Investing can be rewarding, but risk and reward go hand in hand. Crowdfunding is a particularly risky area – we bet on a company being ‘the next Google/Amazon/Facebook/Uber’ and invest in its infancy, hoping to get back hundreds or thousands times our investment back when it exits, but sometimes forget that vanishingly few companies achieve that kind of success.
The odds are against you as an investor, but there are two critical rules you should follow when investing:
1 - Never invest what you can’t afford to lose
Don’t bet the house, it’s that simple! There’s no safety net – if the company goes bust, you are very unlikely to see your investment returned to you in whole or in part.
2 - Diversify your investments across multiple businesses, sectors and asset classes
Remember: 90% of startups will fail within a few years. Just to break even, then, the successful 10% need to be worth at least 10 times more than when you invested. You can improve your odds of finding ‘the one’ by investing in more companies – a good number to aim for would be 30.
As much as focussing your money in one company is a very risky strategy, limiting yourself to one sector can be just as bad – ‘black swan’ events that affect entire sectors can and do happen.
Expanding that further, holding a combination of securities like government bonds, currencies, commodities and equity is a good idea.
There are a few things to remember about crowd equity investing:
1 – You’re playing a long game
The company probably won’t exit for many years; 7-10 would be a good number to bear in mind. Earlier exit opportunities are unlikely as there are no major markets for trading shares in companies this young.
2 – Don’t expect dividends
Startups need to re-invest heavily in growth and will have substantially negative retained earnings for a few years, so couldn’t pay dividends even if they wanted to.
3 – No-one listens to you
Even if you have voting rights attached to your shares, you’re probably a drop in the ocean. Most companies will ensure the founders and/or a key early investor hold a majority, giving them control of the company.
4 – Unless you’re investing a lot of money, you’re not a priority
When a company comes to raise more money a major new investor could make a tempting offer that will see you marginalised by diluting your shares, pricing you out of the next round or inserting themselves ahead of you in the repayment schedule. If they gain a majority, there’s nothing stopping them from completely re-writing the terms of your investment.