Knight Post: Equity Crowdfunding 101

What is Equity Crowdfunding?

Equity crowdfunding is a way for very early stage companies to get financial support from friends and family, who assist in supporting their idea and innovations.

In other words, it’s a substitute for ‘Angel’ investing. Crowdfunding has taken off in a big way, and offers an opportunity that was previously only reserved for high networth individuals. Now every person can invest a certain amount of money as low as fifty dollars in some cases, to as much as one can afford, in certain private companies that offer a lot of potential, and in some cases exponential growth.

A good example is Brewdogs, an independent kraft brewing company , based in the United Kingdom. whose initial investors have gained more than 2,700%  since 2010, from their crowdfunding campaign. They have raised money from successive rounds and have been very successful.

Equity crowdfunding is the most common type of crowdfunding where early stage companies offer stakes in their companies, in exchange for investments from ‘crowdfunding’ customers. This has been the case since 2012, where the JOBS act facilitated collections of up to $1.07 million per year over the internet from crowdfunding capital raises.

There are several risks and rewards to this new way of investing, that everyone must be aware. Some of these companies can offer exponential growth, but in many cases they can also go bankrupt. So let’s spend some time analyzing the risks and rewards, and formulate a strategy for investing.

Risks:

• Risk of Losing Capital – There is a risk to losing the amount of money you put in, as some of these businesses might not succeed.
• Illiquid Investments – The shares or stakes in these companies are not easily tradable as public equity investments; they’re illiquid.
• Lack of Complete Information– Public companies are required to report their 10Qs and 10ks to the SEC, and the public can access these and analyze the financial health of the companies. Private companies offer no such information. Investors are limited to the information provided during the campaigns and subsequent interviews with the founders, in a lot of cases .
• Potential for Fraud – This is a very new form of raising money and is not regulated, but not necessarily well done just yet. There is a chance of fraud, of which everyone should be aware.

Rewards:

• Offers Unique Diversification – Equity crowdfunding offers a unique form of diversification in one’s portfolio, in addition to stocks, bonds, real estate etc.
• High Returns – I briefly mentioned Brewdogs as an enormous success in their crowdfunding campaign. There is another company, called Zenefits, which raised $370,000 in their initial crowdfunding campaign on Wefunder, whose investors have gained more than 4,000% or 40x their initial investment.

Strategy:

Having had a bit of time to digest of what’s in store, it is important to consider that investing in equity crowdfunding is not a lottery ticket.

One can look at it as a unique way of investing in private markets, an opportunity that has not been available to the common investor. Do not invest more than 5-7% of your overall investments in these ventures. As mentioned prior, below can be an example of a portfolio breakdown. This is by no means a recommendation.

• 40% Equity
• 20% Fixed income
• 35% Real Estate
• 5% Private investments

The summary below is a strategy that might prove beneficial if used correctly.

Key Take Away #1: Invest only what you can afford to lose

Crowdfunding investments are speculative and people should invest only amounts of money they can afford to lose. They can also offer exponential reward. There is no need to overextend your finances in these investments.

Key Take Away #2: Do Your Due Diligence

We cannot stress enough how important this point is. Companies can state in their crowdfunding venture anything and everything that they desire. It is up to the investor to conduct research on these companies. One important thing I do is research the track record of the CEO, and  the team. Also have they been backed by a Venture Capital fund. These two are a must for me. Additional Recommendation: Check out our related article on: “Equity Crowdfunding 102: Doing Your Due Diligence”

Key Take Away #3: Invest in reputable Crowdfunding sites

Here at KingsCrowd, we prefer crowdfunding sites like Startengine, Wefunder, Seedinvest and Republic. These are well reputed platforms. If there is a cap raise in another platform of one of the companies that you like, by all means go for it. But do some research.

Key Take Away #3: Be Patient

Think of these investments like you would while investing in public companies like Apple (AAPL) or Facebook (FB) .  You use them daily. Now think of crowdfunding investments as a future. Would you use them now or in the future? Do they have potential? Think of a world that may have use for their products. If not, then it’s not a good investment. Also, some of these businesses take time – usually 3-5 years before you see the true returns. Be Patient! But Optimistic.

Key Take Away #4: Diversify

The emphasis here is to invest in a broad variety of companies from various industries for example: Robotics/Artificial intelligence/Alcohol – Beer/Space… The list goes on. So you get an idea. At a minimum you should have 15-20 companies in your portfolio. These are the ones that you thoroughly researched.

The Bottom Line: Crowdfunding is not for the faint of heart. One has to be bold and willing to take the challenge and have the foresight to invest in these investments. Think of these investments as you would a business venture – there is small likelihood of success, as most businesses fail. But if you succeed, the gains are enormous. If done correctly it can definitely add extra returns to your portfolio.

In subsequent articles, I will write about some of the companies that I like, doing my own due diligence in the process.  Stay tuned.

Notice:

This piece is part of the KingsCrowd Knight Collection. Put simply, this is a crowd contribution. While we ensure it meets our general contributor guidelines we do not endorse this piece. Instead, we recognize that pieces like this add value to our investor community. If you have questions, be sure to reach out to hello@kingscrowd.com.