Title III of the 2012 JOBS Act allows both accredited and non-accredited investors to participate in equity crowdfunding. Under these new rules, anyone can invest in equity shares of a startup through a crowdfunding platform, regardless of their income or net worth. If you’re thinking about wading into equity crowdfunding, there are some factors you’ll want to consider first.
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How Equity Crowdfunding Benefits Investors
Equity crowdfunding involves trading cash for a stake in a company. Individual investors contribute funds to businesses through a crowdfunding platform.
If you’re interested in investing, equity crowdfunding can benefit you in a few different ways. First, it’ll give you the chance to add more diversity to your portfolio. Diversification spreads out the amount of risk that investors take on. If a large percentage of your investments is tied up in a single asset class, you could quickly lose a lot of money if that sector of the market tanks.
Through equity crowdfunding, you might also be able to earn decent returns. If a startup has a huge IPO, you could recoup your initial investment and collect some significant profits in the process.
Finally, equity crowdfunding is extremely accessible. To get started, you simply have to find a crowdfunding platform, create an account and decide what you want to invest in. The minimum investment amount may be as low as $1,000. Compared to certain mutual funds that require $10,000 and up to buy in, equity crowdfunding could be a bargain for smaller investors.
The Downsides to Equity Crowdfunding
The biggest pitfall associated with equity crowdfunding is that it’s not risk-free. You’re basing your projected returns on what you think your shares will eventually be worth. If the company folds or goes public but doesn’t perform as well as anticipated, you may see very little return on your investment. In the worst-case scenario, you could lose a lot of money.
Even if a company does prove to be successful, you’ll probably have to wait a while before any returns materialize. It can take years for a startup to become profitable. In the meantime, the money you’ve invested is tied up. If you value liquidity, equity crowdfunding may not be right for you.
It’s also difficult to pinpoint what a startup is truly worth. Over the last year, for example, there has been a boom of “unicorn” companies, whose valuations exceed $1 billion. Now, the venture capital investors who funded these startups are beginning to question whether those valuations were merited. If you invest in a company whose value is being inflated, you may be disappointed in your gains once it’s time to sell your shares.
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The Bottom Line
Before you hop on the equity crowdfunding bandwagon, it’s a good idea to ask yourself what kind of risk you’re really interested in taking on. If the startup you’ve invested in fails, would you be able to recover relatively quickly? Or would losing that money put your financial future in jeopardy? Looking at equity crowdfunding through that lens can help you decide whether it’s an investment vehicle that’s worth exploring.
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