The Next Big Thing: Where Crowdfunding and Investing Meet

written by Northwestern Mutual Voice - Forbes

It's what many investors dream about: getting in at the ground floor of the next Apple or Facebook. Thanks to the 2012 Jumpstart Our Business Startups (JOBS) Act and a recent decision by the Securities and Exchange Commission (SEC), some investors may be one step closer to uncovering such an opportunity through a new type of investing called equity-based crowd funding.

Crowd funding is part of a worldwide phenomenon that leverages the power of the Internet to pool the resources of people (the “crowd”) in support of a project. “There are two main models for crowd funding: donation- and equity-based,” said John Mroz, Investment Consultant for Northwestern Mutual Wealth Management Company. “Donation-based crowd funding (think websites like KickStarter and IndieGogo) is when people donate funds in exchange for tangible, non-monetary rewards, such as a copy of the company’s computer game or the promise of a future service or perk when the project is completed. In contrast, equity-based crowd funding is where investors contribute early-stage funding to a company in exchange for an equity stake in the business.”

Donation-based crowd funding has seen tremendous growth in the last few years. In fact, industry insider Massolution reported that crowd funding volumes are estimated to reach $5.1 billion in 2013, an increase of 89 percent from 2012. Many expect equity-based crowd funding also to take off.

Equity-based crowd funding took form with the 2012 passage of the JOBS Act, which expanded the ability of non accredited individuals to make direct investments in private companies at the earliest stage of their development through registered web-based portals. Up until this point, the only way to invest in these businesses was through a private equity group, an “angel” investor, or at the initial public offering (IPO) stage. However, before investors can access these web-based portals, the Securities and Exchange Commission still needs to approve final rules governing the operation of this newest capital market. Those rules are expected sometime in 2014.

A level of investor protection

As the proposed SEC rules stand now, entrepreneurs would be allowed to raise up to $1 million in a 12-month period either using a licensed broker-dealer or via a funding portal registered with the SEC. Investors with an annual net income or net worth of less than $100,000 would be allowed to invest up to 5 percent of that or $2,000, whichever is more, every 12 months. Investors with an annual income or net worth greater than $100,000 would be able to invest up to 10 percent of that every 12 months. Securities bought through crowd funding portals would have to be held at least a year before being sold.

Companies would be required to provide detailed information to investors so that they understand what they’re getting into; however, only those raising more than $500,000 would have to file more detailed information with the SEC. Even so, equity crowd funding isn’t without significant risks, including the chance that you could lose all or part of your investment.

Risks and barriers to success

“Equity-based crowd funding can offer investors the chance to own a piece of a fledgling company, but they’re often risky bets and can be more volatile than more established stocks because of how unproven these start ups tend to be,” said Mroz. “If the business succeeds, then its value goes up—and so does the value of that share of the business. But the converse also can be true. That’s why due diligence is key for investors.”

For many entrepreneurs, it can be easier to raise money for a project than it may be to make that project a success. Investors who are sold on a good idea but have no experience working with start ups could easily overlook a weak financial statement or a questionable business model.

“There are lots of examples of individuals who donated money to start ups that never managed to make the leap from concept to actual product,” concluded Mroz. “But even if the company had early success, investors may be surprised to find their original equity stake was diluted as more funding was required to take the business to the next level. What’s important to remember is that just a small number of these startups will be winners, leaving most investors holding stakes in companies that may end up having little or no value.”

For these and other reasons, Mroz suggests speaking with a professional advisor about equity crowd funding and its possible role as a speculative add-on to a sound financial plan. Specifically, he or she can explain prudent ways to invest in the broad opportunities this new and still untested investment opportunity may provide.

The Northwestern Mutual Voice Team is a group of professionals who share insights and opinions from experts and industry leaders across the enterprise. Our vision is to inspire others to take action and plan for their financial future through topics ranging from financial planning, retirement planning and distribution strategies, wealth accumulation and preservation, to leadership, philanthropy and innovation. 

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Why Crowd Funding Rocks

By Hanaan Rosenthal Author, Founder and President of Custom Flow Solutions

There's no doubt that the Internet has changed the way we do many things. I cannot remember, for instance, the last time I visited my bank teller, bought a postage stamp or walked into a book store. While the use of the Internet has some unsavory social implications, such as IAD (Internet Addiction Disorder) to name one, it also has aspects that will forever displace the balance of power from a few at the top calling the shots, to the rest of us determining our own path.

