Investing in People: How Crowd Funding Works

Photo (cc) by 401(K) 2013

You know you can invest in stocks, bonds and mutual funds. But what about new companies or projects? Can you invest in people too?

You can now, thanks to crowd funding, one of the positive changes the Internet has brought to our world. With crowd funding, a new small business, inventor or artist starts a campaign to raise money for a project, then investors or donors pledge funds.

An industry report from Massolution says more than 1 million projects were crowd-funded with $2.7 billion in 2012. This year, it estimates an increase to $5.1 billion worldwide.

In the video below, Money Talks News founder Stacy Johnson interviews a young entrepreneur who used crowd funding to launch his new business. Check it out, and read on to learn more.

Here’s what you need to know to get involved:

1. Types of crowd funding

There are two types of crowd funding sites:

  • Charitable sites such as Indiegogo and Kickstarter focus on creative projects or personal financial needs. You may earn rewards for donating money to the project — like a movie ticket to see the finished film you helped fund — but you won’t earn financial returns.
  • Investment sites let you invest in a company or product from the ground up. You’ll earn a return on any profit the company makes but, like any investment, there are risks.

2. Platforms for crowd funding

There are dozens of different crowd funding sites. Before signing up for one, read the rules and check out the available campaigns. Here are a few examples:

  • Upstart. With this crowd funding site, highlighted in the video above, investors provide funding to a recent college graduate, then earn a percentage of the money they make, whatever they do.
  • Crowdfunder. This site offers a mix of charitable donations and investments.
  • SoMoLend. It focuses on existing small businesses to help them grow or cover their debts.
  • AngelList. This site focuses mostly on tech start-ups such as new software or video game development companies.

3. What to look for in an investment

Investing in an individual, company or a new product is risky. While there are rules in place to reduce the odds crowd funding platforms aren’t havens for scammers, that doesn’t mean all those seeking to raise money will be profitable. Do lots of research before investing.

Forbes recommends these steps:

  1. Examine tax returns and financial statements. These should be provided by the crowd funding site. Businesses attempting to raise $500,000 or more must furnish audited financial statements, but every company attempting to raise money should provide something. If you don’t know what to look for in documents like these, find someone who does, like an accountant.
  2. Look for licenses and registrations. Legitimate companies should be licensed or registered in their city, county or state. Ask to see a copy of the paperwork and look it over. If something doesn’t match up, be wary.
  3. Search for lawsuits. Look for lawsuits against the company or inventor on a site like Justia.com. If they’ve ever been sued, you should know about it before you invest.
  4. Verify personal background. You likely can’t obtain a full credit history, but you might be able to verify that what you’re told is true. If an inventor says he graduated from Yale, contact the university and ask. (Not all will disclose this information.) Verify the person’s location. Look at social networking sites like Twitter and Facebook to see what other people are saying about the company and the people involved, as well as LinkedIn.
  5. Get the required disclosures. A company has to disclose how much it’s asking for and how it plans to repay investors. Will they be raising more money in the future that could dilute your ownership interest? Do they have competition? How will the money be spent? Find out as much as you can about the company and its future plans.

4. The rules for crowd funding

Since crowd funding is a relatively new type of investment, the laws governing it are still taking shape. President Obama signed the Jumpstart Our Businesses Act into law last year, and the Securities and Exchange Commission is hammering out the details.

Forbes summed them up like this:

Without going through an expensive and onerous SEC registration, companies will be able to sell up to $1 million of stock per year to an unlimited number of investors. Individuals who earn less than $100,000 a year can invest up to $2,000 per company per year; wealthier folks can invest 10% of their income up to $100,000.

The SEC has until Oct. 31 to implement the rules of the JOBS Act. For now, companies can take on up to 35 non-accredited investors (people who make $200,000 or less a year), according to the SEC, as long as those investors have a pre-existing relationship with the person or company and enough sophistication to be knowledgeable investors. Meaning, you can invest in a project if you know the founder, she doesn’t already have 35 other non-accredited investors and you know what you’re doing. Or if you make more than $200,000 a year or have $1 million net worth.

Things might be a bit closed off and complicated for now, but expect that to change when the new SEC rules take effect.

Would you invest in a private company or person through crowd funding? Have you? Share your opinions and experiences on our Facebook page!

Disclosure: The information you read here is always objective. However, we sometimes receive compensation when you click links within our stories.

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