Is Equity Crowdfunding a Good Way to Invest in 2022?

Backpack full of cash

An original MP Q&A with Tony Sablan, Managing Principal at Ultimate Wealth Strategies.

MP: What is equity crowdfunding?

TS: Equity crowdfunding is a relatively new extension of the traditional crowdfunding sites that have gained notoriety over the last decade. The big difference is in the compensation that can be offered. Traditional crowdfunding generally involves some type of product, service, or reward given to the funder for their investment. The newer equity crowdfunding sites can go a step further by curating lists of companies that give investors an equity position for their capital. This new system generally provides the opportunity to make investments in private companies that have selected one of the commonly utilized mechanisms, such as the regulated crowdfunding option for a limited raise by filing Form C with the SEC. Companies with larger funding needs can also attract capital through crowdfunding under Regulation A+ and submitting Form 1-A to the SEC.

Who can invest in companies fundraising through equity crowdfunding, and how do one’s income and net worth come into play?

The SEC has provided thorough guidelines for caps placed on equity crowdfunding investments. The limitation considers an investor’s risk tolerance by considering their annual income and net worth. If the annual income or the investor’s net worth is below $107,000, they can invest more than $2,200 or 5% during any twelve months when calculating from the lower figure of the two qualifiers. If annual income and net worth are above $107,000, investors can contribute 10% for the lesser of annual income or net worth during twelve months, but that is capped at $107,000. However, there is also an exception to the net worth calculation that requires the inclusion of liabilities on a primary residence while disallowing the value of that asset in the final total.

What are the risks associated with investing in companies via equity crowdfunding?

There are some potential risks to consider when evaluating equity crowdfunding as a possible complement to an investor’s wealth management strategy. Although equity crowdfunding is regulated, there is less oversight than publicly traded companies face. The added transparency of disclosures from public companies is an important component for investors to consider. Equity crowdfunding is relatively new when compared with other investment mechanisms. Most equity crowdfunding sites have existed for less than five years, and there may still be updated regulations released to govern their operations. Investment in private companies may come with an added layer of risk related to the heavy exposure to start-up businesses on equity crowdfunding sites.

What critical pieces of information should investors consider when investing in companies through equity crowdfunding?

Selecting investments should generally be guided by consideration of risk tolerance and personal wealth management goals. Working with a financial advisor may be an important step in evaluating equity crowdfunding as a component of an overall strategy. Considering an investment in a private company through an equity crowdfunding site may come with additional layers of risk related to unproven business models, limited balance sheets, and lack of financial information. Evaluating companies may not be an exact science. Still, individuals seeking to learn more about a specific business may conduct extensive research on the industry, trends, market positioning, and go-to-market strategy. Those components combined with insights from licensed financial professionals may provide helpful background to consider.

What resources can potential crowdfunding investors use to find the information you just mentioned?

  1. Industry trade journals often provide research on trends that a business might be included in.
  2. The SEC website provides helpful information to consider on equity crowdfunding.
  3. Equity crowdfunding sites generally give insights on related marketing information.

How can investors know the company they are investing in is legitimate?

Unfortunately, many high-profile investment schemes in the digital age have caused a great deal of harm to investors. Working with a licensed financial advisor in good standing may provide a layer of meaningful accountability for investors. However, financial information on private companies generally lags behind their publicly traded counterparts. So, that element is another layer of risk to consider.

What resources can investors use to research a company they’re looking to invest in through equity crowdfunding, and what purposes do they serve?

Each crowdfunding site provides a baseline of research information on the companies for their platform, including access to basic filings. An important metric to evaluate is the percentage of exits on a platform related to the number of companies seeking funding. That ratio is less than half of one percent on some of the most popular platforms. The data indicates most investors will be engaged in platform-specific trading on any equity that they have received. This dynamic can create another potential layer of risk for investors to consider regarding the financial standing of the crowdfunding platform. Most equity crowdfunding platforms are not required to register through a broker-dealer or an intermediary to offer securities. That could make investors especially vulnerable in a catastrophic event or fiduciary negligence by the platform.

How is equity crowdfunding different than purchasing shares of a public company, and what does this mean for investors?

Publicly traded companies, and the major exchanges their shares trade on, are generally regulated with more stringent standards and protections than privately held companies. The additional layer of less regulated crowdfunding platforms may create the potential for added manipulation of values. In addition, publicly traded shares generally offer a higher level of liquidity related to the amount of capital in public markets. As a result, privately held companies trading on crowdfunding platforms may potentially have a significantly smaller pool of buyers and sellers to execute trades at true market value.

DISCLAIMER: Nothing in this article constitutes professional and/or financial advice.

View this article in the December 2021 issue of MP.