Equity Crowdfunding – A New Source of Passive Income?
Private Equity has been around for a long time. An individual or firm provides money in order to get a business venture started. In turn, the investors own equity in the company and get a share of the profits. Crowdfunding has been getting very popular over the last few years especially on sites like KickStarter. People post ideas or things they need money for and people from all over the world can donate to the cause if you will. Sometimes it is just fun to read the posts on that site. I have seen anything from raising money to create movies, to some guy waning to make potato salad! The difference however, is these individuals simply donate money and do not get anything out of it afterward depending on what the kick start entails. An example is, if enough money was raised to fund a movie idea, the movie itself would be its own reward once completed. But what if these two ideas were merged together?
Recently, the tides have shifted combining these two and it is being called Equity Crowdfunding. It has recently come to my attention that there are a few attempting to make a movie using Equity Crowdfunding. And if you have a blog yourself, I’m sure you received the same email from them. Equity Crowdfunding means investors give money to fund an idea or create a product, similar to KickStarter, but also own equity in it. In this instance the equity is in the movie and investors receive part of the profits as a return on their investments. In theory, it sounds amazing. As a big time movie buff myself, I was instantly drawn to the idea. Potentially another source of passive income maybe? But what are the pros and cons of such an adventure? Let’s review the pros and cons using a movie as our example, even though equity crowdfunding can be used for basically anything.
Product – In this case the movie itself. You have heard the phrase “If you want something done right, you have to do it yourself.” What kind of movie do you want to see be made? Maybe a sequel of your favorite stand alone movie, a canceled TV show come back for one last adventure, or just a brand new idea someone wants to run with. You can pick and choose what you want to see and invest in the ones you do. Once it’s finished, it’s partly your movie to go watch and brag to your friend about being a part owner. Your name may even appear in the credits if the company producing the film allows it.
Initial Investment– If someone tells you that you will double your money, yeah no brainer, of course you want to. The company taking your investment should always strive to return your initial investment once they are done with it. But we don’t just want our initial investment back. That is all risk and no reward. We want to make extra on top of it or an ROI. So in my above example, they doubled the money the year the movie was released and the profits started coming in.
Passive Income– The initial investment then brings me to my next point, passive income. Especially those of us in the DGI community, we like long term investments that will keep producing passive income for years to come. The first thing that comes to my mind is big movie series like Harry Potter or Star Wars. Those are huge names that even make money when they don’t have a current movie out. The movie franchises can make money off of merchandise, comic books, theme parks, royalties from playing the movies on TV, etc. It would be awesome to own equity in a major franchise like that and receive consistent payments every month or year passively.
Miscellaneous– While I’m sure not every company will offer extra added perks, some might. Perks could include behind-the-scenes peeks of the movie, before theater releasing private showing, visiting the set, meeting the cast and crew, walking down the red carpet at the premiere or attending the after party, and possibly more.
Wow, that all sounds perfect and exciting! But every investment has its shortcomings. So let’s try to think critically for a second and see what potential pitfalls this type of investment may possess.
Views– When a movie gets off the ground from KickStarter or a similar site, the viewership is already there. People are willingly donating funds just for the opportunity of a movie being made. The movie in itself is the reward and they don’t want anything in return. Everyone who donated will absolutely go see the movie, as well as share the experience with friends and family. With equity crowdfunding, they are there for the money mainly so the only tie they have is monetary. This may or may not get people in the door to see it with equity crowdfunding. The emotional bond is not quite as strong.
Budget– The budget would need to be allocated perfectly. There is a fine line. You want to make a quality movie most importantly. So you will need to account good cast and crew to get viewers in seats. Also special effects and production value. Those things don’t come cheap and get expensive very quickly. However, you want to have more money for the investors. If you keep the investors happy, they will keep the money coming for future endeavors. It can be done to make a quality movie on a low budget, but it does make it more difficult. The overall strategy would have to be sound in order to draw in the attention of potential investors. Low budget but also high quality to have the best chance at an ROI for investors.
Liquidity– It is amazing to double your money, but it is also not very liquid. Meaning, you are unable to pull your money out and turn it into cash if needed. Your investment is tied in production. Unlike real estate, you can’t draw from the equity and unlike stocks, you can’t sell them any time for its current value. It really has no value until the final product is finished. So you really have no potential way to get your investment back unless the movie performs well. And it may take a year or two for the movie to finish being created, edited, and released.
Diminishing Returns– We as DGI investors, like to build income generating assets for a long period of time. Being able to double your investment once the movie is released is great, but temporary. Can it keep producing for the long term? As shown in the passive income “pro” above, it could have potential, but isn’t always the case. Big movie franchises continue to produce because of royalties or replaying them on TV, merchandise, sequels and spin-offs, etc. They have a well-established brand behind them that makes money and keeps producing content; Disney comes to mind. Most movies, especially crowdfunded movies, are a one and done unless they get a big enough following. So the big money will happen upon release and once the “new” has faded it doesn’t produce anymore. So each year the profits become less and less.
Also, in this type of fundraising, you only own equity in the single movie and not the company producing it or the potential movie franchise. So if they decide to make a sequel, you will get nothing from it unless you invest more into the next movie, if the chance is even presented to you. I believe that means any merchandise sold or extra money being produced because of the movie you also get no part in also. Depending on how the investment is set up, you may just get proceeds from the actual movie itself.
Let’s take a look at profit in terms of accounting. In theory, investors are looked at as equal. But this is probably not the case. We know that not all investors will be like myself and are only able to contribute a small portion. You will need to bring in more, higher paying private equity funding. I compare this to the equivalent of preferred and common shareholders of stock. Depending on how much profit is made, the preferred shareholders will eat up most of the profit first before what is left can trickle down to the common shareholders. Depending on how it is set up beforehand, that will usually be cumulative for the coming years. So any extra profit long term will go to them and the common won’t see much, if any of it at all. If that is the case, it may not be a great passive income source for the long term unless you get franchise rights as well.
Crowdfunding has been on the rise recently and can be used for nearly anything. Companies already do this with real estate, private loans, debt and more. Equity crowdfunding if it is not already, has the potential to be the next big thing. Each industry is different and may have different pros and cons. Just make sure to do your research before investing. Same as picking stocks that fall into your market strategy, make sure the company has a sound business strategy to lower your risk and increase your return on investment.
So who wants to help fund my retirement? As a perk I’ll provide monthly updates, send pictures, and give each and every investor a thank you and a theoretical crisp high five.
What are your thoughts on Equity Crowdfunding? Have you ever done it or participated in a KickStarter? Can you think of any other pros or cons that should be added? Do you agree or disagree with any of my points? Is there potential to make passive income? Your comments are always welcome below.