Every few centuries, financial markets across the globe undergo a pivotal revolution, and investors who stay ahead of the revolution become enormously wealthy. Sure, none of us had yet been born the last time one of these investment revolutions happened. But, the next one — the private investing revolution — is here. Inevitably, it’s going to change everything about investing, and create enormous opportunities for savvy investors.
First, though, let’s rewind and understand the context of these revolutions.
Every few hundred years, laws and technology change so that there is an increase in the number of things investors can invest in. Back in the 1100s, France introduced the idea of debt securities, so investors could buy and sell agricultural debt. A few centuries later, banks in Venice pioneered the idea of government securities. By the late 16th Century, the discovery of the New World led to the concept of exchanging cash for shares in a company, and by the mid-20th Century, stock exchanges had been created in most all developed economies, allowing investors to buy equity in a multitude of large corporations.
Broadly, then, an investor’s investment opportunities over the past millennium have expanded from debt, to government securities, to equity in large companies. Now, we are on the cusp of another generational expansion: the expansion into private investing.
Over the past five years, regulatory changes and technological advancements have made it possible for individual retail investors to directly invest in private equity and assets, such as startups, fine art, and real estate. This is a huge change, and it has enormous implications. Perhaps most importantly, everything about this change is brand new, so we truly are in the first inning of a once-in-a-lifetime investing revolution.
How Did the Private Investing Revolution Start?
To get things started, it’s important to understand how we got here.
The private investing revolution technically started back in 2012, when former U.S. President Barack Obama signed into law the Jumpstart Our Business Startups (JOBS) Act. That act had a lot of moving parts. But, the most important part — Title III — is what kick-started the private investing revolution.
Long story short, Title III of the JOBS Act made it possible for retail investors to invest directly in startups and private assets.
That’s a huge change. For as long as financial markets have existed, only institutional and accredited investors like venture capitalists have had the ability to invest in early stage businesses. Retail investors had to wait for a company to go public to invest in it. The result of this barrier was that venture investors had far more opportunities, and saw far bigger returns, than average investors in the investment world.
Title III of the JOBS Act changed that. Ever since it was signed into law in May 2016, Title III has given average investors the same investment opportunities as venture capitalists. Now, average investors can invest in the next Apple (NASDAQ:AAPL) or the next Amazon (NASDAQ:AMZN) at the earliest stages.
This idea — giving average investors access to the private markets — is what underpins the private investing revolution. Over the next decade, that revolution will materialize through two big mechanisms: crowdfunding and tokenization.
What Is Crowdfunding?
The first part of the private investing revolution is equity crowdfunding.
Put simply, equity crowdfunding is raising capital from the crowd online. A company goes online to a crowdfunding website. They complete some paperwork, pay for some legal and accounting fees, and go through a vetting process, often from both regulators and the crowdfunding website. They come up with a valuation for the company and a capital raise goal, often in tandem with the crowdfunding platform, and then sell shares in the private company through the online platform to investors of all shapes and sizes.
That’s crowdfunding in a nutshell. And it’s a great idea because it enables a streamlined process for retail investors to invest directly in startups that need capital.
Coleman Foundation Clinical Associate Professor of Entrepreneurship, Nik Rokop, of Illinois Tech’s Stuart School of Business talked with InvestorPlace about the availability of crowdfunding and whether it’s a valid investment vehicle:
“Less than 2% of all startups raise funds through angels or VCs,” says Rokop. “Startups may have an experienced team, are solving an important problem, and have a good idea for a solution; but they may not be located in a startup hub or have the network to access these funds. At the same time, many investors are looking for opportunities and have funds, experience, and could help startups succeed; but they don’t have the networks to provide access to these opportunities. So how do they find each other? Crowdfunding!”
But, in its current state, equity crowdfunding has some shortcomings. Namely, there’s an investment cap for companies, there are huge upfront listing costs, and the risk-reward for high quality startups to embark on crowdfunding doesn’t make much sense.
These shortcomings will be addressed as legislation evolves over the next several years. The investment cap will go up. Upfront listing costs will go down. Higher quality startups will flock to crowdfunding platforms. And retail investors will get better and better private equity investment opportunities.
“What are you looking for as an educated investor?” says Rokop. “A reasonable return on your investment! You don’t gamble or play the lottery, except for fun. You evaluate risk and accept a return in proportion to that risk. Crowdfunding helps reduce the risk for an investor.”
Thus, within the next few years, I believe that average investors will have streamlined, direct investment access to the best startups in the world.
What Is Tokenization?
The second, and perhaps more robust, part of the private investing revolution is tokenization.
In investing terms, tokenization is a fancy way of saying crowdfunding for assets. In essence, tokenization simply involves creating a digital asset to replicate a physical one, slicing up that digital asset into many different pieces (or tokens), and then selling those many different pieces to investors through a crowdfunding platform.
Sound complex? It’s not.
Think about tokenization in real estate. Tokenization replicates a physical real estate asset — like an apartment building. It then slices the new digital asset up into pieces (say 15 shares in the apartment building). The owner of the apartment building sells those 15 shares of the apartment building to institutional, accredited, and retail investors through a crowdfunding platform. The crowdfunding platform then creates a market for those shares, so that investors can buy and sell shares in the apartment building like they buy and sell stocks.
In other words, tokenization creates a win-win situation. Investors win because they get to invest in things they couldn’t invest in before, and have increased liquidity with respect to those investments. Asset owners win because they get to raise capital through a new route, and will benefit from the creation of liquid markets around their formerly non-liquid assets.
Consequently, tokenization is the future of private asset investing. As is the case with crowdfunding, over the next several years, tokenization will gain mainstream traction, and investors will be presented with tremendous opportunities to make savvy investments in things like real estate and fine arts.
Today, we are on the cusp of a once-in-a-lifetime investing revolution that will change financial markets forever.
Over the past thousand years, the investment opportunities afforded to the average investor have expanded from debt, to government securities, to public equity. Now, thanks to technological and legal changes, it’s expanding to private equity and assets.
Through crowdfunding and tokenization, investors over the next several years will gain direct investment access to the world’s best startups, real estate projects and fine art collections. Investors who stay ahead of this revolution will reap the rewards of being able to partake in these potentially ultra-valuable investment opportunities. Investors who sleep on the revolution will miss out.
Don’t miss out. Don’t sleep on this once-in-a-lifetime change. Instead, stay ahead of the curve, and closely follow this revolution.
Luke Lango is a Markets Analyst for InvestorPlace. He has been professionally analyzing stocks for several years, previously working at various hedge funds and currently running his own investment fund in San Diego. A Caltech graduate, Luke has consistently been rated one of the world’s top stock pickers by TipRanks, and has developed a reputation for leveraging his technology background to identify growth stocks that deliver outstanding returns. Luke is also the founder of Fantastic, a social discovery company backed by an LA-based internet venture firm. As of this writing, Luke Lango did not hold a position in any of the aforementioned securities.