posted Dec 17, 2013, 1:19 PM by Unknown user
updated Dec 17, 2013, 1:20 PM
The grim truth about start-up businesses is that the majority of them fail within the first few years. But like any type of investment, there will always be risks, so this should not scare people away from equity crowdfunding. In fact, as the industry grows and the SEC irons out the final regulations, equity crowdfunding may grow into a form of low-risk investing.
For start-ups and entrepreneurs, equity crowdfunding is an exciting new development. For small-time investors this feeling’s mutual. The crowd’s unique perspective may cast light on minor start-ups that traditional funders otherwise would have missed. So, in this sense, equity crowdfunding is a potential gamer changer.
The Dangers of Equity Crowdfunding
Some portals outline the risks involved directly on their home page. TruCrowd, for example, has posted a disclaimer identifying the areas of risk for equity investors:
Liquidity — Equity crowdfunding is considered illiquid. Without access to the public market, investors may find it difficult to sell of their shares, which, in turn, makes this a form of long term investing.
Dividends — Start-ups are not obligated to pay their shareholders a portion of their profits. In fact, most start-ups will reuse their profits to grow the company instead.
Dilution — Investors run the risk that the start-up will issue too many shares, ultimately reducing the value of each shareholder in the company.
Understanding each portal’s requirements is a huge part of an investor’s research process. In traditional crowdfunding scenarios, projects sometimes fail to deliver on their promises. When dealing with investments, this type of fraudulent activity is a serious concern. Check into the specs of each portal to see what security protocols have been put in place.
Equity-Crowdfunding vs. High Risk Investing
Returns are never guaranteed for any form of investing — so in this aspect, crowdfunding’s no different. The stock market, like a start-up, is incredibly volatile, meaning values rise and fall almost indefinitely. Navigating one’s way around these fluctuations marks the sign of a professional versus an amateur investor.
A high-risk investment is “one where there is either a large percentage chance of loss of capital or underperformance, or a relatively small chance of a devastating loss” (Investopedia). In these situations, many of the same risks as crowdfunding exist, plus a few others. For instance, sectors of the economy change over time. Markets may turn against an investment or even collapse. Furthermore, interest rates greatly affect value in the stock market. While there are many parallels between inflation and dilution as well as failure and economic downturn, due to the regulations in place, equity crowdfunding investors stand to lose less on average. There are even a few things investors can do to minimize the risks.
With or without regulations, stay smart when investing in start-ups. Know what you can afford to lose and do your research — not just in the start-ups, but in the portals as well. Although some investors may not have the funds to do so, diversification is one way to lessen the risk of investment. Essentially, this means spreading your money across a variety of different investments. Carefully pick these investments, however, because you never want to join a project that will leave their investors in the dark. Using portals that perform their own due diligence could help reduce the risks as well. Websites known for this include WeFunder and MicroVentures, the latter of which is a registered broker-dealer.
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