Crowdfunding is shrinking the risk of investing in potential next-big-things.
How could you make $63 billion investing through equity crowdfunding? It’s easy. Just find the "next big thing."
In 1976, Ron Wayne owned 10 percent of a small, startup company with two young, renegade founders working from a California garage. Not wanting to take the risk of being liable for 10 percent of the company’s debts, Wayne sold his stock for $800. Had Wayne held on to that stock in Apple Computer, today it would be worth about $63 billion.
Does that mean you should buy $800 worth of stock in every company using equity crowdfunding to raise capital online? Of course not. But, Wayne’s story illustrates that having the ability to invest in companies at the earliest stages can lead to huge returns. It also shows that those who invest relatively small amounts in startups could generate millions -- cue Dr. Evil ...or even billions! -- of dollars in profits.
I know investing in startups is risky. The Small Business Administration says that about one-third of all startups fail in the first two years. The U.S. Bureau for Labor Statistics says that 50 percent of new businesses fail within five years. Really, all investing has risks. Even investing in blue chip stocks can lead to financial disaster. In November 2006, the country’s largest bank, Bank of America, probably seemed like a safe investment at $55 a share, after years of its stock price climbing without fail. But when the bank’s stock plummeted below $4 a share in 2009, the blue chip stock no longer seemed like such a good investment. Let’s do the math on that one. If, in 2006, you had invested in Bank of America the same $800 Wayne sold his Apple stock for, your investment was worth $58 three years later.
With legalization of JOBS Act equity crowdfunding, for the first time in 80 years, anyone can invest in startups, new companies, growing private companies and other small businesses that only rich and well-connected investors were legally allowed to invest in before. Those nerdy guys down the dorm hallway making an app that lets you ride around town in the backseat of someone’s car rather than a taxi that smells like Bourbon Street on a hot August night? It’s true, you may be able to buy shares in the next Uber through equity crowdfunding.
How do you pick the startup winners and leave behind the losers? What can you do to increase the odds that you will make a good return investing in startups? Here are some tips from your favorite equity crowdfunding expert.
1. Does the business model make sense?
Warren Buffett has made a fortune investing in companies with simple businesses models. If you see a crowdfunding campaign and do not understand what a company does or how they will monetize or scale their business, you probably should pass on that company.
2. Look at the management team.
Who are the founders of the company? Harvard Business Review says that experienced entrepreneurs -- failed entrepreneurs included -- have a much higher predicted success rate then first time entrepreneurs. Check out the management team, and research their prior experience and accomplishments.
3. Find committed founders.
Startups have a better chance of success when the founders make the company their full time job. That means they are getting paid a reasonable salary they can live on. I don’t want to see the founders working two hours a day on the startup and 10 hours a day at Subway making sandwiches to make ends meet.
4. Look at the use of investment funds.
As an investor, you need to understand how the company intends to spend the money you give them. See if the funds the startup is raising will be sufficient to reach important milestones like building a prototype, taking a product to market or ramping up production to scale a business.
5. Be patient.
Even if one or more of the equity crowdfunding companies you invest in becomes successful, it could take five or more years to get a return on your investment. You will probably have to wait for a “liquidity event” such as an IPO or an acquisition by another company. Think about our $63 billion example. Wayne sold his Apple stock in 1976. Apple went public in 1980, four years later, and instantly created more millionaires than any company in history. But the stock splits over the next 30+ years, and the increase in the company’s value during those decades, are what would have amounted to Wayne being a multi-billionaire, rather than a just another millionaire (sarcasm intended).
As Aristotle said, “Patience is bitter, but its fruit is sweet.”