I recently wrote about my attitudes toward Kickstarter, the imperfect but exciting crowdfunding platform. Now, I’d like to turn my attention to a related and similarly exciting use of crowdfunding as an investment vehicle.
(Aside: for those who are interested in Kickstarter, be sure to read this analysis of Kickstarter’s impact on CES from The Verge)
First, if you’re not already familiar with the concept of an accredited investor it’s worth a brief review. In short, if your income tax didn’t go up at the start of 2013, you’re not an accredited investor. Don’t feel bad – we’re much more fun than them.
Normally, in order to purchase equity in a company, the company either needs to be listed on a public exchange, or minimally, the company needed to register a security with the SEC. Needless to say, that presents a non-trivial barrier to entry. Startup companies have been prohibited from raising funds by appealing to the general public. That’s why you can’t get shares in a company when you invest via Kickstarter.
This situation has changed dramatically over the last eighteen months. First, increased interest in the general notion of crowdfunding has resulted in clever “circumvention” of some of these restrictions (more on this in a moment). Second, the JOBS act, passed in March of 2012, creates (or will create) a variety of provisions for direct investment in startups, regardless of personal income status.
It’s important to draw a distinction between this type of crowdfunding and person-to-person lending, as they often get mentioned in the same breath. Person-to-person lending, either as a non-profit endeavor via services like Kiva, or as a for-profit endeavor like Lending Club, connects lenders with borrowers directly. Groups of lenders are connected to loan money to a borrower, who repays the loan to those lenders with a reasonable interest rate (or none at all in some cases). Lenders can, potentially, resell loans on a secondary market, but generally these are long term illiquid investments. Lending Club loans help fund debt consolidation, home and auto refinancing, and other types of general consumer borrowing, and has proven fairly successful.
These types of investments are regulated primarily on a state-by-state basis. Although they’re an interesting alternative to other types of investment, I don’t find them particularly exciting. Instead, I’d like to highlight two startups in the crowdfunding space which I am incredibly excited about, Fundrise and Solar Mosaic.
When discussing Kickstarter, I explained that I invest because I believe the world will be moderately improved if the thing I’m backing exists. In much the same way, both Fundrise and Solar Mosaic provide the opportunity to invest in the creation of a thing – a building in the case of Fundrise, a solar installation in the case of Solar Mosaic.
Both projects offer somewhat similar narratives. They aim to fund things which require large initial capital investments, and offer relatively predictable returns over a fixed period of time. And both projects aim let you “do good” in your community, without having to repress your capitalistic urges entirely.
Solar installations offer a fairly straightforward business proposition. After the initial installation, solar panels produce power at a relatively predictable rate, which can be sold back into the power grid or directly to a customer. Rather than seeking to fund massive generating plants in the desert, Solar Mosaic targets rooftop or other localized solar installs. This type of installation provides a tangible, visible form of renewable energy production directly within communities. By investing via Solar Mosaic, investors have the opportunity to see their investment take a shape, while also generating a reasonable return.
Solar Mosaic is currently limited to small investors in California and New York, as well as accredited investors anywhere. As the SEC sorts out the implementation of the JOBS act, that’s likely to change. They’ve recently moved out of beta and seem to be “going vertical.”
While Solar Mosaic is interesting and exciting, Fundrise falls into the category of please take my money now – I think it’s absolutely brilliant. For a fantastic breakdown of the process which lead to the creation of Fundrise, and the current legal status, check out this in-depth article from The Atlantic Cities. I’d like to offer my own interpretation, as I see Fundrise as a solution to a problem I’ve identified in the past, but never been able to articulate.
I’ve often been confused by the presence of large numbers of abandoned, dillapidated buildings right in the heart of cities with sky-high property values. How can property sit vacant in a place like San Francisco or Washington DC?
When you dig a bit deeper though, it becomes clear that you’re dealing with a classic “bootstrapping” problem. The value of land is so high that the value of the building becomes relatively insignificant. A piece of land with a cat-infested, burned-out shell of a building may only cost marginally less than a piece of land with a mixed use retail structure. Investors therefore have little incentive to take on the risk and complexity of buying and rehab-ing the “ugly” property.
In cities with lower property values, non-profits, foundations or neighbor-revitalization groups might step in to renovate a property. But, when the cost of entry is in the millions or tens of millions of dollars range, even the most well-heeled foundation can only have limited impact.
Fundrise circumvents this problem by seeking investment from individual community members or others interested in revitalization. Collectively, the investors purchase the property and fund the renovation or construction. The property is then leased to a preselected tenant or tenants. Investors are then repaid via rent paid by the tenant, as well as the increase in the value of the property.
While it doesn’t make sense in all cities (including, very likely, my own), I consider this a potentially transformative solution to a vexing problem.
Taking a step back, it’s worth asking whether all of these crowdfunding and person-to-person lending platforms represent a meaningful “alternative” to traditional investing, or whether they simply supplement the standard vehicles.
Much has been written about Gen Y being scared of investing due to the fallout from the financial bubble bursting. Thirty-somethings are leaving their money tucked under mattresses or in low-yield (essentially no-yield) savings accounts.
As a certified thirty-something, I don’t share these fears. However, I’m also a person who values rationality. I want to invest in a company based on a belief that the company has a bright future. Should that belief prove accurate, I’d like to see my investment grow. Over the long term, that may still be the way the markets behave, but the degree of irrationality over the last five years has shaken my confidence. A political party willing to risk government default combined with an incredibly unclear global economic outlook means that investing feels far more like rolling a dice than it did even ten years ago.
Solar Mosaic, Fundrise, and a whole raft of other companies in this space provide an opportunity to see your investment take shape on a community level, and to know that it will succeed or fail based on far more localized, micro-economic variables. They’re not risk-free by any stretch, but at least if they fail you can take solace in the fact that they’ll feel very bad about it.
Fascinating — very good explanation of this new approach to investing in your community. I wonder if organizations like this would expand if the tax code was changed regarding charitable donations. We invest in our community by donating to non-profits and then get a tax deduction (though the deduction isn’t the primary reason, and at our income level, hardly counts).