Crowdfunding Investment: What It Is, How It Works & Websites

By Martin Christensen
December 14th, 2023
9 minutes read

Crowdfunding investments are a way for investors to invest in startups and real estate previously only available to venture capitalists and angel investors. It is gaining popularity among bold investors exploring opportunities not available in the public markets and for entrepreneurs to access capital easily. It brings early access to innovative ideas, and lowers entry barriers to private market assets, while providing a global reach, making it a dynamic and inclusive investment choice.

Key takeaways

  • Crowdfunding investments offer diverse opportunities with low entry barriers and potentially high returns, though they come with some considerable risks.
  • Various models, including equity-based, debt-based, and real estate, characterize the type of crowdfunding investment.
  • StartEngine, Seedrs, and Estateguru are among the world's most popular crowdfunding investment platforms, collectively funding over $1 billion in 2022.
  • Seedrs and Estateguru, leading crowdfunding platforms, report that their investors have historically achieved returns ranging from 9.01% to 13.91%.

What Is a Crowdfunding Investment?

Crowdfunding investing is a type of alternative finance that allows individuals or companies to collectively invest money in a business or project in anticipation of a financial return. It has emerged from the advancement of fintech, particularly with the development of online platforms, connecting startups and small businesses with a pool of potential investors.

Investment crowdfunding is becoming a desirable way for small and medium-sized enterprises (SMEs) to raise capital, as it provides an efficient alternative to traditional financing methods such as bank loans and private equity firms. Global Market Insights predicts that alternative finance will grow at a rate of 15% over the next decade. To put things in perspective, in 2022, peer-to-peer lending, or debt crowdfunding made up $4 billion of the global market, 41.8% of the global alternative finance market valued at $10 billion.[1]

Chart of Crowdfunding Investments in alternative finance
Source: Crowdfunding-Alternative-Finance by Karsten Wenzlaff, Wolfgang Gumpelmaier-Mach, Crowd-Fund-Port.eu.[2]

There are four different models of crowdfunding. Unlike reward-based and donation-based crowdfunding, a crowdfunding investment offers its participants a financial return and is usually a regulated financial instrument in a framework set by the local financial regulator.

How Crowdfunding Investment Works

Entrepreneurs and founders are turning to investment crowdfunding for the financial support they need to launch products, services and development projects. SMEs are utilizing crowdfunding to secure funds for their startup, small business’s day-to-day operations or buy real estate.

Crowdfunding campaigns are created and launched by fundraisers on crowdfunding platforms, where they announce their funding goals to potential investors, including customers, business contacts, and platform users. Interested investors can evaluate the campaign details and, if convinced, pledge funds that will be disbursed upon the campaign's successful completion.

The two types of investment crowdfunding are equity-based and debt-based campaigns. Here is a breakdown of the most prevalent types of investment crowdfunding:

  1. Equity Crowdfunding: With equity crowdfunding, investors get shares or ownership in the company they invest in. If the company does well, the value of these shares can go up, giving investors a chance to make a profit.
  2. Debt Crowdfunding: Also known as peer-to-peer lending, investors act as lenders by providing loans to projects or businesses. Borrowers agree to repay the principal amount plus interest over a set period, allowing investors to earn returns through interest payments.
  3. Real Estate Crowdfunding: Real estate crowdfunding is a specialized form of crowdfunding centered around real estate investment projects. In this type of investment, investors can lend their money to support the development or buy shares in real estate companies.

StartEngine, Seedrs and Estateguru are some of the most popular investment crowdfunding websites. These platforms draw in millions of investors seeking returns beyond traditional finance as an addition to their investment portfolio. In 2022 alone, they collectively funded over $1 billion.

StartEngine

StartEngine is one of the largest US crowdfunding platforms, raising $650+ million for 550+ companies through Reg A+ and Reg CF since its launch in 2014. With the passage of the JOBS Act in the US, any individual can invest in start-ups, breaking down traditional funding barriers. StartEngine allows entrepreneurs to connect directly with a community to fund their ideas.[3]

Seedrs

Since its inception in 2009, Seedrs has emerged as one of the largest equity crowdfunding platforms in Europe, helping entrepreneurs raise funds for their ventures. Headquartered in East London, and launched by Jeff Lynn and Carlos Silva in 2012, it became a subsidiary of the US-based crowdfunding platform, Republic in 2022. Having secured £2.7 billion in funding through 2,128 deals since its start, Seedrs is a key player in the equity crowdfunding space.[4]

Estateguru

Estateguru, the European peer-to-peer lending platform based in Tallinn, Estonia, has soared to the top by funding over €769 million in loans since its launch in 2013. The platform specializes in real estate financing, linking property developers with investors that seek exposure to real estate projects across multiple European countries.[5]

Crowdfunding Investment Returns

Confirming the success of equity crowdfunding platforms can be challenging due to a lack of reliable sources, primarily because these platforms may not always highlight their returns, especially if they are inconsistent. Understanding the reality of startup success rates, where approximately 20% fail within their first year (U.S. Bureau of Labor Statistics, 2023), underscores the need for careful consideration in the equity crowdfunding landscape.[6]

Contrary to the approach of large diversification seen in publicly listed equities, success in equity crowdfunding, akin to venture capital, hinges on meticulous selection. It involves thorough due diligence and choosing crowdfunding projects with promising potential. Quality over quantity emerges as the guiding principle in this realm.

