Equity Crowdfunding Explained

There’s a lot to unpack so here’s what you need to know…

I’m sure you’ve heard of crowdfunding campaigns where some awesome new product gets pre-sold with a slick video, t-shirts and discounts for donating to the campaign, and maybe six months or year down the road you get that new smartwatch or fidget cube. And while this is crowdfunding this is NOT at all what we’re talking about here.

Equity crowdfunding is an SEC regulated securities offering (JOBS Act of 2012) enabling certain companies to offer and sell securities to non-accredited investors on an internet platform. There’s a lot to unpack in that sentence so here’s what you need to know…

Securities

Securities are a financial instrument that holds some type of monetary value in which the holder benefits from the work of others. This can be an equity security in which you own part of an organization aka a share. Or it can be a debt security in which the company borrows money from the investors and the security represents the loan and terms.

So how is this different from the Kickstarter campaign for the fidget spinner? In equity crowdfunding you are purchasing a share in the fidget spinner company, or giving them money in the form of a loan, etc., instead of donating money to the company and hoping they live long enough to ship you your incentive for donating in the form of a fidget spinner.

Non-Accredited Investors

Okay, so you’re buying a security but why can you just do that now? Well in some cases you can… namely for a private offering (aka not a publicly traded company) you must be an accredited investor. “Okay where do I find that form?”.

A fair question, and one we’ve gotten a few times. But it’s not a form, it’s a monetary classification in the US, defined in SEC Rule 501 under Regulation D of the Securities Act of 1933, a government response to the Great Depression. Broken down it says:

  • To be an accredited investor, a person must have an annual income exceeding $200,000 ($300,000 for joint income) for the last two years with the expectation of earning the same or a higher income in the current year.
  • Has a net worth over $1 million, either individually or together with a spouse (excluding the value of a primary residence).
  • A legal entity (like a financial institution or a corporation) with assets that exceed $5 million.

How Does Crowd Investing Work?

Now, if you don’t meet those requirements no big deal. There’s just a different rule set in which the SEC has created to better protect your capital and try to limit your risk. Before the JOBS Act, they limited your risk by not allowing you to invest in private offerings at all… okay not so fair… the rich get richer.

Luckily, the JOBS Act has created a balanced approach to limiting risk while not unfairly blocking opportunity from a non-accredited investor. Here’s how it works (updated in March 2021). A qualifying private company can raise a maximum aggregate amount of $5 million in a 12-month period from an unlimited number of non-accredited investors, so long as they file a Form C and continue to meet annual filing requirements. The thought here is we will spread the risk load across a large group of non-accredited investors who will all be contributing a small investment.

This way if it doesn’t work out, the investor will have only lost a small sum of money. And to further limit risk, they set up rules to how much a non-accredited investor can invest in a 12 month period. For non-accredited investors, if either of an investor’s annual income or net worth is less than $107,000, then the investor’s investment limit is the greater of:

  • $2,200 or
  • 5 percent of the greater of the investor’s annual income or net worth.

If both the non-accredited investor’s annual income and net worth are equal to or more than $107,000, then the investor’s limit is 10 percent of the greater of their annual income or net worth, not to exceed $107,000.

All of this to say, equity crowdfunding is the way regular people can invest in private companies and make money off the investment. And within the regulatory confines, it's 100% legal.

Risks to Consider

Loss: Like any investment, real estate crowdfunding comes with the risk of loss. This is why it’s important to do your homework into the sponsor and the deal. Typically, the higher the reward, the higher the risk. But, this isn’t unique to real estate.

Illiquidity: Real estate is illiquid, which means that you can’t just exit or sell your position whenever you want like you can in the public markets (stocks). When you commit to a real estate crowdfunded investment you are committed for the entire duration. Again, this is why it is so important to review the sponsor’s business plan. Typically, a sponsor will state what the intended hold period is, providing an indication of when he or she plans to sell the property. For this duration, your capital is locked up and you will not be able to access it.

Conclusion

Real estate crowdfunding opens the door for everyone to participate in the world's largest asset class. Real estate crowdfunding has gained a tremendous amount of traction since 2016, and investors have found attractive returns so far. Pistachio is the most accessible way for investors to enter the real estate asset class and benefit from the direct investment of real estate.