We’re all in agreement that the novel coronavirus has overstayed its welcome. But one positive of the new normal is that it has given most of us extra time, thanks largely to remote work. And more than a few of us are using that time to explore alternative investments, particularly equity crowdfunding and rewards crowdfunding.
Perhaps not surprisingly, the trading platform Robinhood enjoyed a surge of new users, coinciding with the nationwide lockdown in the U.S. With nothing to do, many folks turned to online platforms to meet their various needs. As well, the intrepid among us have leveraged this opportunity — along with “free” money from Uncle Sam — to either start or bolster their portfolios.
Of course, Robinhood mostly focuses on mainstream investments. However, enthusiasm is robust for other vehicles, such as equity crowdfunding and rewards crowdfunding. Though a positive for the broader investment industry, prospective participants should understand what they’re getting involved in prior to putting down their cash.
With that in mind, let’s take a brief look at what these vehicles are.
Equity Crowdfunding Opens Access to the Ground Floor
Have you ever looked at the soaring premiums of Apple (NASDAQ:AAPL) or Amazon (NASDAQ:AMZN) and wished you could have been one of the lucky few early bird investors? With equity crowdfunding, you now have the chance to becoming a stakeholder of the next big initial public offering, before the offering.
In a way, this concept is a win-win. Prior to equity crowdfunding becoming legal in the U.S., it was extremely difficult for the average Joe to participate in ground-floor speculation. On the other hand, many startups don’t have access to venture capital. Thanks to the crowdfunding innovation, startups and regular people can participate in an open market.
That’s exactly how equity crowdfunding works. On a particular platform, a company provides a profile and essentially a sales pitch to would-be investors. Here, it’s incumbent upon participating startups to present how their products and services address pressing needs. In addition, smart organizations will reveal the fiscal viability of its operations and strategies.
Obviously, the key principle here is equity. Once the crowdfunding deal is closed, companies receive the capital raised. On the other end, investors receive equity in the startup. Hopefully, the business becomes a booming success, incentivizing an IPO.
Later, you can participate in “FIRE” without having to live on rice and beans every day.
3 Pros and 3 Cons of Raising Equity via the Crowds
Pros:
- Get in before everyone else: equity crowdfunding gives the average retail investor the ability to exercise his/her high-conviction thesis on a promising business.
- Potentially massive discount on tap: because you’re buying into the target company before the wave, you stand to gain big if the organization takes off.
- Management is initially more communicative: if you try to contact Elon Musk of Tesla (NASDAQ:TSLA), good luck trying to get an answer. But with crowdfunding, you should receive an answer because management is trying to pitch you its stock.
Cons:
- Tied-up money: typically, you don’t have a secondary market for the equity shares you purchase. So, if you want to get out for whatever reason, you probably can’t.
- No guarantee of profitability: speculative investments like equity crowdfunding have very high reward potential. At the same time, the risks are very high. You’re not guaranteed anything and you can lose it all before anything (like an IPO) happens.
- The BS factor: it’s very difficult to perform due diligence in this space because of the lack of information relative to the public markets. Thus, buyer beware!
Rewards Crowdfunding Facilitates Connections with Products and Services You Love
For organizations actively accruing capital via equity crowdfunding, the advantages are plentiful. However, sometimes businesses just want a simple way of funding a project. That’s especially the case for non-profit organizations, which is not a business entity per say. In that case, rewards crowdfunding is an ideal solution.
Just like the first platform I mentioned, rewards crowdfunding opens the floor to the general public for potential eager buyers or donors. Again, entities provide their pitch, explaining why they need the money and what they intend to do with it. By utilizing this process, participants have a closer connection to their consumer/volunteer base.
As the name suggests, the emphasis on rewards crowdfunding is what rewards the buyers/donors receive. This is a chance for fund seekers to create a little something special for the audience. Hopefully, this will drum up interest and raise the necessary funds.
What makes rewards crowdfunding distinct from its equity variant is the comparative lack of legal complexities. Hence, participating entities come in all shapes and sizes, from big business to humanitarian organizations.
It’s really a fun way for all involved to participate in a product launch or to raise awareness for a social cause.
3 Pros and 3 Cons of Rewards-Based Crowdfunding
Pros:
- Actively engage favorite brands or causes: if you really believe in a company’s products/services or you want to raise social awareness for a great cause, there are few platforms that offer a combo of financial and marketing impact quite like rewards crowdfunding.
- No big commitment: since you’re usually helping to support a cause with other individuals, the cost is minimal. And if the rewards crowdfunding venture doesn’t meet its minimum funding target, you get your money back.
- Unique rewards: as I mentioned earlier, participating entities have an incentive to deliver rewards that you can’t get anywhere else. This gives you bragging rights that you were right there from the beginning.
Cons:
- No equity: if you’re looking for an investment opportunity, you need to look outside rewards crowdfunding. For instance, just because you buy a lot of Coca-Cola (NYSE:KO) doesn’t mean that when the soft drink giant delivers massive earnings, that it will be a benefit to you.
- Variable rewards: obviously, not all companies are the same so the rewards that you get may vary in importance from one funding venture to another. In some cases, the rewards don’t follow pricing logic.
- The BS factor: if you’re rewarded an end-product, that product could be junk. In the worst-case scenario, you could be funding a scam. If discovered, you should be made whole but the emotional repercussions of being advantaged may linger.
A former senior business analyst for Sony Electronics, Josh Enomoto has helped broker major contracts with Fortune Global 500 companies. Over the past several years, he has delivered unique, critical insights for the investment markets, as well as various other industries including legal, construction management, and healthcare. As of this writing, he did not hold a position in any of the aforementioned securities.
