Did you know that a new kind of alternative investment was made open to everyday investors in 2016?
Investing in startup equity crowdfunding was, up until that point only available to investors who were of substantial means, cutting out the rest. (You can check out the new law here).
As you will gather, investing in startups can be quite lucrative, especially if you’ve managed to pick the next “unicorn” to come out. On the other hand, vast numbers of startups fail so of course there is risk involved too.
Let’s look at what you need to know about startup crowdfunding and a few platforms you can use to get started:
First of all, let’s be clear about what equity crowdfunding is not. It is not a rewards-based funding system as you will have seen on platforms like Kickstarter or Indiegogo. There’s no t-shirt being shipped or receiving a new piece of gadgetry (although some platforms do offer extra “perks” in return for certain minimum investments).
Equity crowdfunding is about investing in a startup so that in return, you own a stake in it. You may have seen shows like Shark Tank, where startup company owners nervously pitch a panel of wealthy investors for the funding they need to grow their venture. The presenter wants something like $300,000 in return for a 10% stake in the company, the “sharks” (if they’re willing to invest) almost always counter with something like “$300,000 for 51%.”
Crowdfunding platforms give you access to investments that you otherwise may not have been able to get in on. Shark Tank is often talking about five or six-figure investment capital, whereas you can get into an investment on most crowdfunding platforms for as little as $100 for a few shares.
You should also know that, while startup investing is not just for “accredited investors” anymore, there are still rules in place to try and prevent people from betting the farm on something that doesn’t pan out. Congress approved rules that state if you have less than $107,000 in the bank, you can invest either $2,200 a year, or 5% of your income or net worth (whichever is lower). If both your annual income and your net worth are equal to or more than $107,000, then you can invest up to 10% of your annual income or net worth, whichever is lower.
Equity crowdfunding gives brings investment opportunities to non-accredited investors Click To Tweet
Given the low minimum investment amounts, this gives ordinary investors a good chance to not only get in on opportunities they may not have been able to access before, but to somewhat spread risk by investing smaller amounts in multiple different companies. We all hope to find the company that, like Instagram, gives early investors a 300% return on investment, although realistically, most investors are looking for returns more in the range of 25%.
One thing to remember here is that startup funding through crowdfunding platforms is still a relatively new activity – there is not a lot of data available yet to examine average returns or the successes and failures of the investments. In general, you should expect to be invested for two years or more in order to see a return. If you look at the Instagram example, investors were seeing the payoff two years later, however, for others, it may be more like three to five years.
How, when, or even if you get a return and your money back will depend upon the investment, so that’s something to look out for at the time of selecting startups to invest in. Usually, when you buy an equity stake, those shares cannot be sold or traded for several years. You should also find out how you will profit – will there be dividends or distributions? How much and how often?
Besides equity, most of these crowdfunding platforms will also offer the ability to invest in convertible notes. These are effectively loans which have associated interest payments, but are set to convert to equity in the issuing company when they reach a set milestone, such as a Series A round. They have a set term by which the company must either repay the loan or trigger the conversion.
Consider this, from Wired, talking to Richard Swart, a former longtime crowdfunding and alternative finance researcher at the University of California, Berkeley:
“It’s the law of startups—mathematically the most likely exit for a startup is failure.”
As a general rule of startup equity investing and any other kind of investment, you should never invest more than you can afford to lose. There is a chance that you may lose the entire investment, which is why being able to spread risk over several smaller investments can be an attractive option.
Larger angel investors follow this idea too. They invest in many startups, hoping to strike at least one big one but knowing that most will fail. As Wired also points out, these types of investors also have more expertise, research and money on hand than the average investor.
A plus of crowdfunding platforms is that they provide access to funding for a multitude of different types of businesses, many of which would never have been on the radar for angel investors. They might be looking for the next Instagram, but there are smaller businesses in all sectors who still manage to make a respectable profit. As an investor, you might see it as a positive to help support small businesses who may not otherwise have had access to funding.
