Crowdinvestment is a form of crowdfunding through which backers invest with the intent of earning returns on their investments rather than donating money. It is not an entirely new concept. Longstanding forms of crowdinvestment include issuing shares and creating mutual funds or banks to pool resources from multiple investors and thus allow them to participate in much larger-scale investments than they could achieve alone. Today, the term is used specifically in reference to the practice of multiple individuals investing directly in enterprises, real estate or projects without money being invested by a third-party on behalf of investors.
How does crowdinvestment work?
Crowdinvesting is typically carried out through online platforms which connect investors with enterprises looking for investment. Enterprise crowdinvestment platforms provide an avenue through which enterprises which would not be eligible for business loans or venture capital can appeal directly to private investors for funding.
In the typical crowdinvestment procedure, the platform lists projects which are open to investment, along with a target capital which must be reached by a certain deadline in order for the investment be made. These may be business enterprises or real estate investments. Investors then select the projects which they want to invest in and transfer the money which they want to invest to an escrow account. If the target capital is collected by the due date, the platform transfers the money to the enterprise. The crowdinvestment platform may attach conditions to transferring investment capital, such as the hiring of business management professionals, the creation of a board of independent directors, or the ongoing presentation of progress reports. When the enterprise turns a profit, the crowdinvestment platform supervises the transfer of dividends to investors. A number of different models are used to grant investors a claim to dividends based on their investments.
1. Subordinated participating bond: Capital investments in startups and other business enterprises through crowdinvestment platforms may take the legal form of subordinated participating bonds. Unlike conventional bonds, participating bonds do not necessarily deliver interest, but rather give the lender a claim to a portion of borrowers’ profits if and when these are achieved. A subordinate bond is a low-priority loan which, in the event of bankruptcy, is only repaid after other debts have been settled. In other words, if the recipient of the crowdinvestment makes a profit, investors earn dividends on their investment. If the recipient goes bankrupt, debt collection claims by crowdinvestment investors are last in line for repayment. In this model, the only limit to profit potential is the profit potential of the enterprises which you invest in.
2. Share ownership: When this model is used, crowd investors buy shares and become shareholders of the companies which they invest in. Depending on the company in question, the shares which you buy may or may not give you voting rights or entitle you to dividends. Investors typically earn profits through capital gains in the value of their shares – particularly if the companies which they invest in are acquired at a profit. In any case, buying shares in a business makes you as an investor a legal owner of that business.
3. Co-ownership: Swiss real estate crowdinvestment platforms typically use a co-ownership model by which all investors in a specific property become legal co-owners of that property. This model provides more security because investments are secured by collateral (the property). The profit potential of these secured crowdinvestments is typically limited to the profit potential of the assets which form the collateral. For example, if you invest in a portion of an apartment, your return will be limited by the amount of rent which can be charged for the apartment. You can find detailed information in the moneyland.ch guide to real estate crowdinvesting.
4. Blockchain token ownership: Initial coin offerings (ICOs) are a relatively new crowdinvestment phenomenon. In this model, investors buy blockchain tokens created by the recipient. These tokens typically form part of a blockchain-based service – most commonly a fintech service offering peer to peer currency exchange, peer to peer money transfers, blockchain-based asset management, cryptocurrency cards or blockchain-based financial contract management. Tokens do not represent shares in an enterprise, they are not debt certificates which give investors a claim to a share of profits, and they do not entitle investors to dividends. Instead, the value of a token depends entirely on demand for that token. Because the supply of blockchain tokens is normally limited, large scale adoption of the service to which they are linked generally leads to increased demand for the tokens necessary to deliver the service. Stronger demand drives up the value of tokens, so the more successful a product is, the more the tokens which power it will be worth. As long as tokens are liquid in that they can be sold for money or exchanged for other assets which can be sold for money, investors can potentially sell their tokens at a higher price then they paid for them, thus profiting off the product’s success. You can find useful information in the moneyland.ch guide to ICO investments.
Benefits of crowdinvestment
The biggest benefit of crowdinvestment is that it allows investors to participate in capital markets without investing large amounts of capital. Crowdinvestment also gives investors access to enterprises which they would not otherwise be able to invest in.
