Should You Invest In a Crowdfunded Business?

“Bene, Don Corleone. I need a man who has powerful friends. I need a million dollars in cash. I need, Don Corleone, all of those politicians that you carry around in your pocket, like so many nickels and dimes.”
–Virgil “The Turk” Sollozzo, The Godfather

“You can’t shine a turd.”
–Rob Gowen

“And what most people don’t understand is the bulk of business in this country is small business.”
–Alphonso Jackson

With the recent passage of the Jumpstart Our Business Startups Act (JOBS Act), the gates will soon open for small investors like you and me to invest in startups. Once the exclusive domain of venture capitalists and the “friends, family, and fools” group when crazy Eddie had the idea to sell personalized dust bunnies, investing in startups will be available to anyone and everyone within certain limitations. The act will prevent you from investing more than $2,000 at a time if your net worth or net income is less than $100,000, or $10,000 at a time not to exceed $100,000 if your net worth or net income is greater than $100,000.

Table of Contents

Just because you can invest in a startup, does it mean that you should invest in a startup?

Rather than being infrequently exposed to opportunities by those in your circle of friends and family, you will be able to sift through and sort myriads of opportunities for investing in startups. Don’t think, though, that you’ll suddenly find yourself investing in a basket of Facebooks and Googles long before the IPO. Let’s look at some more sobering facts about startups.

Most of them fail. According to the Small Business Administration, 30% of startups fail within 2 years, 50% fail within 5 years, and 75% fail within 15 years. So much for buy, hold, and forget as an investment strategy since the ROI after 15 years of 75% of the investments will be -100%.
There isn’t liquidity. Unlike the purchase of stocks, which is done in an open market where prices can be established, purchases of pieces of startups seem to have no guarantee of liquidity. There may, in time, be a secondary market to provide liquidity, but so far, neither the text of the bill nor anything from the SEC seems to contemplate this.
The vetting process isn’t as rigorous. While venture capital firms have experience in vetting the projections of fundraisers and know, in general, when to spot unrealistic expectations, the average investor doesn’t have that knowledge or background.
Even venture capitalists aren’t that successful. According to the National Venture Capital Association, approximately 40% of investments return no capital, 40% return some capital, and only 20% of venture capital investments produce high returns. It’s highly unlikely that the average investor will do better.

Still champing at the bit to take part in crowdfunding of startups?

Here are some things to consider if you’re going to invest.

Make sure it is money you can afford to lose. Chances are that you will lose every last dollar of your investment. Remember, 40% of VC investments fail completely, and another 40% of them have a ROI between 0% and -99.99%. So, you’re probably no more likely to do better than them, and you’ll probably do worse.
Know the industry, and if possible, know the people involved. Everyone is going to try to make their startups look like the next Facebook and will try to dazzle their potential investors enough to get investments. Sure, most of the people who seek funding will have great intentions, but great intentions do not guarantee success.
Don’t be the first one in. Wait until returns on the first set of crowdfunded startups are published and analyze what has worked.
Don’t be anxious. There’s always another investment opportunity right around the corner.
Make sure it is money you can afford to lose. I cannot stress this enough. You may as well go to Vegas.

Author Profile

John Davis

John Davis is a nationally recognized expert on credit reporting, credit scoring, and identity theft. He has written four books about his expertise in the field and has been featured extensively in numerous media outlets such as The Wall Street Journal, The Washington Post, CNN, CBS News, CNBC, Fox Business, and many more. With over 20 years of experience helping consumers understand their credit and identity protection rights, John is passionate about empowering people to take control of their finances. He works with financial institutions to develop consumer-friendly policies that promote financial literacy and responsible borrowing habits.