Course 3:Considerations Before You Invest in Crowdfunding
1. Can you handle the risk and the potential loss of your investment?
Both are real possibilities when it comes to companies that issue securities using crowdfunding. The venture may not succeed. Startups and early-stage ventures can and do fail. You should be able to afford, and be prepared to lose, your entire investment. If you are risk-averse, are just starting to invest, have only a smaller capital to invest, or may need the money in the short term, crowdfunding investments are likely not for you.
2. Early-stage and startup investments involves a high degree of risk
You should be aware that early-stage investments may involve very high risks and you should research thoroughly any offering before making an investment decision. You should read and fully understand the information about the company and the risks that are disclosed to you before making any investment.
3. Early-stage and startup investments are speculative in nature
Investments in startups and early-stage ventures are speculative and these enterprises often fail. Unlike an investment in a mature business where there is a track record of revenue and income, the success of a startup or early-stage venture often relies on the development of a new product or service that may or may not find a market. You should be able to afford and be prepared to lose your entire investment.
4. Early-stage and startup investments are difficult to valuate
Your crowdfunding investment may purchase an equity stake in a startup. Unlike listed companies that are valued publicly through market-driven stock prices, the valuation of private companies, especially startups, is difficult and you may risk overpaying for the equity stake you receive. In addition, there may be additional classes of equity with rights that are superior to the class of equity being sold through crowdfunding and your investments are subject to dilution.
5. Early-stage and startup investments are lack of illiquidity
You will be limited in your ability to resell your investment for the first year and may need to hold your investment for an indefinite period of time. Unlike investing in companies listed on a stock exchange where you can quickly and easily trade securities on a market, you may have to locate an interested buyer when you do seek to resell your crowdfunded investment.
6. Limited disclosure
An early-stage company may be able to provide only limited information about its business plan and operations because it does not have fully developed operations or a long history to provide more disclosure. The company is also only obligated to file information annually regarding its business, including financial statements. Unlike a publicly listed company, an early-stage company is not required to file annual and quarterly reports and promptly disclose certain events, the continuing disclosure that you can use to evaluate the status of your investment. Therefore, you may have only limited continuing disclosure about your crowdfunding investment.
7. Possibility of fraud
In light of the relative ease with which early-stage companies can raise funds through crowdfunding, it may be the case that certain opportunities turn out to be money-losing fraudulent schemes. As with other investments, there is no guarantee that crowdfunding investments will be immune from fraud.
8. Investment in personnel
An early-stage investment is also an investment in the entrepreneur or management of the company. Being able to execute on the business plan is often an important factor in whether the business is viable and successful. You should also be aware that a portion of your investment may fund the compensation of the company's employees, including its management. You should carefully review any disclosure regarding the company's use of proceeds.
9. Cancellation restrictions
The ability to cancel your commitment is limited. Once you make an investment commitment for a crowdfunding offering, you will be committed to make that investment unless you cancel your commitment within a specified period of time.
10. Lack of professional guidance
Many successful companies partially attribute their early success to the guidance of professional early-stage investors (e.g., angel investors and venture capital firms). These investors often negotiate for seats on the company's board of directors and play an important role through their resources, contacts, and experience in assisting early-stage companies in execution of their business plans. However, an early-stage company primarily financed through crowdfunding may not have the benefit of such professional investors.
Crowdfunding investments involve high degree of risks and are not suitable for all investors. You should consult your tax, legal, financial, and accounting advisers before making an crowdfunding investment.
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