Should You Invest in That Equity Crowdfunding Opportunity?
As an investor, you’ll have the opportunity to provide funding to several equity crowdfunding projects — effectively allowing you to become a partial owner in a number of different businesses. But is this a good idea?
The Pros and Cons of Equity Crowdfunding
Let’s start with an assessment of the pros and cons of equity crowdfunding.
Equity crowdfunding works much like other forms of crowdfunding. Each project is publicly available, allowing patrons to contribute a specific amount of money to the project. The difference is, instead of contributing for a specific reward or to back a cause, you’ll be contributing in exchange for fractional equity in the company.
This is valuable to investors for several reasons. You’ll have early access to businesses that aren’t yet listed on the stock exchange. You’ll get to review thousands of different projects to find the best fit for your investing goals. You’ll also be able to do exhaustive research and understand each opportunity thoroughly before investing.
However, there are drawbacks. Equity crowdfunding projects tend to be more volatile and less predictable than other types of assets. You also have no real financial protection; it’s entirely possible that you lose every penny you invest.
Factors to Consider
Because equity crowdfunding can result in a win or a loss, it’s important to do your research in advance to determine whether a given opportunity is worth investing in.
These are some of the most important factors to consider:
- The core idea. Start by looking at the core idea driving the business. What is this business, why does it exist, and how is it going to make money? Intuitively, you’ll immediately get a sense for whether this business plan is viable. Is it something novel and interesting that seems like it would be practically beneficial for a given population? Or do you have to spend an excessive amount of time trying to figure out exactly how this business is going to work?
- Product/market fit. Next, think about the product/market fit. In other words, is this product in a position to effectively satisfy the needs of the business’s target audience? And is that market large enough for that business to be viable and sustainable? To determine this, you’ll need to evaluate the product, the size of the market opportunity, and review any product/market fit data available to you (such as company revenue data and NPS or PMF customer survey feedback).
- Leadership. Take a look at the leadership spearheading this project. Are the entrepreneurs in charge experienced and knowledgeable in this area? Have they had many years of experience in this industry? Or are they total newcomers with little to no business background? Good leaders can support even questionable ideas, while bad leaders can ruin good ideas.
- Financial forecasts. What do the financial forecasts look like? How long will it be before this company starts making money? What’s the plan for the first year? What about the next several years? Is revenue projected to grow consistently?
- Cost and equity stake. How is this company valued? There are plenty of equity crowdfunding opportunities with excellent business plans and clever positioning — but not all of them are priced reasonably. Make sure you understand the costs and benefits of your investment and compare them to the amount of money you’re contributing.
- Future potential. Think long-term when possible. Startup investors tend to favor ideas that are infinitely scalable and capable of generating absurd amounts of revenue at their peak, even if it takes years (or decades) to get there.
- The competition. Conduct a competitive analysis if the aspiring entrepreneurs who created the project haven’t already done so. There are probably other companies doing something similar to this, so how have they fared? What are this company’s differentiating factors, and are they going to be enough to outcompete these rivals?
- Other backers. You don’t want to make investing decisions based solely on what other people are doing. But it’s still valuable to know whether this project has attracted other significant backers.
- The platform. Also, keep in mind that different equity crowdfunding platforms have different rules, regulations, fees, and processes. Review the terms and conditions before you’re willing to contribute.
Diversifying Your Investments
No matter how you choose to move forward with your equity crowdfunding opportunity, it’s important to diversify your portfolio. That means spreading your capital out across a variety of different asset classes, industries, and economic areas. For example, in addition to investing in an equity crowdfunding opportunity, you can invest in stocks, bonds, real estate, and ETFs. Doing so will reduce your exposure to risk and stabilize your eventual returns.
Equity crowdfunding can be a lucrative opportunity, but it could also result in a total loss. Make sure you do your due diligence and continue following your overarching investment strategy; as long as you’re sufficiently prudent and well-researched, you should consistently see positive results.
