Ordinary investors can buy shares of fledgling companies, if they dare
In the old days, an investor hoping to get in on the ground floor of the next Google or Facebook had a couple of options: have a friend or relative on the inside, or sign on with a big brokerage firm handling the startup company’s private placement—a sale of stock that hasn’t yet gone public.
Not anymore. Ordinary investors now can buy shares in startups that are just getting off the ground, sometimes for just a few dollars. If, that is, they are willing to take on a whole lot of risk.
It all started with the Jumpstart Our Business Startups Act in 2012. Since the act’s Title III took effect in May 2016, people no longer have to be well-to-do “accredited investors” to buy into startups.
Their stake can be as little as $10, or as much as they like, within Securities and Exchange Commission limits based on income. Investing is done through the soaring number of online “equity crowdfunding portals” like EquityNet, Fundable, AngelList and Crowdfunder.
But along with hopes of 100-fold gains come big downsides. Many of these startups fly beneath the radar of big venture investors who vet fledgling firms. Often, they aren’t promising enough to go public the traditional way, and they lack a track record, proven product and thorough financial disclosures. And since their shares aren’t publicly traded, it may be impossible to cash out until an exit event like an IPO or buyout, and the firm may tank while you wait.
“Quite honestly, it’s as close to gambling as you can get. You are dealing with a level below penny stocks,” says Keith Hamilton, owner of Hamilton & Associates, a registered investment-advisory and wealth-management firm in La Jolla, Calif. When clients want to invest in startups of any kind, he says, “I tell them to call it their gambling account.”
The crowd gets bigger
This new method of buying into startups is the latest and hottest development in the broader field of crowdsourcing.
Money-lending sites like publicly traded LendingClub Corp. make loans from a pool of investor money and pass payments back to investors. Charitable sites like Kickstarter allow people to give to causes that may be too small for ordinary foundations, like helping an individual accident victim with living costs. Rewards portals such as Indiegogo allow donors to contribute to specific projects such as an independent film, and offer perks like a prerelease showing.
Equity crowdfunding—where contributors get actual shares in businesses—began with portals like MicroVentures, which largely serve accredited investors—people with at least $1 million in net worth excluding the home, or incomes over $200,000.
The 2015 Crowdfunding Industry Report by Crowdsourcing LLC’s Massolution.com, the latest industrywide data available, shows $16.2 billion raised through the various types of crowdfunding in 2014, up 167% from the year before. At the end of 2014 there were more than 1,250 crowdfunding portals world-wide, versus 850 in 2012.
“The floodgates have been opened!” the Massolution report says, and industry experts think growth has continued at a fast clip since that report was written. Many predict more money will be raised in coming years as the number of platforms grows, with new players occupying narrow niches such as fundraising for specific industries and a few big platforms taking an ever-larger share of the market. “International expansion will accelerate,” the report predicts.
For now, the lending, donation and rewards sites dominate crowdfunding. But the equity sector is only likely to grow, as more investors and entrepreneurs learn about it, says John Rampton, an experienced startup investor in Palo Alto, Calif., who has invested in a startups through DreamFunded.
“In the future, a lot more startups will have a chance of being successful because of the funding they can get without [the help of] the institutional investor,” says Mr. Rampton
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