Protecting Your Money while Crowdfunding Equity

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Small businesses and startup companies sometimes use crowdfunding to raise money online, through investments from the general public. Traditionally, individuals can either make a pure donation or receive a small reward for their contribution.

In the past few years, legislative changes ushered in a new form of crowdfunding: equity crowdfunding.

Equity crowdfunding allows entrepreneurs to raise up to $1 million in any 12-month period by selling ownership interests in their businesses.

Owners offer these interests online, through websites run by a broker-dealer or a funding portal. The websites make investment available to all investors.

Rather than just donating funds to crowdfunding ventures, investors may assume partial ownership of the venture and take a financial interest in its success.

How to assess a crowdfunding proposal

Before investing, ask questions and consider all available information:

• Financial Projections: Startup or early stage company values can vary. Examine the basis for all of the issuer’s financial projections, along with any of the issuer or intermediary’s financial statements.
• Product Development: Consider the current development stage for the product or service. Understand the strategies, costs, and time associated with the different development stages, including manufacturing and distribution.
• Capitalization: Successful projects have access to sufficient capital. Consider the current and future capital needs for any venture.
• Management Team: Review the experience and background of the issuer’s officers and directors, and determine whether they have the required skills to successfully build and grow a business.

Myths and realities of crowdfunding

MYTH: You can get rich quickly by investing in startup and early stage companies.
REALITY: Investing in startups is very risky. According to the Bureau of Labor Statistics, nearly 50% of businesses fail within five years. Startup investments are typically viewed as long-term investments, and you might not see significant returns for years.

MYTH: You can trust all companies who post on crowdfunding sites.
REALITY: Crowdfunding sites have different standards and requirements, and they decide on their own which ventures to feature. Individual investors should still investigate any company before investing. Due diligence will help you assess risks and combat potential fraud.

9 Tips for Crowdfunding Investors

1. Don’t exceed individual investment limits, which are based on your net worth or annual income.
2. Expect limited voting rights and control with any new venture.
3. Ask questions and request more information. Due diligence is critically important, so investigate all opportunities before investing. Also, examine all financials and documents provided by the issuer and intermediary.
4. Answer investor questionnaires honestly. They’re issued by intermediaries for your protection. You’ll need to disclose personal financial information and acknowledge the risks associated with crowdfunding.
5. Beware of overly optimistic projections. There are no uniform standards for valuing startup or early stage companies.
6. Learn the barriers for selling crowdfunding investments. It may be difficult (or impossible) to sell your investment because of limited market availability. Typically, crowdfunding investors can’t transfer their shares for one year after purchase.
7. Only invest money that you can afford to lose.
8. Plan for a long-term investment. Crowdfunding investments may not produce returns for several years, if at all.
9. Expect limited rights against an intermediary or issuer in a dispute.