With all the hype around the startup scene, and all the money being made, it’s no wonder people are looking at how they can get involved.
One of the newer and more innovative ways of investing is equity crowdfunding.
But is this the fast track to investing success?
What Is Equity Crowdfunding?
Equity crowdfunding is where a company can raise capital in exchange for partial ownership or ‘equity’. Like crowdfunding, the idea is that an offer is put to the general public where anyone can participate.
Equity crowdfunding helps the company because they get access to potential investors outside the traditional avenues of venture capital (VC) funds, angel investors, or sophisticated investors.
Why Is Equity Crowdfunding So Popular?
More companies are turning to equity crowdfunding as a result to the law changes that happened in October 2018. These get a little technical, but the short version is that previously for a company to engage in equity crowdfunding they needed to become what’s called an ‘unlisted public company’.
Being an unlisted public company requires a huge amount of additional reporting and auditing, which for most small companies involves significant costs and more work than most are prepared to do.
But after these changes, the laws were relaxed, and as a result companies could use equity crowdfunding without having to change their legal structure. This meant they would avoid the massive amount of extra reporting and admin that was previously required.
There is some extra work involved for companies that use equity crowdfunding, but the amount of activity in this space since the changes suggests these are more manageable.
From the investor side, the increase in popularity seems to be driven by the rise of the startup scene.
I know from my financial advice work that many people today have the dream of becoming their own boss. This means there are more startup companies around than ever before.
Also, we’re hearing more and more success stories about companies that have made it big, and made a bunch of money in the process.
The startup scene is a big one, and if you’re like most people you like the idea of being involved in a movement, and the idea of making a bunch of money on an investment and getting in at the ground level is an appealing one.
What Are The Risks?
The main risk with equity crowdfunding is losing all your cash. And the risk is not insignificant.
For even a professional investor, reading and understanding equity crowdfunding offer documents is a challenge. Choosing the right company to invest in, one that will be actually successful, is even more difficult.
Just because something is a good idea, it doesn’t mean it will be a good business, let alone a good investment. For a company to be successful, they need a great team, a great strategy, and a little bit of luck.
While it can be easy (relatively speaking) to come up with a good story to run a crowdfunding campaign, turning that story into a profitable company is much more of a challenge.
Another risk with equity crowdfunding is a lack of ‘liquidity’, meaning you can’t easily or quickly sell your investment. Because an equity crowdfunding investment is in a privately held company that isn’t listed on the stock exchange, often you can’t exit your investment for a significant time period.
Because your shares are ‘unlisted’, the only way you can sell your shares is either back to the company, or by finding someone else to purchase the shares off of you, or by waiting for the company to go public through an initial public offering (IPO).
This means that if you invest, but then something changes in your situation and you want your money back, you may need to wait some time.
Equity crowdfunding is an interesting area, and is giving investors access to new companies playing in exciting markets.
But interesting and exciting are not always the best ways to invest.
Boring is profitable.
And you don’t need to shoot the lights out with every investment to achieve money success. You need to be smart, consistent, and to avoid downsides and setbacks.
Successful investing is about building a good foundation that will drive reliable, consistent progress over time. Once you have that in place, having some more interesting and/or higher risk investments can be ok as part of your broader investment strategy.
But I’ve unfortunately seen many people try to skip steps to make money faster, making high risk and speculative investing their only strategy, and end up losing their hard-earned cash as a result.
If this happens you’ll need to go back and start building your foundation again, which can mean years of wasted time and much slower progress to real financial success.
Equity crowdfunding is no doubt a space to watch, and one that’s getting a lot of people excited.
If you want to get involved, take the time to build your knowledge and deeply understand the risks before you jump in. I promise you’ll thank me later.
For more tips on making the most of your hard-earned, head to our Money section.
Image credit: Birchal
Disclaimer: The information contained in this article is general in nature and does not take into account your personal objectives, financial situation or needs. Therefore, you should consider whether the information is appropriate to your circumstances before acting on it, and where appropriate, seek professional advice from a finance professional such as an adviser.