Have you ever owned a stock or share on a company? If so then that means you have owned equity in the company whose stock you bought. It is the fancy financial term for saying you own part of the company. Although if you own a few shares of Coca-Cola stock you don’t really consider yourself as a partner in the Coca-Cola in truth you really are. This is the most common and well known form of equity owning stock.
In terms of the crowdfunding industry the term equity means the same thing but the implications may be much different. If you decide to buy equity in one of the real-estate projects start-up business listed you become a real partner in that venture. If the venture fails or loses money you may lose all of your equity, but if there is a huge profit then you will share that profit as well. Your equity is almost never safe and carries with it all the risk that the project or business entails. Obviously the risks associated with project will depend on the type of project. A start-up business or a real estate development project may carry the most risk.
When you buy equity in a start-up your share is used to help fund the development or marketing of the business or project. In most cases you are buying into an idea or business venture that has no real assets which help secure your initial investment. For example if you invest $3000 in start-up “SuperShoes” (names have been changed to protect the innocent : ) which is planning to manufacture shoes that allow a person to fly. That money may be used to pay an engineer to develop a prototype shoe all of the money is invested in the prototype and the company may never find a partner or buyer to continue developing the project. In this case all of your money would be lost.
Obviously this a very speculative form of investing and individuals should pursue these type of investments with great discretion. Of course the rewards can be huge though if the product makes it to market. There are start-ups that may be more suitable for instance a start-up which already is producing a stream of revenue. In this case you are still not buying any real underlying asset but since the company may already be profitable or producing revenue the chances of it actually providing the investor with a return are much better.
In general the safest form of equity crowd funded investments are in real estate. In this case you buy equity and become a partner in a specially formed company that holds the title to a specific property. In this case you have bought a real asset and your capital is at much less risk. For example let’s say you spend the same $3000 for equity in “Great Building” on Shore Street (names have changed to protect the innocent : ) The building may have cost $300,000 and that translates to a 1% share in the building. The sponsor of the project projects rental income of $30,000 a year which means your share would return $300 per year or 10%. Now let’s assume the sponsor is never able to find a tenant and property values crash. Let’s even assume a worst case scenario of property values dropping 50% and the “Great Building” is no only worth $150,000. The project was a failure but you still own something, you still own 1% of that building which translates to $1500 (note: this is for illustration purposes only to contrast against the risk of buying equity in a start-up. It assumes there was no debt financing of course, which is almost never the case). So although you lost money some of your capital is still retained, in fact in almost all cases a good portion of your initial capital will always be protected. For the everyday investor we consider this to be one of the safest forms of equity crowdfunding investing.
But if I am an owner of a real estate property don’t I have to do some work? That is where the similarity is between owning these shares and regular stock you might buy on the stock market. The same way you don’t need to worry about the day to day operations at Coca Cola you also don’t need to worry about the day to day operations of your real estate investment.
So how is equity crowdfunding investing really any different than buying stock on the stock market? The major difference is that currently there exists no secondary market in the crowdfunding sector. If you buy $3000 of Coca Cola in June and then need that money a few months later in December all you need to do is sell your stock and you will get your money back depending on the value at the time you sell it. Stock bought on the stock market is therefore liquid you can always sell it and get your money out. When you buy equity in a crowdfunded project your capital investment is basically locked up for the duration of the project which may mean until the sponsor decides to sell the property or until some other predetermined date. Many offerings have a target date which will tell you how long to expect your money to be tied up for but in general there is no guarantee you will be able to withdraw your capital before then or sell you shares. Therefore when you buy equity in these projects make sure you are only investing money which you don’t expect to need for a few years.
The lack of a secondary market can also be advantageous. Although some people may not be aware of this but the price of stock doesn’t actually reflect necessarily the value of the company. If a company is performing well and making money and expects to continue to make money then why would it’s stock price drop? Well this happens all the time in the stock market and although there may be other fundamental reasons that the stock loses value in many cases it is just dependent on overall market sentiment or the way the market views a particular company.
When you invest in a crowdfunded venture or real estate this isn’t a concern. The only concern is the company or projects real value and profitability based on the underlying assets and or the stream of income it is producing. There exists no reason for concern about what the market is doing or whether there is a war in some third world country or not (unless of course the business venture or real estate is located in that country or has direct business in that market).