What you need to know before investing through equity crowdfunding platforms

Photo credit: Guilherme Nicholas

With the rise of equity crowdfunding throughout Europe, Asia, and the United States of America, your everyday investor will soon be inundated with opportunities to invest in the next Uber.

Go through the pitches of these companies and you’ll be hard pressed to find any that don’t believe that they operate in a massive market. Not only have they found an infallible unique selling proposition (USP), they believe that they are well on their way to being huge.

Investors be warned, these are some of the riskiest investment opportunities you will encounter. Upwards of 80% will not make you any form of returns and, if you’re lucky, the one out of ten that you invest in that makes a decent return will just about cover your losses and rake in some profit.

While the decision to invest or not is ultimately yours, here are some pointers for you to take note of with regards to finding the most suitable platform through which you invest.

Am I protected should shares be diluted?

Pre-emptive rights allow existing investors to purchase new shares first before they are offered to new investors. With pre-emptive rights, an investor can ensure that his percentage ownership of a company remains the same in future rounds and avoids dilution.

You must have seen The Social Network and cringed as Facebook diluted the shares of co-founder Eduardo Saverin from 30% to just 0.5%. Any investor without pre-emptive rights could invest in the next Facebook but not see any returns, all in an entirely legal process.

Photo credit: BLOODYDIFFICULT.TUMBLR.COM

Say a company has 100 shares.  You buy 10 of those shares and therefore own 10% of the company. In a year’s time, the company issues 100 new shares. Before a new investor is allowed in, you as an existing investor should first get the chance to buy the shares and keep your 10% ownership. Without pre-emption, the company could issue 1,000,000 new shares and sell them to an outside investor for a discounted price, reducing your ownership of the company to effectively nothing.

Who conducts due diligence?

Regardless of any external due diligence conducted, you should always conduct your own due diligence and only invest money that you can afford to lose.

Some platforms are configured in a way where some form of independent due diligence is conducted. For example, at SyndicateRoom (Disclosure: the author is the co-founder of SyndicateRoom), each investment opportunity must have received investment from a prominent early stage investor (such as Business Angel, Business Angel Network, Venture Capital group or others) before the opportunity can be listed on the platform. This model of having leading investors involved is known as the investor-led model. The lead investor does their own due diligence, negotiating the terms of the valuation and terms of the investment, and allows the crowd to invest alongside them.

In contrast, most platforms operate on what is known as the entrepreneur-led model. The entrepreneur sets the terms and valuation of the investment, and then the crowd is allowed to invest.

While there are no sufficient data points to ascertain which model offers crowd investors better investment opportunities, one may expect that having an experienced lead investor conducting their own due diligence and negotiating the valuation and terms could lead to better returns.

Am I a direct shareholder, or investing through a nominee structure?

Is the financial regulator authorised?