Tips for investing in a crowdfunding deal

With the new crowd-sourced funding regime finally kicking off in Australia, soon anyone can become a startup investor. Follow the tips below to make sure you get it right.

If you’ve picked up a business magazine or newspaper in the last few months you’ve probably seen headlines such as New equity crowd-funding law wins support of start-up community or Buy a share in a brewery: Pozible launches equity crowd-funding site Birchal.

Reports of high Venture Capital returns in recent years has increased the anticipation around equity crowdfunding. In 2015, Cambridge Associates in the US reported a Venture Capital return much higher than that of the S&P 500. According to the report, they made a rate of return of 24.4 percent over 25 years, in comparison to S&P 500’s 9.9 percent over the same period. With results like this, it’s no surprise that many people are looking forward to finally being able to invest in startups.

The opportunity for all Australian’s to invest in startups is quickly approaching, and now is the time to make sure you’re equipped with the tools and knowledge you need before the first investment rounds are open.

Follow our tips below for general guidance, but always remember to seek professional financial advice before making any investment decisions.

1. Invest in the team, not the idea.

If you’ve ever watched Shark Tank, you no doubt have heard the Sharks tell founders time and time again that they’re not too keen on the business idea, but they want to invest because they really like the team.

There’s a really important reason for this. An excellent team with a reasonably good idea is much better than a reasonably good team with an excellent idea. You want to invest in a team that has the skill set, industry knowledge, and ambition to drive the company towards success.

Early/seed startup investor Raj Dhonota outlined this as one of the key drivers behind investing in startups in his recent Businesszone contribution piece.

“I look at the strengths and weaknesses of that individual and whether or not I should back that person. In short, when I choose to invest, it’s 99% the team and 1% the overall idea.”

So, before you invest in a startup make sure you know enough about the team, and really believe in them and their vision.

2. Diversify your portfolio.

Investing in a startup is risky, and not every company you invest in will become the next unicorn startup. It’s very important that you diversify your portfolio in order to minimise the risk of losing all your money.

There are two ways in which to diversify your portfolio. The first is to diversify across asset classes, i.e investing only a certain percentage of your portfolio through crowdfunding and allocating the rest to stocks, bonds, etc. The second is to diversify across startups, i.e investing in many startups to spread risk.

2.1 Diversifying across asset classes.

One of the most important rules of investing is to diversify your portfolio in order to minimise risk and increase the chances of a good return. Diversifying across asset classes means allocating a certain percentages of investment to different asset classes, which can include: shares, bonds, property, commodities, and startups.

The percentage you invest in each asset class will depend on your personal circumstances.

2.2 Diversify across startups.

To decrease risk you also need to diversify across your startup investments. We’ve established that investing in startups is high risk, and many startups won’t make it. Diversifying your portfolio and investing a smaller amount in many startups increases your chances of making an investment in a startup that will actually make it.

In an interview with Business Insider, Co-founder of Blackbird Ventures, Bill Bartee expresses the importance of investing in many startups to minimise risk and increase chances of return.

“Out of ten portfolio companies, you might have one, let’s say that is a rocket. You might have two that are ok. And then you might have four or five that don’t work out at all … At the end of it you hope to have 2 or 3 really good companies in a 20-25 portfolio that are really stars, and if you have that then the likelihood is the return to investors is better than the public market.”

3. Don’t invest money you can’t afford to lose.

No investment comes without risk. You’ve diversified your portfolio and minimised the risk — that’s great, but you’re still not guaranteed a return.

Investing in the next unicorn startup is the dream, but in reality, most startups will not make it.

Unlike stocks and bonds, equity purchased through crowdfunding is difficult to liquidate. Make sure that you know how much you can afford to spend on purchasing startup equity. Keep in mind that the most likely way you will make a return is through an exit and most startups won’t be ready for an exit for several years.

The bottom-line? If you can’t afford to lose the money, don’t invest it.

The unicorn startup.

Yes, statistically, investing in startups comes with high risks, but, although the chances of investing in the next unicorn startup are slim, it’s not impossible.

BrewDog has been the poster child for equity crowdfunding in the UK and is proof that investing in a startup can be rewarding. After running several rounds of successful equity crowdfunding, a private equity company acquired approximately 22 percent of BrewDog for $264 million earlier this year, valuing the craft brewery at $1.24 Billion.

“Shares purchased in Equity for Punks I are now worth 2,765 percent of their original value. Even craft beer fans that invested in Equity for Punks IV, which closed in April 2016, have seen the value of their shares increase by 177 percent in just one year,” says BrewDog Co-founder James Watt.

The deal gives ‘equity punks’ the chance to sell 15 percent of their shares at the valuation of $1.24 Billion.

Remember that equity crowdfunding isn’t just about making a return, it’s also about supporting Australian startups that you believe in and are passionate about.

Click here to check out the brands that will be running equity crowdfunding campaigns through Birchal.

This article contains general information only, and should not be considered as financial advice. You should always consult with a licensed financial adviser before making any investment decisions. Articles published on the Birchal blog contain comments and opinions which are the writers and do not necessarily represent the opinion of Birchal.