Crowdfund Investing For Dummies
Book image
Explore Book Buy On Amazon

If you decide that you want to put a small portion of your investment portfolio into one or several small businesses and startups, a number of crowdfund investing platforms (websites) are available to help you make the best decisions possible. You want to take a lesson from angel investors and venture capitalists and invest small amounts in a number of companies.

If you were to invest in ten companies, for example, you could assume that, over time, some of them would lose money, some would break even, and a few would make money. If you’re lucky, maybe one would have the chance to generate a very positive outcome.

To pave the way for a possible positive outcome, you have to do your homework. Nothing replaces a thorough review of all information available on the investment in question. One of the biggest benefits of crowdfund investing is that lots of individuals are doing the same research at the same time, and you can use online forums to discuss tactics and information.

That said, collaborative efforts should never take the place of your own primary research so that you fully understand what you’re investing in and what the risks are.

How your money will be used

A company wants to grow, so it runs a campaign to raise the necessary capital via crowdfund investing. What exactly will it do with the money being raised? The question is obvious, but you have to make sure you get a concrete answer.

Look at the campaign proposal and how much the company wants to raise. Carefully review its plans for using the funding. Ask yourself these questions:

  • Do you think the amount of money being raised is enough to enact the company’s plans? Do you think the company is asking for too much? For example, say the business plan is to start a cable television channel and the company is attempting to raise $200,000.

    If the plan states that the company can be operational with that money alone, that’s a red flag. The legal bill alone for working with cable companies and the Federal Communications Commission (FCC) would likely cost more than $200,000.

    On the flip side, if a business plan suggests that it will cost $200,000 to start a small landscaping business, you should find out a great deal more information before deciding to invest because that number seems high. (Maybe it isn’t, but you need to study the plan to find out.)

  • Do the company’s assumptions and timelines feel credible? Does the plan suggest that the company can open a restaurant in three weeks? On the other hand, does it suggest that three years of research are required before the company can decide on a restaurant location? Both timelines seem unreasonable and should raise red flags.

    Working quickly is very important, but opening a restaurant in three weeks would require cutting so many corners that it would likely result in problems downstream. Conversely, three years of location research sounds like analysis paralysis.

  • Has this company used investor money wisely in the past? If this isn’t the first time this company has raised money from debt or equity, ask questions about its financial history. If the business has used debt in the past, did it repay the debt on time? If the company offered equity in the past, does it still have good relationships with those earlier investors, and did the company use the money to grow?

If you can’t glean these answers from the information the company itself has provided, use the online crowdfund investing forums to ask very specific questions. If you don’t get satisfactory answers from the company in a timely manner, don’t invest.

Review available financial information

When you make investments in the public stock markets, you can review quarterly and annual reports to see a company’s revenues, expenses, profits, and losses, as well as the typical ratios that investors review prior to making investment decisions. The SEC mandates that public companies provide all this information.

After all, by the time a company becomes public, it has well-organized financial functions and long track records of experience to create this data in a timely manner.

Companies seeking crowdfund investments will likely be newly formed or very young companies, many of which are creating externally visible financial reports for the first time. This fact doesn’t mean that you should expect any less accuracy or completeness from them.

To promote transparency of financial information, the SEC requires companies using crowdfund investments to supply certain information to potential investors (such as prior years’ tax returns or reviewed or audited financial statements depending on the amount of money being sought, if the company is already operating).

You should take full advantage of any financial information supplied by the company during your decision-making process, and if you don’t see the kind of detail that allows you to make a decision you feel confident in, walk away.

Read online opinions and questions about a proposal

All pitches on crowdfund investing websites (called funding portals) offer potential investors the ability to post questions and read comments and answers from other potential and current investors and company representatives. Keep a few things in mind when you enter these conversations:

  • Perform due diligence before asking. When asking questions of the company, remember that these are small companies that are very time constrained. Review what has already been asked and answered. That way, if your question has already been answered, you save time for yourself, as well as for the business owner or representative.

  • Be a constructive part of the dialogue. Posting random or unrelated comments or making inflammatory statements is not appropriate. Be respectful of everyone in the conversation.

  • Leverage other investors’ experience. Let others in the online community help you build your investment skills. Try to find a few trusted individuals you can chat with online about the merits and weaknesses of investments you’re considering.

Talk with people you trust before committing your money

With all the research and collaboration you do online as you make the best decisions possible about crowdfund investing, don’t forget to talk to people in the three-dimensional world as well. Ask for feedback from people you know whose judgment and knowledge you respect when it comes to investing.

Consider forming an informal discussion group to talk about crowdfund investing opportunities. You and a few trusted friends could meet once or twice a month over coffee to talk about a handful of companies that each of you has found online; you can present and discuss the pros and cons of each.

You may be amazed at how hearing different perspectives opens up new lines of thinking or uncovers potential challenges or opportunities for your crowdfund investments. This kind of sounding board is one way to add a layer of protection against fraud. Few investments come with guarantees, but having multiple brains targeted on the same situation usually yields better results for everyone involved.

About This Article

This article is from the book:

About the book authors:

Sherwood Neiss, Jason W. Best, and Zak Cassady-Dorion are the founders of Startup Exemption (developers of the crowdfund investing framework used in the 2012 JOBS Act). They deeply understand the process, rules, disclosures, and risks of capital formation from both the entrepreneur's and the investor's points of view.

This article can be found in the category: