How to Be a Savvy Crowdfunding Investor – Part 1

In yesterday’s post, I discussed the details of three main risks that Crowdfunding investors will face when investing in Crowdfunded businesses – small businesses risk, liquidity risk and the risk of fraud.  This post presents a few strategies that will help investors mitigate these risks and increase their chances of making successful Crowdfunding investments.  At the bottom of the post, I have pasted in a quick-cheat graphic that you can refer to rather than having to read through this whole post again.  I am sure you all will set it as your desktop backgrounds.  Thank me later.

To reduce small business risk, there are several strategies that you can implement to increase your chances of success.  The first is called diversification, which can include such strategies as spreading your money out across several investments rather than investing a large amount in one or two businesses, as well as spreading money out across businesses in different geographies and industries.

For example, if you have $2,000 to invest in Crowdfunded businesses, you will have better chances of succeeding if you invest $100 in 20 different companies, than if you invested $1,000 in two.  In addition, if you decide to invest in 20 different companies, you may want to invest in several different industries and geographies; that way, if one industry or geography has a downturn, you will be able to make it up in other industries or geographies that are doing well.

Strategy #1: Don’t put all your eggs in one basket – diversify by investing in several companies rather than one or two, and invest in several different industries and geographies.

In addition to diversifying, you can help reduce the small business risks by doing some simple research on the companies that you are considering.  All of the information that I am pointing out here is required to be provided in a business plan by the company raising money, per the JOBS Act.  This post is meant to highlight sections of the business plan we think you should really scrutinize.  (CYA Note – All of the other sections are important to consider, as well, and you should also do some research outside of the information provided by the platforms and businesses.  I only want to highlight a few sections that might otherwise not be given much deserved consideration).

The first is the “Use of Funds” section.  Be sure to pay close attention to how the business plans to spend the money you invest, and be thinking about how long it would take, based on their plan, for them to run out.  As I pointed out yesterday, you want to watch out for what they are spending money on and see if they plan to spend money on smart projects.  I would not think you would want to end up investing in a business that raises $200,000, of which $175,000 is going to the CEO’s salary.

Strategy #2: If you are not comfortable with how a company plans to use their funds, you may want to pass.

You will also want to pay close attention to the management team.  Do they have experience running or starting a business; do they have experience in the field they are trying to get into?  A bad management team is a major deal killer for professional investors, so it should be for you, too.

Strategy #3: If you are not comfortable with the management team, you may want to pass.

This next one may seem obvious, but I will say it anyway.  The idea may be a great idea that you love, but can it/does it make money?  There are plenty of good ideas out there, but there may not be a good plan to monetize the idea.  The financial section is a great place to find the information you will need to help with this, as you can identify in their financial section if the projections and assumptions are realistic.  You should not only question their financials, but you should consider such factors as competition (how are they different?) and barriers to entry (is it too hard for them to enter the market/is it too easy for competitors to get into the market?).  The SEC will likely require businesses to disclose these factors, but if not, be weary of companies that omit key obstacles or risks.

Strategy #4: Is the great idea able to make money?

We will stop with the four strategies you can employ to mitigate small business risk for now.  In tomorrow’s post, I will address the other two risks I mentioned yesterday, liquidity risk and fraud risk.  However, I will go ahead and post the cheat sheet, and you can get a head start on tomorrow’s post.