Both venture capital (VC) investing and real estate investing involve some level of risk assessment, they both have the potential for big returns, and investors have the opportunity to help someone else reach a desired goal. Despite this common ground, there are some distinct differences.
Private Equity Investing
VC investing is a type of private equity investing that takes place in stages. The VCs (venture capitalists) use their capital to fund startup businesses that have good growth potential. To realize returns on this type of investment, investors must understand the different stages of the startup cycle, how to evaluate a business plan, understand how to assess talent, technology, and business processes to determine whether a startup has the potential to succeed, and know how to judge market forces that could have an impact on the startup company.
Different investors may define the stages of startup businesses differently. In general, however, the stages are:
· Seed and Development – At this stage, companies are developing their core product, conducting market research, creating a management team, and establishing the business plan.
· Early stage – The early startup stage is about finalizing product development and establishing marketing activities.
· Growth stage – In growth stage, startups are promoting the product, ramping up marketing activities, hiring key staff to grow the company, and defining market segments.
· Late stage – Companies in late-stage are experiencing revenue growth with a commercially available product, but are not yet realizing a profit.
· Expansion stage – Companies are adding locations, developing new product lines, purchasing equipment, ramping up production, and/or working on new marketing strategies.
· Maturity – At this stage, companies are refining their processes and marketing activities to optimize shareholder returns.
Each investment stage may be further divided into sub-stages. Many venture capitalists specialize in one stage (seed or growth stage investing) or may be interested in working with companies in a particular sector at various stages of the startup cycle. In the early stage, VC investors want to fund companies that are not yet profitable but have the potential to deliver high profits and great returns.
Real Estate Investing
Real estate is an alternative asset class that can be structured either as a debt investment or an equity investment. By contrast, venture capital investing is an equity-only type of investment where investors are looking for a return based on an increase in valuation of the business in which they have an interest. With real estate investing, returns are earned in one of two ways:
- Increase in valuation paid at the time that the property is sold; or
- Regular interest payments from debt issued to borrowers through a loan instrument.
The rise of real estate crowdfunding has made both types of real estate investing popular, and more accessible to more investors. Different platforms may emphasize debt investments over equity or vice-versa. Some platforms offer both types of opportunities.
Real estate investments can be structured in many ways to benefit investors who are looking for specific types of returns. For instance, house flipping (Fund That Flip and Peerstreet) or commercial or multifamily flips (Sharestates and Patch of Land) offer short-term gains while rental properties (Roofstock and HomeUnion) offer long-term passive income. Commercial real estate investing (CrowdStreet and RealtyShares) may involve property development or long-term leasing with spans of three, five, ten years or more. New REITs (FundRise eREITs and MogulREIT) offer investors a way to invest in multiple properties or types of real estate through a single vehicle. Real estate funds or portfolios (AlphaFlow) also allow investors to diversify their debt investments through a single vehicle.
When it comes to real estate investing, thanks to crowdfunding and online platforms, there is no shortage of opportunities.
The Impact of Recent Crowdfunding Legislation
Thanks to the JOBS Act of 2012, more people have access to both types of investments (real estate and company equity), and more startup companies and real estate developers have access to private investors who can help them reach their funding goals. The most anticipated parts of the JOBS Act—Title III and Title IV, or Reg CF and Reg A+—went into effect in May 2016 and June 2015, respectively.
Title I of the JOBS Act established new rules for emerging growth companies to issue initial public offerings. Title II allowed companies operating under Regulation D, Rule 506 of the Securities Act of 1933 to publicly advertise their opportunities if they go through the steps of verifying accredited investor status. Title III expanded the availability of investments to more investors with some limitations. For instance, non-accredited investors can now take advantage of equity crowdfunding opportunities, but if they make less than $100,000 per year, they can only invest up to 5% of their income or $2,000, and they can't sell investment shares until they've held them for a year. Title IV of the JOBS Act changed the rules for Regulation A offerings and opened the door for the new REITs.
The JOBS Act can be used to raise capital or invest in equity crowdfunding opportunities for venture capital and real estate crowdfunding. Nevertheless, real estate crowdfunding portals have proliferated since the passing of Title II, and there seems to be no end in sight for the growth of the sector. By the same token, more opportunities for venture capital investing are popping up as online platforms like MicroVentures, FundersClub and NextSeed make startup investing available to a larger pool of investors.
How to Evaluate an Early Stage or a Real Estate Crowdfunding Opportunity
When evaluating early stage VC opportunities, investors should perform due diligence on the startup's business model, the competitive landscape of the market, general market forces, the company's growth potential, available cash flow, capital expenditures, the company's management team, customer expectations, suppliers and business partners, regulation, the company's underlying technology, and, if investing through an online platform, the platform itself.
Investors evaluate these criteria differently based on their own values and goals, but the evaluation process is necessary to manage risk effectively.
Due diligence in real estate investing is also important. Basic criteria for evaluation include:
- The platform – Does it have a strong financial position and available capital? Is the underwriting done in-house or outsourced? What is the background and experience of the management team? What is their plan for insolvency, recouping losses, and managing risk?
- Fees – Every investment involves an opportunity cost. Is there an ongoing management fee, or does the investor pay a percentage based on returns or total portfolio size?
- Borrowers – How does the platform assess borrower track record and credit?
- The investment – What is the developer’s business plan? What are the expected cash flows, expenses, and projected returns? What is the loan-to-value before repairs and after repairs? Are investors in a first-lien position or second? Where is the property located?
As you can see, there are some commonalities between real estate investing and early-stage startup investing, but there are also key differences. Before you tackle any investment, make sure you understand what you are getting into and determine whether this investment fits with your overall investment goals, risk tolerances, and liquidity needs.
Also, it is always a good idea to consult your CPA or even an attorney, especially if you are unfamiliar with the contracts and disclosures. Luckily, with online investing, these documents are readily available, and platforms have customer service (investor relations) teams in place to walk you through the details of any offering.
This article was written for CrowdfundInsider.