I am confident many people have watched the show Shark Tank where a couple of individuals go into a room and pitch their business idea to several angel investors. I find it so fascinating that through a fifteen to thirty-minute pitch, business owners can bring an entirely new set of lifeblood and capital into the business. As an investor and a business owner, there are countless benefits of going this route, but often it can be extremely challenging to connect the Angel Investors with the Business owners and vice versa. So, who fills this gap? How can I get optimal returns on business, increase my risk and reward instead of waiting for an initial public offering half a decade away? Why do I need to be an accredited investor to take advantage of opportunities (Makeover $200,000 per year, or have a net worth of $1,000,000) when I believe in the mission, vision and have assessed the financials as I would with any other investment? I want to capture the upside financially, but also support ambitious and thoughtful entrepreneurs!
I remember a few years back there was this craze of the crowdfunding platform GoFundMe. We all are familiar with the concept where essentially anybody can create a campaign and raise funds for a given cause. Traditionally, it would be very hard to reach fundraising goals, and if the goals were hit, thousands of dollars of administrative and advertising spend would have had to be blown through. With crowdfunding, millions of people can be reached to help support a given cause. Crowdfunding has now hit the investing space and the opportunities and excitement behind it are endless.
Let us first discuss some of the primary risks of equity crowdfunding, afterwards we will discuss some of the major benefits of equity crowdfunding. When we buy shares of any major company such as Twitter, Verizon, Facebook, or Apple we can see a return or loss quickly. The brokerage companies (Fidelity, Schwab, Robinhood) will give you the updated price in near real-time. This is great because one can take a capital gain or sell a loss relatively quickly if they met their investment objective or wanted to protect themselves from the downside. This is not the case in equity crowdfunding. It can take several years to see a return (if any) with these types of investments, and one’s shares may not even increase in value. Additionally, if you did find a buyer, it would be harder to sell these respective securities due to the price being stagnant. This tends to steer many investors away, as we often live in a culture of instant gratification and reward. The shares are illiquid and there is not a well-known secondary market, which means you cannot sell until it makes it on a public exchange (if it ever does).
For large established blue-chip companies (AT&T or BP), we tend to receive payment (dividends) for holding the company. This is seldom when investing in startups, primarily because of the profit they do make, they are focused purely on reinvesting in the growth of the business. The reason the blue-chip companies can pay fantastic dividends is that they are established players that are not as focused on growth anymore, rather they are focused on value. The opposite is true for startup investing, everything must be piled back into the business so the company can see optimal growth, and not just please the shareholders. Also, to reduce risk in these investments, invest in several startups as not all may make it to market. Lastly, as we see with larger companies alike, share dilution is a large risk of investing in startups. These companies are trying to raise as much capital as possible to hit business goals and invest in projects. When the company initiates more shares, your percentage holding is reduced. When investing, try your best to make sure clauses protect you against this in their financial filings.
Now that I went over the potential risks, there are so many fantastic benefits of equity crowdfunding. First and foremost, you are supporting entrepreneurs that have spent countless hours, made tremendous sacrifices to make their products, services, and dreams to market.
This is so rewarding because you saw an opportunity when a large bank or financial institution did not. You gave the opportunity a chance when nobody else would. It is rewarding from both a support and seeing them grow standpoint, but also if they do make it to public market you will likely see well above 20% returns. This is the risk-reward that you have earned for tying up your money and taking a chance on somebody. Over Sunday afternoon football, or at a bar you always hear one of your friends saying, “oh I should have invested in Apple or Tesla at pre-IPO I would be so wealthy”. Well, now you can invest in companies pre-IPO so missed opportunities are a thing of the past.
There are many perks that the companies will provide you when it comes to equity crowdfunding, but certain governments will even provide one with tax incentives to offset the risk of early-stage investing. It is something that governments can and should incentivize as it encourages job growth, competitive products, and filling product/service gaps in our market.
Overall, I strongly urge everyone to put at least a few hundred dollars into a startup that they believe in. The risks outweigh the rewards when you look at it from an entrepreneurial standpoint. While there may be some owners that don’t grow the business in the best manner, there are countless entrepreneurs out there that want to bring their vision to the world and they cannot do it without you or me. I urge everyone to learn about the benefits and risks of equity crowdfunding and support entrepreneurship.
Nothing stated in this article is a recommendation from Forehand Financial to buy or sell a particular security or asset class. You should wisely consider your tolerance for risk, time horizon, and financial goals before making an investment. With investing, you run the risk of losing money, always read an investment prospectus and make an informed decision before allocating capital to a particular investment.