- Speculative investment. Start-ups and early-stage ventures often fail. Unlike an investment in a mature business where there is a track record of revenue and income, the success of a start-up 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 the loss of your entire investment.
- Illiquid investment. You will be limited in your ability to resell your investment for the first year and you may need to hold it indefinitely. 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 seek to resell your crowdfunded investment.
- Cancellation restrictions. Once you make a commitment to invest in a crowdfunding offering, you are committed unless you cancel within 48 hours of the offering’s deadline.
- Overpay for your investment. Unlike companies that are listed on a major stock exchange, where prices are displayed throughout the trading day, the valuation of private companies is opaque. You may risk overpaying for the equity stake you receive. In addition, other investors might have ownership or investor rights that are superior to yours, giving them an economic advantage over you.
- Limited disclosure. A company raising capital must disclose details about its business plan and what it will do with the money it’s trying to raise, among other things. A crowdfunded company might be able to provide only limited information. Also, the company is obligated only to file financial statements annually. Publicly listed companies, by contrast, are required to file annual and quarterly reports and promptly disclose certain events — continuing disclosure that can help you evaluate the status of your investment.
- Misuse of your funds. When you invest in an early-stage company, you’re really making an investment in the entrepreneur or management of the upstart. Thus, a portion of your investment may be used to pay the compensation of the company’s employees, including its management.
- Fraudulent investment. Crowdfunding makes it so easy for early-stage companies to raise money that certain opportunities could turn out to be money-losing fraudulent schemes. There is no guarantee that crowdfunding investments will be immune from fraud.
- Lack of professional guidance. Many successful companies attribute their early success partly to the guidance of professional early-stage investors (such as angel investors and venture capital firms). These investors often negotiate for seats on the company’s board of directors and play an important role by sharing their resources, contacts and experience. An early-stage company financed primarily through crowdfunding may not have the benefit of such professional investors.
In our last blog post, we showed the SEC regulations on the amount you could invest in crowdfunding deals. They are for your protection only. Below are the major risks in crowdfunding investments -
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