An individual considering a private equity offering via a crowdfunding platform should be aware that private equity investments may involve very high risks.
Individual investors should thoroughly research any offering before making an investment decision. Investors should read and fully understand the information about the company and the risks that are disclosed before making any investment. The risk factors involved with private equity investing include, but are not limited to:
Is there a Potential Loss of Investment?
Due to the fact that many new businesses fail, private equity investments are highly speculative. 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. Therefore, an individual should not invest more money in private equity investments than he and or she can afford to lose or without adversely impacting the individual’s standard of living and their associated savings plan as well as their investment plan for retirement.
What are the lliquidity and Lack of Marketability issues?
An individual investor will be limited in their ability to resell their investment for the first year and may need to hold that investment for an indefinite period of time. Unlike investing in companies listed on a stock exchange where an investor can quickly and easily trade securities on a market, an individual investor may have to locate an interested buyer when they do seek to resell their crowdfunded investment. Consequently, any investment an individual makes through a crowdfunding platform will likely be highly illiquid.
Are there Cancellation restrictions?
As detailed under regulations, once an individual makes an investment commitment for a crowdfunding offering, he and or she will be committed to make that investment (unless he and or she cancels the commitment within a specified period of time). Unless there is a material change affecting the company during the period when securities are being offered, the ability to cancel his and or her investment commitment is limited. Specifically, the individual investor will have up to 48 hours prior to the end of the offer period to change your mind and cancel your investment commitment for any reason.
What are the Valuation and capitalization issues?
An individual’s crowdfunding investment will typically 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 to determine and the individual investor may risk overpaying for the equity stake he and or she receives. In addition, there may be additional classes of equity with rights that are superior to the class of equity being sold through any given crowdfunding offering.
What should you know about Limited disclosure?
Regulations stipulate that the issuing company must disclose information about the company, its business plan, the offering, and its anticipated use of proceeds, among other things. A start-up or 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. A publicly listed company, in contrast, is required to file annual and quarterly reports and promptly disclose certain events—continuing disclosure that an investor can use to evaluate the status of that investment. In contrast, an individual investor may have only limited continuing disclosure about their crowdfunding investment.
What should you know about Investment in personnel?
An start-up or 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 considered an important factor in whether the business is viable and successful. An individual investor should also be aware that a portion of their investment may fund the compensation of the company’s employees, including its management. The individual investor should carefully review any disclosure regarding the company’s use of proceeds.
What should you know about the Possibility of fraud?
In light of the relative ease with which early-stage companies are anticipate to 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.
What should you know about the Lack of professional guidance?
Companies may partially attribute any 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 executing on their business plans. An early-stage company primarily financed through crowdfunding may not have the benefit of such professional investors.
What should you know about the Tiered financial disclosure?
The minimum level of financial disclosure required by the company depends on the amount of money being raised or raised by the company in the prior 12 months:
• $100,000 or less – financial statements and specific line items from income tax returns, both of which are certified by the principal executive officer of the company.
• $100,000.01 to $500,000 – financial statements reviewed by an independent public accountant and the accountant’s review report.
• $500,000.01 to $1 million – if first time crowdfunding, then financial statements reviewed by an independent public accountant and the accountant’s review report, otherwise financial statements audited by an independent public accountant and the accountant’s audit report.
What should you know about Dividends?
Start-ups, early stage and emerging growth private companies do not usually pay dividends. Profits, if any, are typically re-invested into the business to fuel growth, fund capital expenditures and build enterprise value. Companies typically have no obligation to pay equity shareholders dividends and may not disclose that intention. This means that if an investment is made in a private company through a crowdfunding platform, even if the company is successful the crowdfunding investor is unlikely to see any return of capital or return on capital until there is a liquidity event for the issuing company. As already mentioned, even for a successful business this is unlikely to occur for a number of years from the time the initial investment is made.
What is Dilution?
Any investment that an individual makes through a crowdfunding platform is likely to be subject to dilution. This means that if the company raises additional equity capital at a later date, it will issue new common or preferred shares in the company to the new investors, and the percentage of the issuing company that the investor previously owned will be reduced. These new shares, often effected through a preferred stock offering, may also have certain preferential rights to dividends, sale proceeds and other matters, and the exercise of these rights may work to the previous investor’s disadvantage.Dilution can also occur as a result of the grant of options (or similar rights to acquire shares) to employees of the issuing company and or to service providers and other parties connected closely with the management of the company.
What are the Agency and Control issues?
An agency relationship arises whenever one party delegates decision-making authority or control over resources to another party. This will likely be the case for individuals making a private equity investment. While agency and control relationships often work well, problems may arise if Management and or Members of the company’s Board of Directors make decisions that are not in the best interests of the company’s shareholders.
What should you know about Voting?
Voting rights, privileges and restrictions can vary considerably with different classes of equity securities.
What should you know about Diversification?
Investing in start-ups and early stage private companies should ideally be done as part of a diversified portfolio strategy. This means that an investor in private equity should invest in a manner that is suitable to his and or her individual financial situation and investment strategy. Risk tolerance, return objectives and financial constraints should be an integral part of the process of determining if investments in private companies are suitable for you.