BY Lauren LeibowitzPrincipal at 1st BridgeHouse Securities, LLC, CrowdfundBeat Sr. Guest editor,

This blog is a part of a 3 blog series. Click here to read Part 1: The apples and oranges of Crowdfunding – Reward/ Donation Crowdfunding is not investing.

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The Risk Vs Reward tradeoff in the PIPR Market

Startups can fail for many different reasons and most do!  Within the Final Regulation Crowdfunding Rules, the SEC comments about theSurvival Rates for Startups and Small Businesses

Startups and small businesses that lack tangible assets or business experience needed to obtain conventional financing might turn to securities-based crowdfunding in reliance on Section 4(a)(6) as an attractive potential source of financing. There is broad evidence that many of these potential issuers are likely to fail after receiving funding. For example, a 2010 study reports that of a random sample of 4,022 new high-technology businesses started in 2004, only 68% survived by the end of 2008.

Similarly, other studies suggest that startups and small businesses financed by venture capitalists also tend to have high failure rates. One study finds that for 16,315 VC-backed companies that received their first institutional funding round between 1980 and 1999, approximately one-third failed after the first funding round. Additionally, another study of more than 2,000 companies that received at least $1 million in venture funding, from 2004 through 2010, finds that almost three-quarters of these companies failed.1304 Another study, based on a sample ending in 2005, found cumulative failure rates of 34.1% for VC-financed firms and 66.3% for non-VC-financed firms, with the difference driven by lower failure rates of VC financed firms in the initial years after receiving VC financing.

Taken all together, the failure rates documented in these studies are high for startups and small businesses, even with the involvement of sophisticated investors like VCs. Because we expect that issuers that will engage in offerings made in reliance on Section 4(a)(6) will be in an earlier stage of business development than the businesses included in the above studies, we believe that issuers that engage in securities-based crowdfunding may have higher failure rates than those in the studies cited above.”

Now as you are fully aware of the startup failure risk, it is important for prospective investors to learn and research as much about the company, its management, the market, and its future plan prior to making an investment.  From the beginning of investing in small businesses and startups, the odds are against you. Since there is a lot of risk then the trade off, the reward could be very lucrative but do not discredit the historical rate of startup failures.

Final Thought

Caveat Emptor- [Latin, Let the buyer beware.] A warning that notifies a buyer that the goods he or she is buying are “as is,” or subject to all defects.

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