What to look for in an equity crowdfunding investment

The recent explosion of equity crowdfunding presents a wealth of opportunity for
new businesses to thrive.

Entrepreneurs now have a viable alternative platform through which to secure the funding they need to launch their new venture, and investors’ options for portfolio expansion and increased return on their investments are significantly enhanced.

The risks involved in investing in start-ups are high though, and it’s imperative that potential backers complete due diligence and properly assess the risks both present and future prior to making any investment decisions.

Below is our guide on what to look for when considering making an equity crowdfunding investment

1. A powerful pitch. Prospective investors need to be captivated and enticed
   by a pitch. They need to be drawn in by the concept and convinced of the passion, drive, determination and business acumen of the entrepreneur first and foremost.
2. A clear, robust business plan. The pitch must be backed up by a sound plan
   for the venture which clearly demonstrates accurate current market viability, realistic and achievable financial targets and plans detailing how progress will be achieved.
3. A project with the opportunity to invest only what the backer can afford
   to lose. There is a significant chance that each new start-up venture may fail, so the risks of investment are high. If this happens, neither the crowdfunding platform nor the company itself will be liable to pay the investor back the money lost.
4. Opportunities to diversify. Investing all available funds in one project maximises risk, so all investors are advised to diversify their portfolio and spread available capital across a number of different types of investments to lessen risk. If one of the invested businesses fails, the remaining portfolio should be able to mitigate the losses.
5. At least a 50% annual return. Many experts assess that up to 90% of start-ups are prone to failure, so the risk is high. Success is absolutely possible, as long as investors back companies which they are certain are going to grow and deliver a decent return. As a general rule, 50% return is considered a decent return, however many investors may aim even higher than this to compensate for the lack of liquidity of a new business and the fact that they are unlikely to be able to release their capital for a number of years.
6. Exposure to future dilution. When a start-up grows and attracts more investment in the future, existing shareholders may find themselves subject to dilution; whereby their shareholding decreases as the company sells more shares. This may mean reduced voting rights and dividends as well as a drop in the overall value of the shares which could affect the viability of the investment. Prior to making an offer of investment via a crowdfunding platform, a prospective investor should investigate whether the entrepreneur is prepared to offer them protection from future dilution. This is usually done by inviting them to purchase additional shares to preserve their existing shareholding in advance of new campaigns for additional investment. Future dilution will make it more difficult for an investor to achieve their target return, so this must be factored into the initial decision to invest.
7. A clear exit strategy that offers a realistic return on investment.