Many young companies fail for lack of capital. With Crowdfunding making much more capital available, it seems plausible that more young companies will succeed. Even so, the nature of capitalism is that many will fail and investors will lose their money. And unfortunately, with so much money flowing through new channels, the nature of human beings is that Crowdfunding will attract its share of the outright unscrupulous.
You can never protect yourself completely, but here a few tips to reduce the risk.
If you are an Investor:
- Use common sense. If something seems too good to be true it probably is.
- A company financed by Crowdfunding is no more likely to be successful than a company financed the old-fashioned way.
- One of the great things about Crowdfunding is that you get to see a lot of companies. It follows that you can afford to be picky.
- By all means, register at more than one portal.
- Don’t invest in a company just because others are investing.
- Often, it makes sense to invest in industries you already know something about.
- Make sure you are satisfied with the due diligence.
- Figure out how much money the business must earn for your investment to be worthwhile, i.e., to earn a profit commensurate with your risk. Do you understand how the business will make that much money? If not, you probably shouldn’t invest.
If you are a Portal:
- You are going to be swamped with companies looking to raise money. Your greatest risk is that a company you sponsor turns out to be a fraud. Beware: con men are very good at what they do.
- Develop strong contracts with companies and investors, making clear exactly what everyone can expect, and what they can’t.
- Do not allow your portal to infringe upon the rights of third parties.
- Comply with all laws and in particular the securities laws. When – not if – investors lose money, the chances are very high that you will be sued.
- Buy insurance.
If you are a Company:
- You are now using OPM – Other People’s Money. Your expenditure of every nickel may be scrutinized by a plaintiff’s lawyer with the benefit of 20/20 hindsight. Have strong accounting systems in place.
- Develop strong contracts vis-a-vis investors.
- Disclose everything about your company up front, especially all the bad news, and otherwise comply with Federal and State securities laws. Your greatest risk, by far, is that you fail to comply with these laws.
- Make sure your portal is reputable and complies with the law also. If the portal doesn’t comply, you are going to be sued.
- Try to raise enough money the first time around.
- Make sure your corporate structure allows you flexibility in the future, including the flexibility to raise more money.
- Buy insurance.
Questions? Let me know.