Today, stock exchanges generally have strict financial requirement and complicated listing and reporting procedures. This makes it impossible for many small businesses, startups and entrepreneurs to list and sell shares on the stock market. Crowdinvestment platforms provide a “stock market” for business ventures which would otherwise be unserved. Investors can take advantage of crowdinvesting to get in on the next big thing long before it becomes the next big thing.
It is important to understand, however, that your return on investment (ROI) will likely be much lower than the ROI advertised by crowdinvestment platforms. The reason for this: A majority of your investments may yield little or no returns, while only a small minority of investments are likely to yield good to excellent returns.
Risks of crowdinvestment
No matter which model is used for crowdinvestment, a complete loss of all invested capital is possible. The venture you invest in may be mismanaged or even fraudulent. Even solid enterprises can fail if the product is not well received by the market. By following a few simple guidelines, you can minimize the risk of making heavy losses.
1. Choose the right platform. Crowdinvestment platforms play a significant role in screening enterprises, facilitating investment and managing investments on an ongoing basis. For this reason, you should choose a solid platform run by a reputable company which is financially sound. The last thing you want is for the crowdinvestment platform managing your investments to close up shop. Although with most models (all but blockchain tokens), a legal contract binds you and the enterprise which you invest in, managing your investments in the absence of the services provided your crowdinvestment platform can be an administrative nightmare.
2. Do your due diligence. Good crowdfunding platforms should use fairly strict criteria to screen applicants before allowing them to request investment. However, you should still take the time to perform research on enterprises which you are considering investing in. Who are the company’s founders? Where is it located? How is it regulated? What is the venture’s legal status (private individual, self-employed, partnership, corporation)? What is the management structure? Is the company dependent on one or two key employees for the delivery of its products? Understanding these key aspects of an enterprise can help you make a sound decision as to whether or not it is a safe investment. This is especially true when you make larger investments in one enterprise.
3. Spread your investment capital. Product success rates can largely be broken down to the law of averages. For every product which is successful, many other products will fail. For this reason, the fewer different enterprises you invest in, the greater your risk of losing money on failed products is. Ideally, you should divide your investment capital between a large number of different ventures. Some platforms provide the option of having your investment capital automatically divided equally between hundreds or even thousands of different ventures. The logic behind this service is that gains from the ventures which are successful will balance losses from investments which are not successful. In the same way, the more capital you invest in a single enterprise, the more capital you stand to lose if that enterprise goes pear shaped. Some crowdinvestment platforms place low limits on the amount of money which you can invest in a single enterprise in order to minimize risk for investors.
Important: Shares of companies which are not listed on stock exchanges are often highly illiquid. If you want to sell your shares in the future, you may find it difficult or impossible to find a counterparty. When you invest in enterprises through crowdfunding, you should be aware that there is a chance that you will never be able to sell your shares. In other words, the fate of your investment is intrinsically linked to the success of the enterprise.
Costs of crowdinvestment
Crowdinvestment platforms generally charge enterprises a fee for listings. Platforms may also charge investors a fee based on the amount of capital invested. Some platforms apply different fees to different types of investments. Swiss enterprise crowdinvestment platform Investiere, for example, charges a one-time fee equal to between 3% (investments of 100,000 francs or more) and 6% (investments of 25,000 francs or less). Real estate investment platforms generally charge investors’ fees based on investments as well. Other platforms, like Conda, a platform which lists investment projects in Switzerland, Austria and Germany, do not charge investors a fee when they make investments.
In Switzerland, dividends paid out to investors are subject to income tax. Capital gains earned from the sale of shares are not taxable as long as you are categorized as a private investor by the tax office.
Crowdinvesting provides an interesting alternative for investors who want to invest in startups with growth potential, small and medium-sized enterprises (SMEs) and the development of interesting ideas, products and services. Through real estate crowdinvesting, investors can purchase shares of ownership in investment properties with relatively low amounts of capital. In terms of risk, crowdinvestment may require higher risk tolerance than stock market investments, particularly when you invest in startups as these have a high chance of failure. As a relatively high-risk investment vehicle, crowdinvestment projects should make up a relatively small portion of your total investment portfolio.
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