After coming up with a business plan and doing some market research, traditional commercial investors typically shop their concept around to a variety of wealthy investors or financial institutions to gather up the funds needed to make the commercial investment come to life. At the end of the day, only a few key investors would be a part of the plan.
Crowdfunding takes a different approach, and essentially involves generating capital with the help of friends, family, clients, and individual investors. Rather than tapping into a limited number of key players – as is the case with the traditional approach – crowdfunding reverses this effect. Crowdfunding greatly expands the exposure and reach for commercial investors and boosts entrepreneurship by taking advantage of a much larger pool of prospective investors.
This method of raising investment funds makes use of the easy accessibility of social media websites – including Facebook, Twitter and LinkedIn – to spread the word about new business ventures and attract investors.
It’s important to note that crowdfunding in the US is restricted by regulations regarding who is and isn’t allowed to fund a new business venture, and how much money is allowed to be contributed. The reason for such regulations is to protect non-wealthy or non-savvy investors from risking too much of their savings in the event that the specific business fails.
There isn’t just one way to take advantage of crowdfunding. Here are three main types of crowdfunding to help you reach your investment goals.
▪ Donation-based crowdfunding – This type involves no requirement to make a financial return to contributors. Usually, this type is reserved for fundraising for charities, non-profit organizations, and disasters relief efforts.
▪ Rewards-based crowdfunding – This type of crowdfunding involves individuals or companies investing in your deal in exchange for a reward in the form of a service or product from your organization. This version allows business owners to offer incentives to contributors without having to sell stake in ownership or incur a lot of extra expenses.
▪ Equity-based crowdfunding – This variation gives contributors the opportunity to become part-owners of your company after capital is traded for equity shares. These contributors then are entitled to receive a financial return on their investment, and get a share of your company’s profits in the form of a distribution or dividend.
Streamlining the Business Model
Instead of presenting a researched idea to a narrower group of individuals, crowdfunding allows you to pitch your idea to a much wider audience with potentially interested investors, providing them with more avenues to help you grow your commercial investment business.
Going the traditional route can put you at a much higher risk of losing out on your time, effort and capital by selling your idea to the wrong investor(s).
What Type of Equity Does Crowdfunding Usually Require?
While the kind of terms you can expect from equity crowdfunding will depending on the exact company, equity crowdfunding generally requires a rate of return between 8% and 12% percent, as well as an additional small amount of equity.
To illustrate, let’s assume this preferred rate is 10%. That means that if a specific crowdfunding firm invests $500,000 in your commercial investment deal, you will be responsible for paying them out the initial $50,000 (10% of the $500,000).
Since this could possibly use up all the working capital, some companies will need to take steps to defer a portion of the return until a refinance or sale.
What’s the Ideal Type of Commercial Real Estate Deal to Use Crowdfunding For?
First let’s mention a type of deal that crowdfunding is not best for: buy-and-hold investments. That’s because the majority of equity crowdfunding firms require quite a high preferred return, which will eat up the cash flow needed to support the investment.
This leaves us to the best type of deal that crowdfunding is used for: development opportunities that have the potential to have plenty of value added to them over a couple of years. This buys you time to build up value and finance out the crowdfunding, and even swap it for more affordable financing.
Equity crowdfunding might not necessarily be the right choice for every commercial real estate deal. But it certainly does offer investors a number of benefits that traditional methods just don’t match. From reaching a broader pool of investors, to promoting your campaign via social media, to streamlining fundraising efforts, crowdfunding might just be the perfect solution for your particular deal.
At the end of the day, crowdfunding can offer you a way to raise a significant amount of cash with reasonable provisions for a commercial real estate investment.