Do you want to get in on the next DropBox, Uber, or Facebook?
You can now invest in startup companies online from the comfort of your own home. With the click of a button, you can become a partial owner of a new fast growing tech company.
You don’t even need any previous experience!
Without a doubt, giving retail investors access to these previously exclusive deals is a good thing, but there must also be some guidance and education so that you don’t lose your shirt.
Every investment comes with a certain degree of risk. This is true of the stock market, bonds, real estate, commodities, and equity crowdfunding. The more risky that something is, the higher the potential return.
With this article, I’m going to dive into several key equity crowdfunding tips for investors that will help you navigate this new industry. I also have a book called Equity Crowdfunding Explained, which goes far more in-depth.
1. Equity Crowdfunding Investments are Illiquid (and Profitable)
When you buy a stock on the stock market, you can immediately sell it. There is an established secondary marketplace of buyers and sellers that trade the stock.
On the one had, this is good because it means your investment is very liquid. You can easily convert it into cash at any point in time. You don’t risk “getting tied up” with one company for years on end. On the other hand, it can lead to a lot of volatility with constant trading.
“Unless you can watch your stock holding decline by 50% without becoming panic-stricken, you should not be in the stock market.” – Warren Buffett
Unlike the stock market, there is no secondary market for the shares that you buy of an equity crowdfunding campaign. For the most part, you will only have an opportunity to cash out when the startup is purchased or it goes public.
This means that you won’t be able to easily convert your equity crowdfunding shares into cash. This long-term investment horizon means you’ll be betting more on the fundamentals of the company.
2. You Have a Special Name as an Investor…
Yes YOU!
If you earn more than $200,000 per year and have more than a $1 million net worth (excluding your house), then you are referred to as an Accredited Investor.
There are some other stipulations when it comes to gaining the status of an Accredited Investor, but for the most part, it’s ultra-high net worth individuals who can afford risky investments. Some institutional investors will also gain this status because of the funds they command.
Recognizing your status as an investor is important because it will determine the types of companies you can invest in and the platforms that you can use. Not every equity crowdfunding platform is created equal.
3. Minimums, Maximums, and Limits Imposed
Every equity crowdfunding campaign has a minimum amount that is required in order to enter the funding round. This could be $500 or $1,000. It’s going to vary.
Depending on the type of investor that you are, there will also be maximums imposed as set forth in the rules for the Jobs Act and the regulation that the company is using to raise funds.
Under regulation crowdfunding, there is a limit on the amount that you can invest in a 12 month period that are outlined as follows:
- Annual or net worth < $107,000: You can invest up to the greater of $2,200 or 5% of your the lesser of your annual income or net worth.
- Annual income and net worth are equal or > $107,000: You can invest up to 10% of your income or net worth, whichever is less, but no more than $107,000.
You can find an example of this below as pulled from the SEC website.
These limits are imposed to help prevent investors from themselves. By having a healthy limit, it will ensure that individuals don’t incur massive losses in a short amount of time. I think it’s a very good idea.
4. Diversification Is King
Every professional investor diversifies across many different asset classes and investments. This helps spread out the risk for your portfolio.
While equity crowdfunding might fit into the “alternative finance” part of your overall diversified portfolio, I would also recommend diversifying your investments within the equity crowdfunding industry.
This means that you shouldn’t put all of your eggs in one basket. Even venture capital firms will spread their checks across 10 different companies to help spread out the risk. If one firm goes belly up, it won’t hurt their portfolio as long as they get one or two major wins.
Along with lowering the risk of your portfolio, diversification will also get you used to these online interfaces and get you quickly familiar with how equity crowdfunding offerings work.
5. Only Invest in Startups You Understand
It’s very important that you ONLY invest in startup offerings that you understand. When you don’t know what you’re doing, it’s a fatal mistake.
As an employee, investor, or entrepreneur, you naturally have real-world experience when it comes to marketplaces, industries, and key players that you’ve dealt with in the past. Even as a consumer, you have a sense of different solutions out there that cater to problems you directly experience .
In investing terms, this gives you a competitive advantage over others in the marketplace because you have access to knowledge that they don’t have. Because of your direct experience in an industry, you could KNOW without a shadow of a doubt that a particular solution in sorely needed.
This informational advantage is what can lead to making good investment decisions that others fail to capitalize on. When you understand the fundamentals of the company and the marketplace, it brings a certain degree of certainty to the investment and mitigates the risk.
The inverse is also true. When you don’t have a lot of information or knowledge about a particular marketplace, product, or solution, then you have a disadvantage as an investor. You have to quickly do your own research to figure out whether or not this is actually a good investment.
