A Closer Look at the Risks and Rewards of Crowdfunding

By Tim Maverick

The long-awaited crowdfunding rules finally came into effect on May 15, 2016. Listed under Title III of the Jobs Act, these regulations are meant to put parameters in place for what has been, until now, an unprecedented and unpredictable marketplace.

Crowdfunding allows start-up companies to raise seed capital – up to $1 million – from regular, non-accredited investors through online equity crowdfunding platforms.

Since the beginning, crowdfunding has seemed rife with opportunity.

Who doesn’t want the option of investing in a unicorn at the ground floor?

It boasts the illusion that anyone can earn major profits by either capitalizing on public interest in a great idea, or having the foresight to invest in an idea that seems promising.

With crowdfunding investing platforms, million-dollar investments are no longer reserved for Silicon Valley venture capitalists.

But that’s not quite accurate. In fact, like most get-rich-quick schemes, there are tremendous risks involved.

Government Limitations

These risks are the reason behind the government-imposed limitations on how much an individual can invest in start-ups via crowdfunding.

If a potential investor has an annual income or net worth of less than $100,000 annually, then that person may invest only the greater of $2,000 or 5% of their annual income or net worth (whichever is less) in a 12-month period.

Individuals with both an annual income and net worth of at least $100,000 can invest up to 10% of annual income or net worth, whichever is less.

This precaution, put in place by the government, is a crucial element in protecting the investor – as well as the companies involved in crowdfunding – and it makes perfect sense.

Risky Business

First of all, the Securities and Exchange Commission (SEC) has imposed some rather onerous rules on the firms raising capital through crowdfunding platforms.

This addresses the question of whether the companies on these platforms are small start-ups with promise, or whether they simply have no other alternative financing options.

While it’s not entirely likely that an average person, sitting at home on their computer, looking for a sound investment, will stumble unbeknownst upon the next Snapchat or Uber, sometimes, the most desperate, low-quality companies know just how to sell their product on the internet without much real-life potential.

The odds of losing all of your investment is higher than in any other investment platform. In the UK, a recent study showed that one in five firms that raised capital via crowdfunding between 2011 and 2013 ultimately went bankrupt. Thus, investors lost out completely on that venture.

There are doubts, too, as to whether many investors on these crowdfunding platforms even know what they’re getting into. Many don’t realize that the success rate for even the most successful Silicon Valley venture capital firms is very low. And those guys are picking from the cream of the crop of start-ups and get sweetheart deals.

Pause and take a moment to look at what’s happened recently to some of the most promising young companies. Their valuations in the private market rose too far too fast, like the mythological Icarus. And now many mutual fund firms have had to write down the value of these investments.

These firms include the likes of Fidelity, BlackRock, and T. Rowe Price.

This has led to the resurfacing of the word “bubble” in connection with fledgling tech companies.

Earlier this year, the Founder and CEO of Salesforce, Marc Benioff, predicted, “There are going to be lots of dead unicorns.”

Unicorns turning into uni-corpses, that is.

Therefore, if even the market darlings are headed for trouble, it doesn’t seem like now is the ideal time to be putting a lot of money into these type of start-up investments.

Where to Invest

In the instance that an investor is really ready to take a gamble, there are other – more sound – options.

As Bill Gates, the Co-Founder of Microsoft, says: “Be discriminating when investing in technology start-ups. Do your due diligence.”

I would stick to the higher-quality crowdfunding platforms that have a higher success rate. Some that come to mind include: SeedInvest, StartEngine Crowdfunding Inc., OurCrowd, and AngelList.

Just remember, even though the investment is done online, with the click of a mouse – this is still real money that, even if invested in a winner, will be tied up for a very long time.

Good investing,

Tim Maverick

Source: http://www.wallstreetdaily.com/2016/06/13/crowdfunding-start-up-investing/

Ready to start learning about exciting companies?

Sign up to discover the latest emerging growth companies using Regulation A+!

Click here to sign up