In 2020, the U.S. Congress passed the Jumpstart Our Business Startups (JOBS) Act, a groundbreaking law aimed at expanding opportunities for startup funding. By loosening federal regulations, the JOBS Act made it possible for individuals to invest in businesses in exchange for equity, not just donations or rewards. This shift has led to a significant rise in crowdfunding investments, enabling both accredited and non-accredited investors to pool their money and invest in early-stage ventures. As a result, raising capital has become a faster, more accessible process for businesses.
Today, crowdfunding is increasingly common across various sectors, including small businesses, real estate, private equity, and more. Investors are eager to back companies they believe could become the next big success story—think Google or Amazon. But while crowdfunding offers the potential for high returns, it also comes with its own set of risks. According to the U.S. Small Business Administration, only half of small businesses survive beyond their fifth year, making investing in early-stage companies a high-risk venture. Many investors are unaware of the potential pitfalls, such as when and how they can expect returns, or even how their investment works.
What is Investment Crowdfunding?
Crowdfunding is the practice of raising small amounts of money from a large number of people to fund a project or venture. While crowdfunding itself isn’t new—originating in the 19th century in Germany—it has evolved significantly. Initially, crowdfunding was about supporting projects without the expectation of receiving anything in return. Over time, however, the model has expanded to include investments, where contributors receive equity in exchange for their financial support.
Types of Crowdfunding
Crowdfunding is categorized into several different types:
Rewards-based crowdfunding (e.g., Kickstarter): Backers contribute to a project in exchange for non-financial rewards like products or services.
Donation-based crowdfunding (e.g., GoFundMe): Individuals donate to a cause without expecting anything in return.
Investment crowdfunding (e.g., Wefunder, StartEngine, DealMaker): This includes both equity and debt crowdfunding. Investors receive a financial return, typically in the form of equity in a company or debt repayment.
Equity crowdfunding: Investors receive shares in a company in exchange for their capital. Platforms like Wefunder and StartEngine specialize in this model.
Debt or revenue-based crowdfunding (e.g., Honeycomb Credit): Investors lend money in exchange for interest or a share of the revenue generated by the company.
While rewards and donation-based crowdfunding have existed for a long time, investment crowdfunding is different because it offers potential returns on investment. As such, it’s regulated by stricter laws to protect investors and prevent fraud.
The Rise of Equity Crowdfunding
Before the JOBS Act, only accredited investors—those with a high net worth or significant income—had access to equity investments in startups. With the passing of the JOBS Act, however, non-accredited investors were given the opportunity to participate in these ventures. The rise of the internet has further expanded access, allowing anyone, regardless of location, to invest in a promising startup.
Now, equity crowdfunding has become a powerful tool for both businesses seeking capital and individuals looking to invest in high-growth companies. Unlike rewards-based platforms like Kickstarter, which allow people to support projects in exchange for products or perks, equity crowdfunding gives investors a stake in the company itself, making it a more compelling option for those looking to earn a return.
The Rewards of Equity Crowdfunding Investments
Equity crowdfunding opens up investment opportunities that were once reserved for wealthy, accredited investors. Here’s why it’s gaining popularity:
Access to high-potential ventures: Previously, only wealthy individuals could invest in early-stage companies with high growth potential. Now, equity crowdfunding allows average investors to participate in funding innovative startups.
High returns: While investing in startups is risky, the rewards can be substantial. For example, Oculus Rift, which was funded via Kickstarter, was later acquired by Facebook for $2 billion. If investors had backed Oculus through equity crowdfunding, their modest contributions could have turned into substantial profits.
Support for small businesses: Small and medium-sized businesses (SMBs) are the backbone of the U.S. economy. Equity crowdfunding provides these businesses with the capital they need to grow, create jobs, and contribute to economic development.
Personal satisfaction: Equity crowdfunding gives investors the chance to support businesses they believe in. Whether you’re passionate about sustainability, technology, or social impact, you can choose to invest in companies that align with your values.
The Risks of Crowdfunding Investments
While the potential for high returns is appealing, equity crowdfunding also comes with significant risks that investors should consider:
High risk of loss: The failure rate of small businesses is high—around 50% of startups don’t make it past five years. As an equity investor, you’re at the back of the line in case of a company failure, meaning you could lose your entire investment.
No immediate income: Startups rarely pay dividends or interest in the early stages, so equity crowdfunding isn’t a good option for investors seeking regular income.
Due diligence risks: Much of the due diligence is handled by the crowdfunding platforms themselves, which may not always align with your best interests.
Dilution risk: Startups may issue more shares in future funding rounds, diluting your ownership stake in the company.
Lack of liquidity: Unlike publicly traded stocks, equity crowdfunding investments are illiquid. You generally can’t sell your shares until the company is either acquired or goes public—if that ever happens.
How to Assess an Equity Crowdfunding Opportunity
To increase your chances of success, you need to carefully evaluate any equity crowdfunding opportunity. Nathan Rose, author of Equity Crowdfunding: The Complete Guide for Startups & Growing Companies, suggests two key factors to look for:
A company solving a real problem: Investors are more likely to back companies with innovative solutions to pressing issues.
A strong community: Successful companies often engage with their customers and build a loyal following, leading to better products and stronger business growth.
Before investing, ask yourself key questions: Do you believe in the company’s product? Is there a market for it? What are the company’s financial projections? Also, check if professional investors, such as angel investors or venture capitalists, are backing the company, as this indicates a higher level of due diligence.