Do your homework. The SEC recommends that, like any investment, early-stage companies should be researched thoroughly before you invest in them. Keep in mind that audited financial statements are not required for companies seeking to raise less than a half million dollars, be especially cautious and complete your own due diligence before participating in small campaigns.
Investing in start-up companies is always risky, but a majority of entrepreneurs who have raised funds using equity crowdfunding have successfully achieved their financial goals, according to Sherwood Neiss, a partner at Crowdfund Capital Advisors. Presumably, so have their investors.
“Unlike venture capital, where less than 6.5% of startups successfully raise funds, the success rate in Regulation Crowdfunding hovers around an impressive 60%,” Neiss wrote in VentureBeat. “A key data point for industry followers is that the average raise ($270,996) helps startups hurdle the ‘valley of death’ they often face after expending their internal or personal capital.”
Regardless, the SEC notes that “investments in startups and early-stage ventures are speculative and these enterprises often fail. … You should be able to afford and be prepared to lose your entire investment.”
Think long term. You can buy and sell stock in a public company anytime. Private stock is illiquid. There are exchanges for trading it, like Forge Global and EquityZen, but otherwise if you want to cash out you will have to wait until the company is acquired or has an initial public offering (IPO).
Understand the value of your shares. Public markets set prices for stocks through supply and demand. If a company performs well, its stock becomes more valuable and its price increases. For a private company, the value of its shares is not as well defined.
An understanding of the company’s financials can help you determine the value of shares you receive through crowdfunding, but most start-ups that participate in crowdfunding don’t have a long enough financial history to provide in-depth information.
“In any equity crowdfunding round, the entity’s valuation is a function of the dollar amount raised against the amount of equity offered, independent of company fundamentals,” according to Moneycrashers. “A funding round that raises $1 million in exchange for 20% of a company’s total share count values that company at $5 million.”
Note, too, that there may be additional classes of equity with rights that are superior to the shares made available to investors through crowdfunding.
Knowing the history and experience of the company’s leadership may help you determine whether an investment is worth the risk. If the leadership has had past success, it is more likely to succeed again.