[Editor’s Note: “What Investors Need to Know about Equity Crowdfunding” (Part 1) explored the background and growth of equity crowdfunding as an alternative choice for retirement plan strategies – like self-directed Individual Retirement Accounts (IRAs). Part 2 sets out to weigh the pros and cons of this rising asset category.]
Equity crowdfunding offers a very public way to support the dreams of American entrepreneurs as you pursue your own dream for an attractive rate of return.
While investment crowdfunding is viewed generally as a positive game changer, some consumer advocates are concerned that relaxing accreditation standards for investors could lead to broken nest eggs.
“Because the investments are usually complex, crowdfund-minded investors should undertake their own research and speak to a financial professional before making a commitment,” said Jeffrey Kelley, senior vice president of Equity Institutional.
“Custody of equity crowdfunding vehicles,” Kelley continued, “shares similarities with custody of real estate investment trusts, mortgage notes, limited partnerships, limited liability corporations, precious metals, joint ventures and private equity – which is quite different from custody of traditional investments like stocks, bonds and mutual funds.”
When it comes to equity crowdfunding, there are three potential advantages that prospective investors should be aware of:
Even with those notable advantages, there are a couple disadvantages to the crowdfunding model that investors should know:
Startups have unique risks: Many firms that rely on crowdfunding will likely be in their early seed stage; they are riskier than startups that have already proven their ability to attract capital.
The stock price of a larger company is generally transparent and published daily. A private company’s stock, on the other hand, may be more difficult to value.
However, Patrick W. McKeon, JD, CFP, ® who has studied crowdfunders who are looking to build their presence and create new relationships, points out that “the trend toward crowdfunding transparency is on the upswing.”
The top 50 crowdfunding deals are listed daily. Offerings range in size from $150,000 to $5,246,000. Some start-up companies have increased in value by a factor of several hundred while they were still private. The Wall Street Journal’s “Billion Dollar Startup Club” now lists 90 members worth from $1 billion to $40 billion.
“The fact is that crowdfunding has been in operation long enough that some transparent sign posts are appearing,” McKeon says. “The companies on the Crowdfinance 50 Index, for example, are operating companies that represent sectors that everyone knows: commerce and industry, consumer goods, energy, finance, health care, materials, services, and technology.”
Equity crowdfunding returns may be subject to the same tax consequences as other investments. By investing through a self-directed IRA, however, you can gain access to the potential benefits of crowdfunding on a tax-advantaged basis.
“IRA-minded clients, as well as their advisers, must undertake their own review and analysis of crowdfunding selections,” Kelley added.
“For the retirement-minded investor willing to undertake some due diligence, crowdfunding opportunities accessed through a self-directed IRA can be an attractive way to pursue return on a tax-deferred basis, while putting an added measure of diversification to work.”
[Editor’s Note: Check out these related webinars, which can be taken for Continuing Legal Education (CLE) credit, or simply for practical and entertaining education for business owners, Accredited Investors, and their legal and financial advisors: Crowdfunding from the Investor’s Perspective]
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