1: High Risk Long Term Investment
When investing in a Crowdfunding offering, it is almost impossible to say how long it may take to see a return on your investment, if at all. Startup investing is a long term investment strategy carrying a lot of risk. The startups and small businesses that rely on the crowdfunding exemption are likely to experience a higher failure rate than a more seasoned companies seeking an investment. Investing in startups and other private companies is highly speculative and should only be done by investors who can bear the complete loss of their investment without any change in their lifestyle.
2: Absence of a Secondary Market
Crowdfunding investments are highly illiquid. This is a result of the limitations on transferring your shares and the lack of an established secondary market. There is currently no public exchange (like Nasdaq or the New York Stock Exchange) where shares bought through equity crowdfunding can be readily traded. To review the restrictions on the resale or the transfer of ownership rules from shares acquired through equity crowdfunding please review section (3) below;
3: Transfer or Sale of Equity Shares
There is a mandatory lock-up period of 12 months from the date of purchase during which investors can’t sell the securities purchased through Regulation Crowdfunding (Title III of the JOBS Act) unless the shares are transferred:
- to the issuer of the securities;
- to an “accredited investor”;
- as part of a later offering registered with the Commission; or
- to a member of the family of the purchaser or the equivalent, to a trust controlled by the purchaser, to a trust created for the benefit of a member of the family of the purchaser or the equivalent, or in connection with your death, divorce or other similar circumstance.
4: No Successful Exit?
Because there is no established secondary market, you may have to hold on to your investment until the company completes an IPO, merger or gets acquired to realize any sort of material gain. Such an event may never occur, and if it does not, your entire investment may be lost. Investors should consult a financial advisor and discuss whether investing in startups, new ventures or private companies is the right investment strategy for them.
5: High Company Valuation
Private company valuations are typically set by the company’s management at their discretion. Often, the accuracy of that valuation has not been verified by an independent third-party expert. The scenario of an overvalued pre-money valuation of a private company is a common occurrence in Crowdfunding. As a result you may end up paying more for the shares than they are actually worth.
6: No Dividend Payouts or Profit Sharing
Unless otherwise stated in the offering documents, for your investment, you might not receive any monetary benefits in the form of a dividend payout or profit share during the lifespan of the investment.
7: Use of Proceeds are Subject to Company Discretion
Crowdfunded companies are obligated to provide details of how the raised proceeds will be used, but this typically provides company management with flexibility. The company may have discretion, as per the subscription agreement, to reallocate the funds without any actionable accountability.
8: Limited Disclosure and Lack of Historical Data
While companies looking to fundraise through Regulation Crowdfunding have some disclosure requirements including management, business plan, subscription details and use of proceeds, many early stage companies lack operating history and have limited disclosure requirements moving forward.
In contrast, a publicly listed company will have significant operating history and is required to file quarterly and annual reports while promptly disclosing certain material events.
*Please refer to #4 “Scope of Disclosure” under Course VI – Regulations and Regulatory Bodies to learn more about issuer disclosure requirements.
Some startup companies may experience multiple rounds of fundraising. Therefore, when a company issues additional shares to raise capital it causes dilution to your ownership in the company. Dilution means you have reduced (less) proportional ownership in the company.
10: Speculative Investment
Investing in an early stage startup or a seed stage company is very speculative in nature and more often than not, these businesses fail. Unlike an investment made in a mature business where you can readily find a track record of revenue and income, the success of a startup or early-stage venture usually depends on the development of a new product or service that may or may not find a market. You must be able to afford and be fully prepared to lose your investment.
11: Reduced Market Valuation for Future Rounds of Fundraising
In the event a company seeks further capital, there is a possibility that the value of the company is reduced from when you made an investment. That reduces the value of your shares in the original investment.
12: Lack of Professional guidance
Angel Investors and Venture Capital firms offer more than just funding to startups. They bring expertise, knowledge, resources and contacts to the company. That aids these vulnerable startups in achieving success. A seed-stage company that chooses to Crowdfund will get the capital but may lack the professional guidance.
13: Theft of Intellectual Property
Early stage and startup companies lack resources and many times they do not give enough emphasis on patenting or copywriting their intellectual property. Not protecting intellectual property creates additional risks to your investment.
14: Risks Due to Rapidly Changing Technology
In a world where new technologies are getting launched ever more frequently, there is a wide prospect that the product of the startup you have invested in becomes obsolete before it can get to market.
15: Failure to Obtain Market Approval/Consumer Appreciation
Some startup companies may raise funds with only prototypes that have not undergone customer or market scrutiny. The success of any company remains in its ability to deliver a product or service which is wanted by consumers.
16: Legal Disputes
The Company may from time-to-time be subject to a variety of legal and regulatory actions relating to the Company’s current and past business operations, including, but not limited to disputes regarding:
- Its products and services
- Employee actions
- Sales practices, disclosure, licensing, regulatory compliance and compensation arrangements
- Taxing authorities regarding tax liabilities
- Governmental or administrative investigations and proceedings in the context of the Company’s regulated sectors of activity.
The Company cannot predict the outcome of these investigations, proceedings or lawsuits, and cannot guarantee that such investigations, proceedings or lawsuits would not materially adversely affect the Company.
17: Risks Based on Specific Share Class
The class of share you own based on your subscription agreement may be subject to dilution and may include no voting rights. Your investment may be the last to be honoured if the company fails to receivership or files bankruptcy.
18: Possibility of Fraud
Although Crowdfunding is a regulated process there still remains a possibility of fraud. Crowdfunding portals are required to do limited due diligence. However, there is no substitute for performing your own due diligence and review of the offering, the company and its management. As with other investments, there is no guarantee that crowdfunding offerings will be immune from fraud.
19: Changing Economics
External circumstances can be attributed to the success or failure of any company. Disturbances in external economic cycles or systems like the credit or equity market can create a hindrance in the operation of a startup. Crowdfunded companies are not immune to various global cues like unstable markets, terrorism, acts of war, natural calamities or such other unpredictable events.
20: Investment in Personnel
For most startups, human resources is one of the most neglected aspect of the business. Understand that your money could be spent to hire and manage personnel.