Investing Trend for 2014: Equity Crowdfunding

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This story appears in the December 2013 issue of . Subscribe »


It has been a good year for crowdfunding. The Securities and Exchange Commission lifted the ban on general solicitation, meaning U.S. entrepreneurs can advertise publicly that they're looking for investors. Research firm Massolution estimates that individuals have raised $5.1 billion on crowdfunding sites this year, nearly twice as much as in 2012.

Platforms that take a cut of the capital, such as Kickstarter, are no longer the only way to go, as Crowdhoster and Selfstarter have made it possible to run a DIY crowdfunding campaign. But the latest platforms, such as Upstart and Pave, don't even require a solid idea or business plan. With these services, 'treps can sell equity in themselves to accredited investors in exchange for a small cut of their future income.

Rachel Kim, a Harvard MBA who has worked at Google and Zynga, raised $100,000 from 37 investors on Upstart this year. She used half to pay off her student loans and half to launch her e-commerce company Nailed Kit. "I was able to quit my job at the end of May to pursue this full time," she says. "The money I raised basically will give me six to 12 months to prove this out."

In return, Kim will pay investors 6 percent of her income for the next decade. If her salary doesn't clear $30,000 one year, she gets a pass on repayment, and the contract extends a year. "My student loans don't have any of that flexibility," she says.

Since Upstart's launch last November, backers have made $2.1 million in offers to 160 people. "At least 50 percent are entrepreneurs specifically trying to get a business off the ground," says CEO Dave Girouard. A quarter of the 225 active investors have backed more than one upstart, he adds.

To protect borrowers, Upstart caps repayment at three to five times the total funding received. Lendees can choose a five- or 10-year repayment plan. Pave, an Upstart competitor, has similar protections. If a prospect's income drops 150 percent below the poverty line, he or she gets a pass on repaying backers that year. If prospects make a killing, they can buy out backers for five times the initial investment.

Borrowing against future income is a good bet for cash-strapped entrepreneurs, says Pave CEO Sal Lahoud. "You're allowed to fail doing this," he explains. "It allows you to get up and build something again, and your investors are completely aligned with you."

The vested interest in lendee success prompts many investors to mentor the 'treps they finance. Zimuzor Ugochukwu, who raised $5,600 from four investors on Pave, appreciated their guidance on her wearable digital health products. "I got connected to people in the digital health space I wouldn't have otherwise connected with," she says. "It has definitely opened a lot of doors."

Miguel Palacios of Vanderbilt University's Owen Graduate School of Management says that as long as repayment limits protect lendees from becoming indentured servants, selling equity in oneself is a great option. "The investors are taking an extra step," he says. "They're betting that the entrepreneur is going to come up with a viable, good idea."

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