as news stories exposed concerns about the inner
workings of LendingClub, the U.S. government has been
opening the door for Americans from virtually any income
level to dabble in the speculative world of crowdfunding.
you may recall, was born out of the financial crisis. At
a time when trust in banks was low, new Internet sites
like LendingClub arose, allowing regular people to spot
anyone who needed a loan or a small investment to get a
new business off the ground. Then, through the websites,
individuals either loaned or invested money knowing that
the future of getting repaid was uncertain.
about a decade after the folksy approach began,
crowdfunding involves billions of dollars. A recent
report on alternative financing by the University of
Cambridge Judge Business School and the Polsky Center
for Entrepreneurship and Innovation at the University of
Chicago Booth School of Business identified $36.17
billion in transactions in the U.S. in 2015.
the average American can still do a good deed through
crowdfunding websites by lending money to people who
want to pay off credit card debt, huge institutions,
such as hedge funds, are now involved.
loans, peer-to-peer websites such as LendingClub and
Prosper attract large hedge fund investors, as well as
individuals, by offering interest rates around 7 percent
— a huge draw when banks and bonds are paying so
little. But these are no equivalent to savings accounts.
There are no guarantees that the money will be repaid.
risks in equity investments through websites such as
AngelList, Wefunder or StartEngine are greater. After
all, business ideas may sound impressive, but about 80
percent of small businesses fail. Then, nothing is
in a startup is incredibly risky," said Olav
Sorenson, professor at the Yale School of Management. He
draws a distinction between sites like Kickstarter,
where individuals might back a creative endeavor, and
those that attract major financial interests.
sites that appeal to serious lenders and investors
provide some confidence by screening applicants for
example, LendingClub uses computer algorithms to suggest
how likely a borrower will be to default, or fail to
repay a loan, based on credit scores. Individual lenders
can then pick the level of risk they are willing to
take. Often, they extend small loans of just $20, but
combined with money from many lenders, the impact can be
is working on repairing its image after an internal
investigation over loans earlier this month led to CEO
Renaud Laplanche’s resignation.
crowdfunding has matured since the Great Recession,
analysts warn individuals that it is still a long way
from having all the kinks removed and appropriate
regulation in place.
will be cleanouts and crashes, and we will have
regulatory reform," said Bob Rosenberg, professor
Securities and Exchange Commission enacted rules May 16
that limit annual exposure to $2,000 for people with
income or net worth of less than $100,000. But, for the
first time, the measure that came out of the Jumpstart
Our Business Startups Act of 2012, known as the JOBS
Act, does open speculative investing to people who aren’t
considered "accredited investors," or wealthy
people. The idea was to give small companies more
options to get financing.
is important for individuals to realize that
crowdfunding platforms vary considerably, and even with
solid screening there are defaults. While you might be
attracted by a 7 percent interest rate, defaults can cut
equity investments in businesses, the risks are even
greater because investors get nothing back if a business
collapses. And Christian Catalini, professor at the MIT
Sloan School of Management, warns not to expect
investing in the next Uber. He notes that the best deals
are likely to go to those accredited investors, not
people who are allowed under the new regulations to
invest $2,000 or even $10,000.
these companies with a high level of skepticism,"
said Charles Rotblut, vice president of the American
Association of Individual Investors. He notes that when
he recently perused crowdfunding sites, he found a great
diversity of businesses — from biodegradable
toothbrush producers to a social media app for dog
where they are in terms of business development, if they
have an actual product currently being sold, what their
revenue and profitability trends are and how competitive
their industry is," he said. Compare the likely
revenue and profits to the business valuation and
"find out how the proceeds from the offering will
be used, what rights as a shareholder you have and how
the company will keep you informed."
keep up your guard. Rotblut notes: "The companies
seeking crowdfunded investment dollars will do all they
can to make their prospects sound great … this is
gambling, not investing."