How Private Investors Compare to Crowdfund Investing

Crowdfund investing doesn’t compete with or replace the need for professional private money. Crowdfund investment campaigns have funding caps that are significantly lower than most venture capital and private equity investments. Instead, crowdfund investing runs parallel to private money, funneling funds to types of businesses that previously didn’t stand a chance of receiving private support.

What exactly is private money? It’s money that comes from companies or very wealthy individuals — people called accredited investors by the SEC — who, just like regular investors, want to maximize the returns of their investment portfolios.

Credit: ©iStockphoto.com/Jacob Wackerhausen

The concept of an accredited investor came into being with the creation of the SEC in the early 1930s. The idea was that, as the 1929 stock market crash illustrated, marketing stock investments to the public at large could be dangerous for the entire economy, and only certain investors should have the greatest freedoms to risk their money on certain types of investments.

To be qualified as an accredited investor today, you must have a liquid net worth of at least $1 million (excluding the value of your home), or you must have earned more than $200,000 for each of the last two calendar years ($300,000 if you’re married). The SEC deems that investors with this much capital can fully and freely make investment decisions in both public and private companies.

Private money organizations aggregate capital from a mix of accredited investors (including companies and financial institutions) for the purpose of making investments primarily in private companies or nonpublic offerings.

The goal of these organizations is to pool large amounts of investment capital and employ investment experts who can find and invest in great deals that will deliver higher rates of return than more traditional investments in public companies. (Of course, these deals also carry a lot of risk.)

There are three types of private money investors, which differ based on the size of the investment made and when during the company’s lifecycle the investment is made. At each stage, these private investment firms provide not only capital, but also advice, connections, merger/acquisition targets, and external accountability and expertise to help companies succeed.

The goal of these private money organizations is to create an exit for themselves (as well as the entrepreneur) that will deliver at least a tenfold (or 10x) multiple on invested capital.

Here’s a brief overview of the three types of private money entities:

• Angel investors: These people usually make bets on companies at their earliest stages (sometimes called seed-stage investments) and can play the role of a guardian angel. Angel investors usually form groups to allow them to jointly review investment opportunities, share information, and provide a potential pool of dollars that will attract good company founders who want both expertise and cash.

  Typically, these types of investors have some experience in entrepreneurial ventures and want the excitement of being part of something and helping it succeed. Individual angel investors typically make investments in the $25,000 to $100,000 range, which are small compared to later-stage investments.

• Venture capitalists: These investors (which are usually firms, not individuals) often invest between $1 million and $10 million in companies that have begun to grow out of the seed stage and are showing traction and results in their market space.

  The companies may or may not have revenue but likely are not profitable because they’re spending all they make, in addition to the money that’s invested in them, in order to grow as quickly and effectively as possible. Venture capitalists invest in companies that are believed to have very high growth potential and need capital to be able to scale quickly to take advantage of the market.

• Private equity investors: These firms tend to invest even larger amounts than the venture capitalists and look for more established companies with profits and successes that are looking for growth-stage capital.

  Today, the lines between venture capital and private equity are fairly blurry. Many times, the way the firm wants to position itself from a marketing and strategy perspective makes the distinction (as opposed to what the firm invests in).

Obviously, getting your hands on private investor money could be a life changer when you’re starting or growing your business. But the vast majority of businesses never touch the money supplied by accredited investors. And prior to the JOBS Act, unaccredited investors (people whose liquid net worth or annual income doesn’t meet the accredited investor thresholds) were severely restricted from directly investing in many private businesses.

The JOBS Act opened up private company investment, in limited and regulated ways, to everyone. This significant regulatory change occurred in part because lots of people today (as opposed to in the 1930s, when so many of our financial regulations were crafted) have some level of investment savvy thanks to their retirement plans, which are invested in stocks, bonds, and mutual funds.

In addition, the Internet and social networks have democratized access to information in real time that was unimaginable even a decade ago. Everyone with an Internet connection (more than 80 percent of the U.S. population) has access to information directly, as well as via their social networks, that can be used to make investment decisions.