Examining two prominent platforms, Seedrs and Estateguru, offers insights into their reported returns. Seedrs claims an annualized Internal Rate of Return (IRR) of 12.91% in 2022 for its investment portfolio.[7] Estateguru, Europe's largest peer-to-peer lending platform, has consistently reported a weighted average return ranging from 9.01% to 13.91% since 2014.[8]

Crowdfunding Investment Advantages

Crowdfunding actively empowers individuals, projects and new businesses, allowing them to transform their creative ideas into reality. Crowdfunding revolutionizes the funding process in ways that traditional methods cannot match. Here are a few advantages of investing with crowdfunding.

  1. Diversification: With crowdfunding, investors can better distribute their funds across various ventures, reducing the impact of poor performance in any single investment. This represents a significant advantage compared to traditional finance, which often ties up funds in specific industries or markets, exposing investors to concentration risk.
  2. Lower barrier to entry: Smaller minimum investments are required for investment crowdfunding compared to alternative options of the same assets like venture capital or private equity. This opens up investment opportunities that were once reserved for big institutions or wealthy individuals, allowing a wider range of people to participate.
  3. Potential for high returns: Crowdfunding makes it possible to invest in start-ups and early-stage companies and private market debt, known for their high risk but also promising substantial rewards.
  4. Community engagement: Investment crowdfunding creates a strong sense of community between investors and entrepreneurs. It brings investors and entrepreneurs closer, enhancing the connection and creating a more fulfilling investment experience while supporting ventures and projects.

Crowdfunding Investment Risks

Investment crowdfunding enables investors to financially support projects, businesses, or startups in anticipation of receiving a monetary return, along with the repayment of their initial investment. However, just like any investment, it carries certain risks. Let's explore some of the potential pitfalls associated with investment crowdfunding.

  1. High risk and uncertain returns: Many crowdfunding investments involve early-stage companies or projects, which are inherently riskier than more established businesses. There is a higher chance of failure, and returns might be uncertain.
  2. Lack of Liquidity: Crowdfunding investments may lack liquidity, unlike publicly traded stocks. Selling or transferring your investment can be challenging, especially if the business or project performs differently than expected.
  3. Limited Information and Due Diligence: Crowdfunding platforms may offer less information or transparency than traditional investment vehicles. Investors might encounter limited access to financial data, business plans, or the track record of the entrepreneurs involved.
  4. Platform Limitations: Crowdfunding platforms can sometimes impose restrictions with their rules and fees, and failing to achieve your financial target may result in walking away with nothing.

Is Crowdfunding a good investment?

Crowdfunding has come a long way, evolving from mainly platforms that fund personal causes to a regulated financial investment instrument. Crowdfunding investments present an appealing option compared to traditional investment methods, especially real estate and startups, due to their potential for substantial returns. However, investors need to carefully consider their risk tolerance and investment goals, particularly when dealing with the inherent risks of early-stage ventures.

Crowdfunding investments might not bring quick returns and you are at risk of losing the entire investment. Always consult with a financial advisor before making investment decisions and approach crowdfunding with caution, despite its perks such as low entry thresholds and the potential for high returns.

How do crowdfunding investors get paid?

In theory, crowdfunding payouts sound simple: investors benefit from capital appreciation and may earn dividends or interest on loans. However, in reality, things are more complicated. Crowdfunding platforms provide various instruments and investor strategies with different conditions.

The payment structure for crowdfunding investors depends on the model and terms set by the fundraising company, but some platforms offer a secondary market for an early exit. For equity-based crowdfunding in startups, the investors typically earn money when the company is sold to a larger company, merges with a company or goes public.

For Convertible Notes and Simple Agreements for Future Equity (SAFE’s), the terms can vary greatly, but usually, this type of debt instrument needs to be converted into equity in the future before investors can receive a return.

In debt-based crowdfunding, investors receive regular interest payments throughout the loan, with the investment terms specifying the interest rate. Typically, at the end of the loan term, the fundraiser repays the principal amount to the investors.

Articles Sources

  1. Global Market Insights: "Alternative Financing Market Size"
  2. Crowdcreator.eu: “Crowdfunding - Alternative-Finance”
  3. StartEngine: "Leading the industry: $650M raised"
  4. Seedrs: "Total Investments - Total Funded Deals"
  5. Estateguru: "Statistics"
  6. U.S. Bureau of Labor Statistics: “Survival Of Private Sector Establishments by Opening Year”
  7. Seedrs: "Seedrs Portfolio Report 2023"
  8. Estateguru: "Statistics - Historical Performance"