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What’s in a Word: Crowdfunding

Hands dropping coins into box

  |  By Christopher Orr, SDIP

The word crowdfunding made its way into Merriam-Webster’s dictionary in 2014, but the explosive growth of the industry means it is now being used as a blanket term to describe all sorts of online fundraising efforts.

But before putting money behind a crowdfunding campaign it’s important to understand what type of crowdfunding you’re participating in and what you can expect to receive, if anything, for handing over your money.

When people hear the word crowdfunding they often think of Kickstarter or Indiegogo where participants pledge money online to support to a fledgling business or product. In return they receive a “reward,” like dibs to buy the product first when – and if -- it hits the market.

But individuals who fund these campaigns do not receive an ownership stake in the business or the product they are supporting. If the business fails or the product never gets developed, there is typically little to no recourse.

A quickly growing subset of the crowdfunding industry falls under what is being called “equity crowdfunding” or “crowdfinancing” or even “securities crowdfunding.” Equity crowdfunding campaigns give backers an ownership stake in the business or the fund, qualifying them as a type of private placement investment. That means they should be taken as seriously as any other investment that you are contemplating adding to your portfolio.

A good way to understand the difference between something like rewards crowdfunding and equity crowdfunding is by looking at one of last year’s most viral crowdfunding campaigns – the potato salad campaign. An Ohio man started a Kickstarter campaign to raise $10 to make his first batch of potato salad. He ended up raising more than $55,000. The campaign was funded by almost 7,000 people and half of them donated less than $3. What did they get in return for their donation? A promised bite of potato salad.

Now, let’s say that man used those funds and went on to develop the world’s best potato salad recipe, and that recipe was purchased by a food company for millions of dollars. Would those 7,000 Kickstarter backers, who gave money to help him come up with that recipe, get a share of those millions of dollar? No, because their money did not give them an ownership stake in the potato salad recipe.

But in equity crowdfunding, participants would be, in effect, buying a stake in a manufacturer that makes the potato salad recipe. So if they invested money in a company that developed a successful recipe, they could have expected to receive a payoff when it sold for millions of dollars.

At PENSCO, we are big proponents of encouraging our clients to conduct careful due diligence when considering how to invest their retirement dollars. If you are exploring a crowdfunding opportunity for your IRA, be sure you know the difference between reward- or donation-type campaigns and equity campaigns.

Also remember that equity crowdfunding opportunities can require long holding periods and success – or a payoff – is never guaranteed. Investing through crowdfunding can require an additional layer of due diligence. To participate in these campaigns, investors often need to qualify as an accredited investor, and can expect to fill out purchasing document and agree to terms and conditions.

If you are interested in learning more about equity crowdfunding one place to visit is The PENSCO Marketplace,™ which features crowdfunding sites that give accredited investors access to private placement opportunities that can be held in retirement accounts. You should consider how an equity crowdfunding opportunity would fit into your overall portfolio and your retirement savings plans. After all – you can’t fund your retirement with a bite of potato salad but you could help to fund it with proceeds generated from the sale of the world’s best potato salad recipe.

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This Blog does not provide investment, tax, or legal advice nor does it evaluate, recommend or endorse any advisory firm or investment vehicle. Investments are not FDIC insured and are subject to risk, including the loss of principal.