Financial Planning for Regular Folks
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Investing in Startups Through Crowdfunding

 

 

INVESTING: Making Your Dollars Work For You – Investing in Startups

Until recently, it wasn’t possible for the average investor to invest in a startup company. The equity crowdfunding rules were recently changed (Nov. 2015) to allow small businesses to raise money through brokers or platforms available online. If you’ve ever wanted to invest in a startup, the time is finally here.

Approximately 500,000 new businesses are started each year in the United States alone. Acquiring funding for these companies is very challenging. Often it falls on friends and family to provide the necessary startup funds. Crowdfunding is a new opportunity to raise funds and grow a new or small business.

Historically, only accredited investors could invest in startups. To be an accredited investor, you must have an annual income of $200,000 or more and have at least $1 million in assets.

Now, however, you can be a venture capitalist, even if you only have a few hundred dollars to your name!

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Investment Limits

If you’re not an accredited investor, there’s a limit on how much you can invest:

  • If your net worth or income is less than $100,000: you’re limited to investing $2,000 or up to 5% of your annual income or net worth, whichever is less.
  • If your income is $100,000 or more: You can invest 10% of your net worth or annual income, whichever is less.

You can’t invest a lot unless you’re an accredited investor, but you can get in the game. The SEC set these rules to protect investors from the possibility of losing too much. Investing in startups is especially risky.

Crowdfunding Details

Crowdfunding is a new method for business owners to raise funds:

1. Startup and small business owners can raise up to $1 million per year through crowd funding.

This is enough money for many smaller companies to grow, but it’s not an excessive amount of money.

2. Businesses seeking to raise money via crowdfunding must disclose financial details of their operation.

The extensiveness of the disclosure depends on the amount of money raised. Some companies need only provide minimal details, while others are subject to full financial audits.

3. Businesses and investors can find each other through business brokers or online portals.

These portals are similar to other funding portals, such as Kickstarter and GoFundMe. The equity portals are already in place for accredited investors. However, there’s a big difference between equity crowdfunding and other funding portals:

  • With portals like Kickstarter, you’re limited to a free product, a discount, concert tickets, and the like. You’re never a part owner. It’s similar to charity, without the ability to take a charitable deduction on your income taxes.
  • With equity crowdfunding, you own equity in the company. You’re a part owner.

4. Many of these small businesses would never be able to get venture capital financing.

These investors reject 99% of the companies that are looking for funds. They’re only interested in the select few that have opportunity to become incredibly successful.

  • Most venture capitalists are looking for the next Facebook. They’re not interested in investing in a motorcycle repair shop.

5. There are currently limited opportunities for unaccredited investors to invest in startups at this time.

While it’s legal, there are few platforms that have taken advantage of the new laws. There are still several rules that need to be finalized by the government before the crowdfunding equity platforms are willing to accept non-accredited investors.

The fundamental laws are in place to permit regular investors to have the same basic access to investing opportunities previously only available to wealthy investors and venture capitalists.

It certainly sounds exciting, but can you afford to play the game? Most startups fail to ever turn a profit. No profit means your money is ultimately lost.

Risks and Rewards

Consider these risks and rewards of investing in startups:

1. The risks are significant.

The odds are overwhelmingly against you. Most startups end in failure.

2. Successful angel investors and venture capitalists invest in dozens of companies.

These investors know that most of their investments will fail. They’re looking for that one special company that can make them millions. These companies are impossible to identify accurately, so it’s necessary to invest in a lot of companies.

  • Since you probably can’t invest in 50 companies, the odds of suffering a financial loss are much greater.

3. There is a chance to make a lot of money.

It’s not inconceivable that a small investment of few hundred dollars could grow into millions. It has happened. But it doesn’t happen often.

4. Research is crucial.

These companies aren’t required to provide the same reports and documentation that companies on the stock exchanges are required to provide.

  • The company may not have a lot of information to provide. If the company is raising funds to get started, there won’t be any financial data.
  • Stick with industries you understand. If you don’t know anything about the petroleum industry, it doesn’t make a lot of sense to invest in a new oil well technology.
  • Find out everything you can about the people running the company. Find out the credentials and past of the company founders. What is their story? Do you believe they can be successful?
  • How long will it take the company to turn a profit. For example, if the company is looking for money to perform research and development to create their first product, it could be years before they even have something to sell.
  • How will the company make money? Are they selling a product or service? Will they be able to sustain themselves far into the future?

The risks and rewards are magnified when investing in startups. It’s also much more challenging to do the proper due-diligence. Avoid investing money you can’t afford to lose. Odds are that you will lose it.

Investing in Startups – in Summary

Ensure that your skill set and financial situation are appropriate for this type of investing.

It’s an exciting time for aggressive everyday investors and startup companies. Startups and smaller investors will finally be able to work together. The rules are still being finalized, but it’s a formality at this point. The groundwork has been laid for the average investor to invest directly in small businesses that aren’t on the stock exchange.

If this new investing opportunity sounds good to you, before you jump in, ask yourself if such investments mesh with your investing goals, risk tolerance, and expertise.

 
 

 
 
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