There are equity crowdfunding platforms popping up all the time, but not all are built equally in terms of the standards they have in place and the quality of investment options available. A personal rule of mine is to only use US-based platforms and to carefully choose my investments on those. US-based platforms all must have been vetted by the Securities and Exchange Commission and the Financial Industry Regulatory Authority in order to list startups who are looking for equity funding.
These are 4 platforms that I like:
What: Wefunder is a crowdfunding platform which is built on a socially-conscious premise, as stated in their aim:
“We aim to revitalize capitalism and keep the American dream alive. GDP growth is slowing. Wealth inequality is increasing. Entrepreneurship is dying across America; falling from 10.6% to 3.6% among those under 30 since 1989. We aim to reverse these trends by funding more deserving businesses.”
Their simple vision involves giving regular businesses the same access to capital that tech companies tend to enjoy and they played a role in helping Congress pass the JOBS Act of 2012, the piece of legislation which opened up startup equity investing to more investors.
Wefunder is currently the largest of the crowdfunding equity platforms and tends to charge lower fees in comparison to its competitors.
How: First of all, Wefunder state that if either you can’t afford to lose every dollar you invest or you can’t afford to wait up to seven years for a return, you shouldn’t be investing with them. If you can meet those criteria, then you are able to invest up to the maximum allowed under the law per year.
You need to do your own due diligence on investments and Wefunder does not give recommendations for any of the investment opportunities on their platform. There will be a minimum investment shown on each opportunity which can be as low as $100.
Wefunder calculates your maximum allowable annual investment from information you supply and tracks how much you have invested throughout the year. Any investment you are eligible to make shows up with a green “invest” button.
What: Republic was founded and built by AngelList alumni with a mission to drive growth for innovative companies while offering everyone the opportunity to invest. You’ll find investments under multiple categories, many including socially-conscious options, like “social impact,” “minority founders” or “climate change.”
How: As with any other platform, never invest more than you’re prepared to lose. Republic advertises that they have investments available with as little as $10 to buy in. They are very clear about how you make money:
“You earn a return if the company you invested in is acquired or becomes a publicly traded company at a higher price than you paid. If the company fails to do either, you do not receive your money back or a return.”
It’s also worth noting that there currently is no secondary market (like the New York Stock Exchange) for trading your equity purchased on any of these platforms. Republic states that you cannot transfer your investment within the first year, with very few exceptions.
What: Seedinvest was another early-starter in equity crowdfunding, with the founders also being involved with the recent law change. They have a large network of investors and are known for their stringent eligibility requirements of companies who wish to be funded. Like other platforms, accessibility to investment opportunities is a key goal of theirs. They offer investments for both accredited and non-accredited investors.
How: Seedinvest asks you questions at signup to help them to customize the deal flow that you will see, based on your own preferences. Again, they strongly emphasize the need to do your own due diligence for any investment. Companies set investment minimums at the time they set up their profiles – you’ll find some as low as just a few dollars.
What: Microventures has been around since 2009, as a platform for VCs and angel investors. They have a strong background of experience and have opened the door for non-accredited investors by offering opportunities to invest in pre-vetted companies for much less capital commitment than would otherwise be required.
How: Their signup process is slightly more involved in that once you sign up, they contact you in-person to confirm your details. There is no obligation to invest once you have signed up and they have investment opportunities for as low as $100.
There are many other platforms springing up, but I have focused on these particular ones because I have found them to be trustworthy.
Startup crowdfunding is at the risky end of alternative investments and as such, it’s important that you do your due diligence before diving in.
Most of the good platforms out there do some kind of vetting before allowing companies seeking funding to be listed, but that does not take the place of the individual investor doing their own homework.
On the other hand, you have the opportunity to strike gold if you’re able to pick the right startups to invest in. Will you find the next big thing?
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