Equity Crowdfunding: Is It For You?

By Rick Pendykoski, Crowdfund Beat Guest Post,

Equity crowdfunding is a huge trend in the startup market, helping a number of companies launch their goods and services without heavy investment of their own. While it’s widely considered one of the coolest ways to see ideas come to fruition, equity crowdfunding may not be the best option for every investor.

What is Equity Crowdfunding?

Crowdfunding is the practice of raising funds for a venture or project through the collective efforts of a large number of individual investors, largely through online crowdfunding platforms. Equity crowdfunding, also known as invest crowdfunding or crowdinvesting, is an online process where investors can buy shares in a new, unlisted private company.

Image credit: Jim Frazier

Image credit: Jim Frazier

Why is Equity Crowdfunding So Popular?

Equity crowdfunding has become a popular trend in the startup industry. Particularly in developing countries, small business owners and budding entrepreneurs can use this method to raise the necessary capital and launch new ventures. By selling shares through an online platform, it is possible to acquire funds from a large pool of non-accredited investors.

With this method of investment, there are also significant benefits for small-scale investors, who have the opportunity to invest in endeavors that seem to offer the most promise.

Should You Invest in Equity Crowdfunding?

Despite its many benefits, equity crowdfunding is not without its share of drawbacks. There are risks associated with such a venture, not least of which is the high chance of failure. As an investor, be prepared for a negative outcome from the get-go. Also, think about how a failed business venture may affect your retirement savings and income.

Weigh the pros and cons very carefully if you decide to invest in an equity crowdfunding venture. Even smart and experienced entrepreneurs can end up losing money in startups, but they have ample means at their disposal and can usually afford a loss. Can you say the same for yourself?

The JOBS Act and Its Governing Rules

The 2012 Jumpstart Our Business Startups (JOBS) Act is designed to assist startups in raising funds from small investors. By easing certain securities regulations, the JOBS Act has opened up new pathways for startups to raise investment capital. This way, private individuals can capitalize on investment opportunities once reserved for those with ample means alone.

Starting May 2015, anyone is able to invest in startups registered for equity investment with the Securities and Exchange Commission (SEC). The agency has certain rules and regulations that potential investors are required to comply with, and these include:

  • The upper limit that startups operating under the banner of SEC can raise is $1 million over a 12-month period.
  • Individuals whose net worth and annual income is $100,000 or more can make a maximum investment of 10% of net worth or annual income over a 12-month period.
  • Investors who earn $100,000 or less annually can contribute a maximum amount of $2,000 or 5% of their net worth or annual income over a 12-month period.
  • The maximum limit an individual can contribute in one or more ventures through crowdfunding, whatever their annual income or net worth, is $100,000.

Key Considerations for Potential Investors

Equity crowdfunding is open to private individuals, but does that mean you should invest in such an endeavor?

Keep these important considerations in mind before you make your decision:

  • Startups have a very high rate of failure. A large majority of startup projects simply fail to take off, in which case your investment can backfire. Before you go ahead, keep in mind there is a very big chance you may end up losing every dollar of your initial investment.
  • Startups that operate through crowdfunding channels can bypass standard investment banking procedures. Such processes include auditing, which is intended to uncover major risks or complications associated with the venture. As a result, many startups are able to hide potential problems, and investors may not realize what they are getting into until it is too late.
  • Enterprises involved in crowdfunding are also able to sidestep standard investment valuations. Rather, the value of the investment is based on fair estimation. In the absence of an authentic investment price, the values are often left to be determined by random investors or company sponsors. Such a valuation based on guesswork and speculation may not reflect the actual worth of the venture.

When you invest in crowdfunding, ask yourself these key questions:

  • Are you financially and emotionally prepared to lose your initial investment?
  • If the venture fails, how long will it take you to recoup your losses?

Don’t invest in crowdfunding unless you have a proper plan of action. If you step in blind, you may end up losing all your money and incur unrecoverable losses. This may have an adverse impact on your nest egg, even with employer-sponsored retirement savings as a backup.

About the author: Rick Pendykoski is the owner of Self Directed Retirement Plans LLC, a retirement planning firm based in Goodyear, AZ. He regularly writes for blogs at MoneyForLunch, Biggerpocket, SocialMediaToday, NuWireInvestor & his own blog for Self Directed Retirement Plans. If you need help and guidance with traditional or alternative investments, email him at rick@sdretirementplans.com or visit www.sdretirementplans.com.

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