Weighing the Risks & Rewards
Equity crowdfunding is the latest rung in the ladder of crowdfunding innovation, and it’s continuing to revolutionise funding as we speak. Since its recent rise to popularity, equity crowdfunding has caused all sorts of disruptions, particularly in the dominance of venture capitalists over startup investments.
As noted by a recent Forbes article, “Traditionally, startups raised capital through VCs, but the number of startups that receive investments from VCs is incredibly low… Crowdfunding gives startups a way to bypass VCs and get funding another way.”
Why are startups looking to bypass venture capitalists as a funding source? Well, venture capitalists can be quite unforgiving, to say the least. The majority of VCs are risk-averse, and the venture capital industry works as a kind of peer-review for startups. It’s important that a company ticks all the right boxes and meets the high expectations of investors to get the funding that they need, which explains the significantly low number of startups that receive funding from VCs. Add this to the current dearth in the supply of venture capitalists in Europe, and you have the current abysmal rate of funding in the EU.
Equity crowdfunding has provided startups better access to funding by widening the threshold and giving them the means to tap into the power of the crowd. Success stories like Schaeffer Nutraceuticals are proof that equity crowdfunding works and stands to help many startups as they seek to create new jobs and contribute to the economy.
It begs the question: should you invest in equity crowdfunding?
As beautiful and as promising as it sounds, equity crowdfunding campaigns are not magic piggy banks that will automatically double your money. On the contrary, many people new to equity crowdfunding tend to lose money, especially those who fail to diversify their portfolios properly. That’s because failure rates for equity crowdfunding campaigns are significantly higher than with traditional IPOs, and if you put all your eggs in one basket, you lose all of them if the fox named Failure takes them away.
Caution is advised: if you are looking into investing in an equity crowdfunding campaign, you should be aware of the risks and advantages involved, the most relevant of which are listed below:
Equity Crowdfunding: Risks
You don’t get your money back right away. Unlike in the stock market, you don’t get to trade your shares the next day after you purchase them. You have to be ready for illiquidity when investing.
A good portion of companies/projects campaigned will fail. Since the majority of companies that rely on equity crowdfunding, loss of money is almost guaranteed for every portfolio. Always diversify as a rule of thumb!
Fraudsters abound. The social nature of equity crowdfunding makes it rife for opportunistic con artists who are out to prey on gullible or fledgeling investors. Since there is no peer-review as in the primary and secondary markets, many who fail to exercise due diligence fall victim to these fraudsters.
It will take some time before you rake in significant profits. Equity crowdfunding isn’t a get-rich-quick scheme. Smaller investment minimums mean more modest returns, even if return rates are higher. The majority of your profits, in the long run, will come from investments you lucked out on, i.e. successfully funded projects that have gained their footing in their respective markets.
Equity Crowdfunding: Rewards
You get more for what you give. Make no mistake: substantial outright returns might be uncommon enough, but they do happen. In the case of the Oculus Rift, for example, Investopedia claims that “Had Oculus Rift raised its initial capital through equity crowdfunding rather than donation-based crowdfunding, the Facebook buyout would have generated an estimated return of between 145 times and 200 times the original investment, which means that a meagre $250 investment would have resulted in proceeds of $36,000 to $50,000.”
No accreditation, lower minimums. Before equity crowdfunding, you had to be vetted by some regulatory authority to invest. Now, you can invest as little as 100€ on a project you believe in and see gains up to 20% on your investment upon maturity, depending on the project/company.
You help create more jobs. Since its formulation, equity crowdfunding has always been startup-friendly, which means it encourages growth among SMEs that choose this method of financing. In the EU, startups are a primary resource for job creation, so supporting equity crowdfunding initiatives inadvertently boost the economy.
You can help support great causes. There are social benefits to equity crowdfunding as well. Increasingly, equity crowdfunding platforms are becoming venues where humanitarian organisations and NGOs can raise funding for their causes.
Is equity crowdfunding right for you? Only you can ultimately answer that after weighing the risk/reward ratio as it relates to your situation and investment capital.