Crowdfunding is an effective way to raise money for ventures. But what about the opportunity for all of us to become supporters of emerging companies and financially benefit from their growth?
Until recently, individuals who were not wealthy did not meet the definition of an accredited investor, and were denied the chance to invest in private offerings. That hot tech company looking for funding? Sorry, you could not invest. Your neighborhood gourmet donut shop in need of growth capital? Nope, you were not allowed to buy their shares. However, the landscape has changed as sections of The JOBS ACT — legislation intended to free up small business capital — rolled out to the public over the past year.
There are three ways this new legislation now allows everyday people to invest — Intrastate Crowdfunding, Regulation Crowdfunding and Regulation A+ offerings.
Intrastate Crowdfunding is available in 33 states and allows residents of these states to invest in companies headquartered in their state.
Regulation Crowdfunding goes beyond the state level and allows investment into any company nationwide that is raising capital via an online, registered funding portal.
Regulation A+ offerings bring opportunities to investors in multiple states and is a funding approach usually employed by companies that are further along in their growth cycle.
However, all of these funding avenues limit the amount individuals are allowed to invest, in most cases this will probably fall between $2,000 to $5,000 a year per person.
But now that you can invest in and support your fellow entrepreneurs, should you? Yes and no. Given that 90 percent of start-ups fail it’s important to proceed with caution. It may be best to invest in an entrepreneur you know or business you frequent so there is a degree of familiarity and accountability. If you are unfamiliar with the venture, at least research the track record of the founder and team. Do they have the background and management skills to bring the product or service to market? Since the number one reason a start-up fails is because it makes a product no one needs, has there been market validation from customers for what the company is offering? Have you reviewed the financial projections and do they look realistic? What is the competitive landscape for their venture?
Given the hazards, how does one mitigate the risk and be positioned for a better return? Diversification. Having an abundance of capital on hand has afforded deep-pocketed Venture Capital investors the luxury of moderating risk by spreading their capital across a variety of private companies. Because of technological and legislative restraints, smaller retail investors have not had the same opportunity.
New technology has emerged to make micro-investing affordable. Finally, smaller investors will be able to benefit from diversification strategies that are employed by institutions. Whether it is buying a $25.00 note on a peer lending portal, making a $100 investment via a Regulation Crowdfunding platform, or investing your spare change in your peer’s business every time you shop, individual investors can finally spread their risk over multiple investments just like Venture Capitalists. As an industry insider said recently, “If you make 100 small bets, that’s a portfolio. If you make one big investment, that’s Vegas!”
Over the past 30 years, early-stage venture capital has returned 21.29 percent, significantly out performing stocks and bonds. So investing in start-ups can be a great way to grow a portfolio while supporting dedicated entrepreneurs in the process. Just be sure to conduct your due diligence on the investment opportunity — don’t jump in based on hype or headlines — and take the most cautious approach to investing in these innovators.