Should You Invest In a Crowdfunded Business?

An easier way to make money than crowdfunding.

“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.

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.

Published by

Jason Hull was the co-founder of Broadtree Partners, a firm that acquires $1-5MM EBITDA companies. He also was the co-founder of open source search consultancy OpenSource Connections, a premier Solr and ElasticSearch firm. He and his wife FIREd (financial independence retire early) at 46 and 45, respectively. He has a BS from the United States Military Academy at West Point and a MBA from the University of Virginia Darden Graduate School of Business. He held a CFP certification from 2015 - 2021. You can read more about him in the About Page. If you live in Johnson County, Texas or the surrounding areas, he and his wife are cash buyers of Johnson County, Texas houses.

6 thoughts on “Should You Invest In a Crowdfunded Business?

  1. The JOBS Act might work out fine– the “accredited investor” bar has been eroded by inflation for years. High incomes or a million bucks just ain’t what they used to be. Startups cost a lot less than they used to.

    I began angel investing five years ago to “immunize” myself against the temptation. It’s succeeded beyond my wildest expectations– only the immunization part. It’s hard work (when you do it right), none of my investments have paid out yet, and I’m probably going to have funds tied up for at least another five years. Some of the older members in my group joke that their investment exit strategy is “probate”.

    It’s made me a better investor. I’ve met amazing people (at both ends of the bell curve). I’ve made friends. It’s taught me to read dozens of books & blogs & reports, to understand legal vocabulary, to learn accounting, to ask good questions, and to stay skeptical. I’ve learned (the hard way) to limit this “testosterone-poisoned moonshot lottery ticket” asset class to 10% of the investment portfolio.

    I’ve learned that I’m not a VC, let alone Warren Buffett. Every time I look at an angel “opportunity” I move one step closer to low-cost index funds. I haven’t been tempted by Kickstarter or peer-to-peer lending, and I don’t think that I’ll be tempted by the JOBS Act.

    1. Nords–What a great, and insightful comment. Thanks for sharing! I love the probate comment and I’m sure many business owners can attest to similar feelings.

      In my old company, we got asked quite often to work for equity for startups. All of them sounded like good ideas, and had we invested our sweat equity in all of them, I’m sure we would have folded. Actually, we did turn down a couple that subsequently went on to have significant exit events, so it might have turned out OK had we been able to hang on long enough. But, what I learned in seeing all of them was that, to me, they all sounded like they had potential. I even knew the market really well. What I couldn’t account for in those “angel” opportunities was the execution of the management team and the vicissitudes of the market. We also didn’t have the size to play VC and diversify our bets. We had to choose very wisely.

      So, instead of playing VC, we let VCs play VC. If they were VC funded and wanted us to work for equity, we’d do so as long as they covered our actual costs in cash. Equity shares do not fill a plate. We wound up holding a grand total of one company’s stock in our “mini-VC” portfolio, and it’s still alive and kicking. Unfortunately, it would have to have a Google-esque IPO to make me a king, and I passed out from holding my breath a long time ago.

      If you’re into crowdfunding to meet people and get a taste of running a business, then it’s probably a great and cheap education and phenomenal network building path. If you’re into a moonshot…green 00?

  2. Frankly, if I’m going to wildly speculate on any small business venture, it’s going to be my OWN company, not one that’s run by someone else. And even for my own business, it’s going to be money I can afford to lose (as I phrased it in a previous blog post: I’ll invest it if my worst-case scenario is that I’ve lived more frugally than I otherwise would have needed to).

    For long-term investing, I’m sticking with ETFs and rental properties.

    1. Amen. I have an internal locus of control (more on that in a future blog post), so I’d much rather have my destiny in my own hands than someone else’s. At least, then, if it doesn’t work out, I know where to look, as I smash the mirror to blame that guy who caused it to fail! 🙂

  3. I do not prefer to invest in a crowdfunded business, specially based on services. I did not invest in Facebook so far and awaiting for right time to invest in it. If business is one or two services providing then it is not horse of long race. Therefore I bought share of Apple recently instead of Facebook.

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