Crowdfunding and Securities: What You Need to Know to Stay Protected

Crowdfunding, like any investment, has both risks and benefits. Before investing, make sure you understand both.

As of May 2016, investors are able to buy stock in early-stage companies through crowdfunding, a system in which companies raise small amounts of money through many people, typically on internet-based platforms.

To many, crowdfunding sounds like an exciting new way to invest, but it’s important to understand the type of business you’re investing in: what it does, how it makes money, and the inherent risks in investing in start-ups and other early stage ventures.

Can you handle the risk?

Investing in startups is extremely risky, and you’ll only want to invest money that you can lose safely. Ideally, an amount of money that will not affect your family’s quality of life, your ability to pay bills and debts, or your retirement plan.

Fifty percent of new businesses fail within the first year. And 95 percent of businesses fail within the first five years. Startups that raise new money through crowdfunding are just businesses, and they’re still likely to have the same failure rate as other types of companies, if not more.

No matter whether they display an attractive website, use exciting new technology, have entertaining product videos, or generate lots of online buzz, 19 out of 20 startups will still fail.

It’s exciting, but how does it make money?

Don’t fall for the hype surrounding many startups. Always analyze the investment from a business perspective. Determine the suitability of this company as an investment by asking questions like these:

• What industry is this company in?
• Is that industry growing or shrinking?
• What exactly does this company sell (e.g., a product, a service, or both)?
• Is there demand for this product or service?
• How does it plan to market and price the product or service?
• Has the company actually sold its products or services to paying customers? If so, how have the products or services been rated?
• Who are this company’s competitors?
• What does this company do that its competitors do not?
• What are the company’s projected profit/loss margins? If it’s running at a loss currently, when does it plan to become profitable? Is this realistic?
• Who are the founders of the company?
• Do the founders have significant experience or have they successfully started similar companies?
• Have the founders personally invested in the company?
• Are the founders aiming for an IPO (Initial Public Offering) in the future?
• Are the founders aiming to be acquired by or merged into a larger company?

Watch out for fraud

Crowdfunding is an excellent opportunity for fraudsters to take advantage of unsuspecting and uneducated investors. Since so much of the investing activity occurs online, it’s all too easy for a few individuals, especially if they’re outside the country, to create fake or fraudulent companies and promote them through online platforms.

Criminals may even create false websites claiming to represent legitimate startups and crowdfunding platforms, so it’s important to watch out for unsolicited emails and strange email addresses, especially if they ask for personal information like social security or credit card numbers.

Of course, it’s also important to be on the lookout for traditional signs of investment fraud, such as unrealistically high returns (especially if they’re guaranteed), lack of information about the business you’re investing in, and high-pressure sales tactics.

Crowdfunding isn’t a scam, but it is high risk

Crowdfunding is a high risk investment in new companies with a high potential for failure. Do your due diligence on any company you’re considering, be on high alert for fraud, and invest a small amount of money that you’re okay with losing.

If you think you’ve been defrauded by a broker or financial advisor, contact Silver Law Group today for a free case review.