People look to startup investing for three main reasons.
They want diversification in their portfolio.
The potential upside of their investment could mean huge returns.
And…they want the bragging rights that come along with picking a winning company.
But it takes a strategy to make these aspirations into a reality.
What’s your strategy?
The first place most people turn when wanting to invest in early-stage startups is what is called Equity Crowdfunding or RegCF.
Let’s look at equity crowdfunding from two different angles.
First, for founders and entrepreneurs, equity crowdfunding is an easily accessible way to raise capital to grow their business. By turning to the “crowd”, i.e. independent investors, many small investments can add up to a substantial amount of funding.
Next, for investors, equity crowdfunding is the number one easiest way to invest in unlisted (not yet public) companies. If an investor isn’t accredited, equity crowdfunding is the only way they can invest in these types of pre-IPO companies.
The whole process takes place on online platforms that connect startups to investors. These usually have low prerequisites for investors, allowing them to sign up and make investments with ease.
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How Do Investors Benefit From Equity Crowdfunding?
There are many benefits to equity crowdfunding for investors. Here are just a few of them.
1. Diversify Your Portfolio
You know the saying — don’t put all your eggs in one basket.
This applies to investing as much as anything. I find many investors who are missing out on startup investments. They will often have a variety of low-risk investments like bonds or CDs, and then something with moderate risk like stocks.
Most of them just don’t realize they aren’t diversifying their portfolio across risk levels.
Often, they have no idea that there is a high-risk, high-reward investment like equity in a startup or how this can benefit them.
“What, like on Shark Tank? I can’t invest like that!”
Little do they know, they actually can have all of the fun of angel investing with the same high return potential but for very low minimum investments. This is what equity crowdfunding is all about. Nearly anyone can do it.
2. Highest Return Potential
As I touched on before, the returns on startup investments are incredibly high. They yield higher returns than venture funds, hedge funds, the S&P 500, and NASDAQ.
Investing through equity crowdfunding platforms, you should be aiming at startups that yield 20, 50, or 100 times your initial investment.
It’s incredibly exciting when you get a big payday from a startup you supported. There just isn’t another feeling like that. A big win means one investment can pay for dozens and dozens of future ones.
For this reason, I always say startup investing is the ultimate tool for wealth creation. Don’t get me wrong, if your goal is wealth preservation, you could be fine with a low-risk, low-reward index fund. But, for creating generational wealth, there isn’t another type of investment that comes close.
3. Tax Incentives
Congress decided that investment in startups is important, so they added sections to the tax code to encourage it.
For example, section 1045 of the tax code states that profits from qualified small business investments (startups) can be rolled over into new investments in small businesses. This way, the first startup is tax-free.
Section 1202 allows investments in certain small businesses to be sold (when you exit) tax-free.
Another good one, section 1244, allows you to deduct up to $50,000 from a loss in an investment in your tax returns as an ordinary loss instead of a capital loss, potentially saving you a bunch of money.
These all depend on the companies you invest in and your specific situation, but the tax incentives can be really attractive to many investors.
To learn more startup-investing strategies, download our free Startup Investor’s Playbook.
What Are the Drawbacks of Equity Crowdfunding?
Now that we have seen the pros, let’s look at the cons.
It’s not all roses and sunshine, there are some things to consider if you want to take part in equity crowdfunding.
1. It May Be Years Before You See a Return
Investing in startups is a long-term game.
Startups need time to scale for you to get returns. It usually takes around 5 years to get your payout. For many investors, this can be frustrating. You will rarely if ever get a quick exit on a startup.
If you suddenly need cash, you won’t be able to sell your shares. These investments are illiquid and will be locked up until a liquidity event like an IPO, acquisition, or bankruptcy occurs.
Luckily, this can be mitigated by smart investing. Rather than investing in ten startups at once, you can spread investments out over a few years so you will get returns periodically. This will ensure a healthy return cycle.
Dilution is a necessary evil of startup investing. Here’s how it goes.
You invested in a startup and received shares in the company. Your number of shares and your percent ownership of the company are based on its valuation at that moment in time.
Now, let’s say the startup is doing well and has grown. That’s great for your investment, but now the startup needs more capital to continue scaling. It will hold another round and sell more of the company to keep the ball rolling.
This new round will always shrink your slice of the pie. Before, your X number of shares represented 10% of the company, but now, the same shares represent only 2% of the company.
I’ve outlined the most vital pieces of MY Angel Investing strategy in this FREE investing guide. Click here to download your copy of the Startup Investor’s Playbook.
What Is The Biggest Advantage of Equity Crowdfunding?
The single biggest advantage of equity crowdfunding is how crisis-resistant it is.
The crowdfunding sector isn’t linked to other financial markets. When the stock or real estate market is suffering, crowdfunding can be booming. Often, crowdfunding gets kicked into overdrive specifically when there’s a crisis as raising capital through other methods becomes more difficult.
On top of that, equity crowdfunding is all about startups. Startups can persevere through any crisis, especially when they solve the problem of the day or work around it.
Throughout the COVID-19 pandemic, we have seen startups and seed funding stay fairly strong. Many huge successes have come out of industries like healthcare, home goods, and e-commerce because they swim with the current, not against it.
Why Is Equity Crowdfunding So Popular?
Equity crowdfunding has been growing rapidly. If you told me five years ago that this many people would be investing in startups, I’d have called you crazy.
Apart from the potential to build wealth, there are a few unique things that make equity crowdfunding so popular.
1. It’s Easy to Get Started
On most equity crowdfunding sites, you can sign up and make your first investment in just a few clicks. You don’t need to have powerful angel investing friends or be an expert on startups to get involved. And with a resource like this, you’ll be able to implement your own angel investing strategy.
Most other types of investments have much stricter requirements and steeper learning curves
2. Small Investment Size
You can back a startup for as little as $100 on most equity crowdfunding sites. This ties into accessibility, but it also enables a very secure and profitable investment strategy.
Instead of investing $10,000 into one company, you can invest $1,000 into ten companies. Throwing out a wide net will catch the winning startups and mitigate the risk of failures.
With angel investing, it’s always better to invest in more companies. The rule of thumb is to have about ten startup investments at a time. With equity crowdfunding, nearly anyone can do this because of the incredibly low minimums.
3. Support Real Businesses
Investors love funding innovative ideas made by passionate entrepreneurs.
There are real businesses out there that need your help to grow. While you build wealth and improve your financial situation, you are making a real impact on the world. The startup-angel investor relationship fuels innovation and greatly helps the economy.
Best of all, when you support a startup and watch it grow and succeed, it’s just the best feeling in the world.
On equity crowdfunding platforms there are low minimum investments, easy setups, and few restrictions. This has opened up the world of angel investing to millions of regular investors.
Equity crowdfunding is a high-risk, high-reward strategy worth fitting in your portfolio. The return potential is huge and it doesn’t take much money to place multiple investments that will mitigate risk and give you a nice return cycle.
Just keep in mind that your investment will usually be held up for years without a way to liquidate it.
If you play your cards right, you can grow your wealth with equity crowdfunding and have fun doing it.
To learn more about my startup investing strategy, click here to get your FREE copy of the Startup Investor’s Playbook.