So you are thinking about getting into equity crowdfunding investing. Do you think you know how to spot great potential in very early stage companies? Perhaps you have built and managed a successful business yourself? Maybe you have been deeply involved in startup markets for long enough to know that you have pretty good instincts about which companies will flourish and which will flop. Maybe you are just skeptical that brokers and investment gurus know anything you don’t. Whatever your reason, now is the time to start getting serious about your equity crowdfunding investing strategy. Before you invest your first dollar, make sure you know the 5 deadly mistakes to avoid being a sucker.
5 Equity Crowdfunding mistakes to avoid
Mistake 1: Getting hunted
Anyone who has watched a little National Geographic knows, you either hunt or get hunted. This concept applies perfectly to the high stakes realm of equity crowdfunding investing. I remember overhearing one of my economics professors talking with a relative who had been pitched some mutual fund on the phone by a salesperson doing cold calls. The relative insisted the trusted econ professor give her opinion on the investment. Her answer? “Don’t invest in anything that someone is trying to sell you.” She was annoyed and impatient, but understandably so. The relative was behaving like docile prey, just waiting to be gobbled up my financial predators.
Equity crowdfunding will continue to generate a lot of buzz. More and more gurus will pop up claiming to know who the next unicorn company is and promising you that if you just invest in what they tell you to, you too can earn 10,000 times your investment. They will make outlandish yet seductive claims like “Do you want to get in on the next Facebook? I’ll show you the secret formula.” If you find yourself falling for this kind of sleazy sales pitch, equity crowdfunding is not for you.
Investors need to be much more savvy. Good investors need to know what they want and go out and hunt it. Be proactive in devising your own investment strategy and hunting down the companies you want in your portfolio. Scope out the territory. Know all the players and various factors that may come into play. The King of the Jungle doesn’t wait for a juicy impala to run towards it, it prowls carefully to execute the perfect hunt.
Mistake 2: Putting all your eggs in one basket
Ok, this one is a classic. Nevertheless people still make this cardinal mistake. Everybody knows the most basic tenant of investing is diversify, diversify, diversify. Of course, knowing how to diversify is important. Equity crowdfunding experts I have spoken too say that investing in anything less than 7 companies is tantamount to throwing your money away. So 7 should be the absolute minimum number of companies in your equity crowdfunding portfolio. This means that you will need at least 7x the minimum investment amount to even consider getting started. As of publication, the minimum investment (minimum reservation) on Crowdfunder is $5000-$10,000. That means you would need at least $35,000 to build a minimally diversified portfolio. Ideally, you would want more than 7 companies. Though minimum reservations may begin to fall once Reg A+ goes into effect, until then you need to be an accredited investor to even be eligible for crowdfunding investments. When the market opens up to everybody, you still need to check that the amount of money you are willing to risk in this market is enough to build a reasonably diversified portfolio.
Mistake 3: Being lazy
Again, this sounds like the oldest advice in the book, but with so much buzz about equity crowdfunding and hot investment opportunities, it is tempting to just believe the hype and skip the legwork. Don’t. This is your hard earned money we are talking about. Before deciding to invest, make sure you have done your homework. How well do you understand the technology? How well do you know the market? Don’t trust the pitch. Dig deeper. Ask trusted colleagues to give you their opinion of the technology. If the company’s market isn’t one you know well, do your own Internet and face-to-face research. Find out who the competitors are and make sure the company you are investing in has a clear, unique competitive advantage. You also need to take a close look at the leadership team. What about their background signals that they will be able to successfully lead this venture to market?
I know you are a genius, but it wouldn’t hurt to also ask other people what they think. Start with a search on Zirra to see how the investor crowd ranks the investment. This will give you a very good feel for how your peers assess the opportunity. Next, do a simple Google search to see what kind of press the company has been getting. Articles will offer more information from an unbiased source. Press coverage can also be a good indicator for how much general market interest there is and the company’s marketing capabilities.
The team is more than just a few names and resumes. These are the human beings you are trusting with your money. You are trusting they will be able to turn your investment into a nice return. Dig a little deeper. See where they have worked previously. Chances are you know somebody who has worked at one of their previous companies and they can give you some inside info on their ability to execute.
Mistake 4: Flying solo
Again, we know you are a genius, but genius needs company, right? Seriously, you wouldn’t be in this market if you didn’t have the ability and expertise to properly evaluate investments. Your education, career and life experience have all prepared you for this, but you still need to at least listen to what other investors like you have to say about investment opportunities you are considering. This doesn’t mean you let other people influence your decisions, it just means you open up your eyes and ears to other opinions and information sources. As you build your portfolio, wouldn’t it be interesting to know how other investors are building theirs? Which markets are they getting into and which markets are they avoiding. Why? Do they agree with the listed company valuation? Is it too high or too low? How big of a return to other investors expect and what is the timeline to ROI? How good do other investors think the leadership team is? Is their product truly innovative? Often times sharing feedback with other investors will surface issues that you aware not aware of from the prospectus and your own research. Join an investor group or community dedicated to equity crowdfunding. Ask questions and listen to what your peers are saying.
Mistake 5: Don’t bet the farm
Our final cliche is as true as ever. Besides being good advice it is also the law. An important clause of the new SEC Reg A+ rules deals with protecting equity crowdfunding investors from betting the farm. The rules limit the amount private individuals can invest in this market to no more than 10% of their net worth, not including their home. The government doesn’t want people risking too much money in this new investment class. The possibility of big returns comes with the risk of big losses. Just like in Las Vegas, only bet what you can afford to lose. For most new investors this will likely be even less than 10% of their net worth. Make sure you are within the legal limitations and within your personal risk tolerance. Though nobody likes losing, make sure you don’t invest more money than you can afford to lose without seriously affecting your lifestyle and savings. I’m not your mom. I can’t make this decision for you. You know how to make responsible financial decisions. Make sure you are the adult in the room when it comes to your money.
Use common sense, be proactive, diversify, do your homework, consult with trusted peers, and invest only what you can afford to lose. Use both online and offline resources to research portfolio strategies, discover and evaluate companies. Most of all, build a network of trusted peers who can give you additional information and serve as a reality check before you invest.
How are you preparing the start investing in equity crowdfunding?