the progress of the project and tickets to attend related events.
- Debt Crowdfunding
Debt Crowdfunding is also referred to as peer-to-peer lending. Lenders expect to receive back their contributions with interests. In addition to the monetary benefit that lenders receive, they also feel satisfied for contributing to an idea they believe in. Contributors may sometimes lend money to very poor people especially in developing countries in which case, they do not charge interest.
- Equity Crowdfunding
Equity crowdfunding involves investing in a project in exchange for equity. Investors give money and receive shares in the venture. If the project succeeds, the value of the shares goes up to the advantage of the investors. in the event the venture is not successful, the investors stand to lose as the value of their shares goes down.
How to Make Profit by Investing in Crowdfunding
Crowdfunding can be a very risky way of investing because it does not guarantee investors their money back. Some start-ups fail and investors incur losses. Even where the venture succeeds, the value of your shares could be diluted by issuance of more shares. Here are key tips that will help you invest profitably.
- Limit Your Exposure
Invest up to 5 percent of your portfolio. Do not put money that you will need to live on into crowdfunding. Investment money should be extra money. By making limited investments, you will not suffer financial distress in the event that the venture fails.
You should not put your money into one investment. Invest in multiple projects so that in case some fail, others may succeed.
- Do your Research
Before investing through a platform, you need to find out the expertise and investment history of the team behind it. Find out how the companies that have been funded through the platform are doing. You should also find out the company that is being funded, the founders experience in the industry and academic background.
Going by the internet explosion that continues to be experienced in financial sector, there is no doubt crowdfunding investments are becoming the mode of raising funds by small investors. It is important to know when, where and how to invest in crowdfunding.