Yes it can get frustrating to find a simple answer to what seems to be a topic that everyone is talking about lately!
Congratulations! You’ve decided to educate yourself and become a trendsetter. Soon, you’ll be taking advantage of exciting new finance regulations to get your money working for YOU while your friends are busy setting piles of money on fire (hint: don’t do this – it’s totally illegal). When they see your success and they start asking questions, you’ll need to be ready to explain the system cleanly and clearly. Let’s break this down to help you understand the definition, history, and potential benefits of equity crowdfunding for real estate.
DEFINITION + HISTORY
In basic terms, crowdfunding is a broad term used to describe an online process where an individual (or company) raises small amounts of money from a large amount of people in order to fund a project or venture. In 2010, websites such as Kickstarter, Indiegogo, and GoFundMe had become household names. Most projects or ventures were rewards-based, meaning that people would commit small amounts of money in exchange for a product or service, such as a sticker with the company’s name or advance versions of an early prototype. However, a hand full of companies decided to offer a small piece of the business in exchange for money – this is known as equity crowdfunding – which quickly bumped up against federal financial regulations. The SEC viewed equity crowdfunding as an easy way for scammers to take advantage of uneducated investors, so it created regulations that would place controls on the budding industry and protect consumers. In 2012, the JOBs Act was officially signed into law, meaning companies could legally use the internet to market investment opportunities to pre-qualified individuals. While this was a major milestone for the equity crowdfunding industry, ordinary investors who did not meet a specific financial profile remained unable to access investment opportunities. Finally, in 2016, Title III Regulation CF went into effect and allowed companies to publicly market investment opportunities (securities) to anyone. This legislative shift instantly created access for millions of Americans who wanted to safely invest in start-up companies or venture projects but were previously unable to overcome hefty investment minimums ($10,000+) or strict pre-qualification standards.
HOW DOES EQUITY CROWDFUNDING FOR REAL ESTATE WORK?
Investments must be offered through an SEC/FINRA registered company or online portal. A company can advertise an investment opportunity anywhere, but an investor can only commit money to the opportunity through the registered portal. This structure is designed to filter out start-up companies that may be attempting to defraud potential investors. Companies that wish to market an investment opportunity must adhere to strict guidelines and be audited by a registered CPA. Each investment must be accompanied by complete detailed financial models that describe past performance and explain projected future returns. Every investor must be provided with a full disclosure that conveys the terms, risks, and value of the investment opportunity. PRO TIP: equity crowdfunding typically relies on large numbers of investors. Before your money can be put to work in an investment, the company in which you are invested must raise a minimum amount of money, otherwise the money is returned to you.
WHAT THIS MEANS FOR YOU
Money placed in a investment is generally inaccessible until the investment ends (typically 2 – 3 years), but the benefit is that your money has a chance to grow more quickly than it would in a savings account or other low-yield investment option. While there are no guarantees with any investment, by through crowdfunding you are putting your money into a physical asset that has an inherent value.
KEY TERMS FROM THIS ARTICLE
Regulation D (RegD) – a set of rules authored by the SEC that governs how companies (or individuals) can raise money for investment opportunities.
Regulation CF (RegCF) – a subset of rules under RegD that dictate the steps a company must take in order to legally offer an investment opportunity via equity crowdfunding.
Securities and Exchange Commission (SEC) - formed in 1934, is an independent agency belonging to the US Federal Government and responsible for regulating the securities industry.
Security - in finance, this term is used to describe a digital file or paper receipt that explains ownership or debt, as well as the value of and terms associated with each.(For more, download our free ebook The 50 Terms You Need to Know Before Investing in Real Estate)