Take A Second Look Before You Crowdfund Invest In A Startup
This past April, Title III of the JOBS Act was finally approved after nearly three years of back and forth negotiations. This opened the playing field for many potential investors who weren’t previously qualified to invest in startups. It also gave many people the hope that they, too, could invest in the next Uber or Facebook. In summary, the new ruling now allows individuals with income of $100,000 or less per year to invest $2,000 or 5% of total income yearly — whichever is less. With this, countless online investing platforms opened up their service to the general public, and many people are jumping on the opportunity of investing in the first startup they find.
Let’s slow down for a second…
Risk comes with reward, right? Not exactly..
There are many different factors that you should consider when investing in startups, such as deal structure and whether or not this is even an equity investment or if it’s simply just a loan, who the founders are, and how the company plans to monetize their product or service, to name a few. But one of the most important factors that I haven’t seen discussed enough, or really talked about at all on many of these platforms, is the EXIT STRATEGY!
Exit Strategy — … a contingency plan that is executed by an investor, trader, venture capitalist or business owner to liquidate a position in a financial asset or dispose of tangible business assets once certain predetermined criteria for either has been met or exceeded.
— Investopedia
Reward may come with risk, but only when you know what your risks are.
Frankly, it isn’t too hard to make money in the stock market over the long-term. Why? Because you can invest in a company, or group of companies, that have (usually) already monetized their product/service and have a track record of generating revenue, but most importantly, because publicly traded stocks are highly liquid securities. Is your stock losing money? Fine, sell it in the matter of minutes on your phone. Is your investment in the next big startup losing money? Good luck selling your equity…
And this is why the exit strategy should be the most important deciding factor should you should to invest in a startup. I, personally, have found many startups through these crowdfunding services that I know could be great companies, but that doesn’t mean that they deserve your investment. Just like investing in public companies, startups and small businesses are no different. One of the first things you may think about is what your potential return could be, whether that’s through historical return averages, or even just the stock’s dividend yield. Contrary to some, not all startups should go public, either. So how else can you make money through these private investments? Well, dividends or profit sharing is one way that will generate you some passive income. Or one of the more popular ways is through an acquisition, which often allow investors to recoup their principal, along with some potential gains.
What happens without an exit strategy?
Without one, you may find your capital tied up for a bit. See, unless there is some type of exit, there are limited opportunities for you to liquidate your equity holding. When there is a personal relationship in place, you may be able to negotiate terms for a pre-defined liquidation, but that often isn’t possible when investing through online crowdfunding platforms.
So the next time you find the “next big thing,” look for what the exit strategy might be. You very well may have the next Facebook, but if you have no clue how you might get your money back, then your money is just as well spent on a lottery ticket…