Displacement The first such phenomenon in my mind, was YouTube. Before YouTube became popular, you were a star when Nickelodeon or Disney told you you were. Someone in those corporations would scout talent, made them up and then made them famous. Now take Fred , for example. He put some crazy-funny home-made videos up, and people liked him. He now has over a billion views and over 2 million subscribers. No one at Disney told him what to say or what to wear. Or Jenna Marbles, the hilarious inappropriate blond hottie, who's now sporting over 11 million subscribers and over 1.27 billion views. I dare Nickelodeon to sensor her rants. The web, in these cases, is all about displacement. Letting you and I decide what goes and what doesn't rather than having some suit decide for us. Amazon.com is another great equalizer -- not so much for book stores, but very much for authors. Anyone can write and publish book and get a chance to sell it along side the best sellers. I like that! Getting funded The next such form of displacement is another example of how the masses can grab control previously held by the wealthy few: Funding. Yes, rich people have more money, but take all us average Joes, and together we have a bundle.

And now, with crowdfunding, we can combine that money to decide what projects get funded. The traditional methods of funding meant that people with great ideas and creativity were actively looking for the few people with money to spare. Those few would then decide if we, the people, are or aren't interested in their idea. Crowdfunding skips that step altogether. Why ask one person what the rest of us want when you can just as the rest of us? With crowdfunding, anyone can invest as little as $1 in any project. Sometimes to buy advanced product, simply to be a part of the next big thing, or even buy shares of the company, as may be soon possible. The difference is that the company or individual that put the product together don't have to go begging. All they have to do is make a compelling video and convince you and I that helping them with $12 will be just too much fun to pass. 2013 is becoming a $5 Billion year for crowdfunding projects, up over 500 percent from 2010.

Next step When you have successful sites revolving around a new phenomenon, you start to see aggregator sites. While some of those are aimed towards the crowdfunders themselves, a new, unique site is emerging that aims to make projects across all crowdfunding sites more accessible to investors. By investors, of course, I mean you and I.

Meet dropkic.kr. A brilliantly designed new site that allows you to discover, rate and share crowdfunded project across all sites. Part of Betaspring, a startup incubator in Providence RI, dropkic.kr founders Matt and James have something really cool going on. I caught up with founders Matt, James and Olivia, their social media marketing coordinator, to get a better idea of what they are up to. Dropkic.kr

Q: What is dropkic.kr?

Matt: Since Kickstarter was kickstarted in 2009, literally hundreds of crowdfunding websites have sprouted up, releasing thousands of projects every day. Today, we - the backers - simply can't find the campaigns we care about, let alone keep up with them. Dropkic.kr is the new tool for project supporters. It pulls together the projects from all major crowd funding platforms. Whether you're a fashionista or a gadget enthusiast, dropkic.kr learns what you love, and recommends you the hot new projects you would never have found, as soon as they come out. For projects you've liked, it alerts you if you're about to miss an early bird discount or the closing date, so you don't end up kicking yourself once it's too late.

Q: How are you positioned relating to other sites?

Matt: There are a million and one tools and websites out there which help fundraisers get their campaign off the ground, but supporters are left to fend for themselves. We either have to trawl through projects across a dozen of our favourite sites every day, read an email on what the Kickstarter staff happen to like that week, or more often just miss out. We've been called 'the crowdfinding app' and 'the Kayak of Crowdfunding', but really our mission is to help crowdfunders find and back the projects they care about.

Q: What do you see the role of crowdfunding in the world economy?

Matt: Crowdfunding is a fundamentally new, more democratised flow of capital. $5 Billion this year will grow to more than $10 Billion next year. If you think this is a big deal, analysts estimate that crowdfunding will unlock as much as $1 Trillion in capital with the JOBS Act. The crowdfunding movement is enabling all of us to collaborate with a flood of inventors, creatives, entrepreneurs and altruists, to make their ideas a reality and the world that bit better. As a startup ourselves, we have seen so many world-changing projects fail because of a simple lack of capital. Making these new markets more efficient by bringing the right people together definitely gets us out of bed in the morning.

Q. Are you looking for funding yourselves?

Matt: Truth be told, if we were, we couldn't legally announce it right now. We'll be raising a seed round very soon though, and with the JOBS Act lifting the ban on public fundraising last September, everyone can now benefit from the same investments rich VCs have accessed for decades, through equity crowd funding sites.