Crowdfunding has been used by many to solicit money from people online. Now, entrepreneurs can also utilize crowdfunding to keep a lookout for investors who can help finance their respective startups. In return for their investments, investors can be shareholders of the company.
Although investors might be extremely optimistic and hopeful that the startup they invest in will become the next Facebook or Google, some advocates are skeptical, and recommend that investors practice caution.
“It s highly speculative, and you should only invest money you expect to lose,” says Barbara Roper, director of investor protection for the Consumer Federation of America. She adds, “Most early-stage start-up companies fail.”
Jumpstart Our Business Startups (JOBS) Act of 2012, which became effective on May 16, has made it possible for startups to raise capital via crowdfunding. Congress realized that by removing the startups’ securities restrictions, it could encourage more jobs and spur new businesses. Startups can now seek out investors from all over the country.
Equity crowdfunding restrictions were also created for the investors’ protection. Every year, startups are not allowed to raise an amount that exceeds $1 million through crowdfunding, while the amount that investors are permitted to invest is dependent on their net worth and income. Also, entrepreneurs should offer their private securities via the U.S. Securities and Exchange Commission (SEC) registered funding portals and online platforms. They are not allowed to sell them directly to investors. The SEC took diligent steps when designing these rules, primarily to safeguard investors from falling victims to fraud. Nonetheless, SEC believes that there is a chance there could still be fraudulent activities.
According to Roper, aside from fraud, investors can still lose their money. Startups may fail due to possible reasons, such as they’re driven out from the market by a bigger player, if it’s done better by someone else or if their idea isn’t good enough.
“You could overpay for your shares based on an unrealistic valuation for the company,” Roper says. She adds that even though investors are fortunate enough to fund a successful startup, it’s not guaranteed that they will be part of the success since the the value of their securities may thin out as the startup sells more shares in order to acquire more capital.
“Even venture capitalists who do this for a living … expect to lose money on seven out of 10 of their investments, break even on two and hope to make money on one,” Roper says. “This is not an appropriate form of investment for individuals, most of whom haven’t begun to set aside enough money for retirement. ” she added.