More often than not, you will be more easily swayed by the information the startup is providing you, leading to bad decisions that are based off of biased data. With less knowledge, you will be more easily swayed into making bad decisions, in the same way that consumers with little knowledge tend to overpay for products and services.
By investing in startups you understand, you’ll avoid making some costly mistakes and poor decisions.
6. Tune Out Your Emotions (Or This Will Happen)
The surest path to making a bad decision is to simply follow your emotions.
Don’t get me wrong. Sometimes, you can make very good decisions by listening to your emotions. However, when it comes to business, it’s a recipe for disaster.
Sales people know that making a customer feel strong emotions is the easiest way to get them to take action and either buy a product or invest in an opportunity.
If you only listen to your emotions when it comes to studying an equity crowdfunding offering, you will end up “feeling good” about a particular startup, but you’ll probably end up losing your money.
There is a difference between an investment “feeling” like a good decision in the moment compared to being an objectively good decision in the long run. The more logic that you apply to your decision-making process, the better.
You really have to try to tune out your emotions to the best of your ability. Look at the data, numbers, and metrics that underly this company. Don’t be seduced by a fancy video, compelling story, or positive future prospects.
7. Owners Should Be Marketers
As an investor in an equity crowdfunding campaign, you shouldn’t just sit back on your laurels and wait for the startup to appreciate in value. You have the opportunity to speed up that process.
If we take a look at other investment opportunities, like Bitcoin, we can quickly see how the marketing and promotion that goes on in the community actually increases the value of the underlying asset.
The people who got in early into Bitcoin were significantly rewarded the more that it was talked about. So they were actually incentivized to talk about the currency and get more people interested in it.
As an owner in a new startup company, you could sit back and let the company do all the world, or you could also become an evangelist for the product and brand. By helping to spread awareness about the startup, you’ll help it get more users, traction, and thus increase in value.
Don’t just be an owner of the startup. Also be a marketer. The more you talk about the startup, the more people will also become interested in future funding rounds.
8. Expect To Lose Your Money (or Hit it Big)
I think it goes without saying, but investing in ANY startup company is very risky. The majority of startup investments do not result in a positive ROI (even for seasoned investors).
A lot of startups will tank, go nowhere, or run out of funding before they are able to fully monetize their opportunity. Your risk of losing your investment is pretty obvious. The Ubers and DropBoxes are few and far in-between.
That being said, you also stand a lot to gain if you invest in the right team and the right startup. Even early employees in companies like Facebook grew their net worth into the tens if not hundreds of millions of dollars.
The reason why there is such a big opportunity is because of the way that startups can scale quickly using technology. When a startup gets product-market fit and has the right resources, it can easily blow up into a big company.
As an investor, you’ll own a small piece of the pie, but it will be a gigantic pie. This is why your investment can appreciate a lot over time and well exceed the value of your entire portfolio. In fact, most VCs will only experience one major “home run” in their portfolio, which is what leads to most of the ROI of the fund.
9. Don’t be Dumb. Do Your Homework
Don’t rely on the due diligence of a crowdfunding platform. Just because they vet startups to some degree does not mean that every investment will be profitable.
The same goes for actual the startups. A startup will do everything in its power to convince you that they are a growing company with a bright future (because they want your investment). This means that the materials and data they provide you can be very biased.
It’s important to do your own research and analysis for your investments. Verify the sources of the data that the startup brings up. Look into the industry yourself. Take a look at other existing solutions that are out there. If nothing else, plug the name of the company and the founders into Google to see what comes up.
Sometimes, as investors, we get so excited about a company and just simply want it to work out well. Unfortunately, the market doesn’t care about our feelings. Logical analysis is the name of the game. Otherwise, you’re going to lose your shirt.
10. Learn How It All Works
I’ve already covered earlier in the article how when it comes to investing, information is king. This is also information when it comes to the actual crowdfunding process. The more you know about how crowdfunding works, the better.
This is why I recommend picking up a copy of my book, Equity Crowdfunding Explained, which goes in-depth into each platform, the various fundraising regulations, along with the dos and don’ts of equity crowdfunding. You can grab a copy here.
In addition to learning through my book, you can also check out other free content, like my YouTube channel and interviews that I’ve done on my podcast. As you gain more familiarity with the industry, you’ll come to master key terms and feel much more comfortable in this arena.
Not only does education give you a sense of how the process works, but it also will give you realistic ideas about a particular startup can raise capital in the future. Remember, funding is the lifeblood of every company.
If a tech startup can no longer raise funds, then that startup will DIE. It’s really that simple. With equity crowdfunding knowledge, you’ll be better able to assess a new company’s chances when it comes to startup funding.
