1. Know what you are buying
Startups can offer equity or debt, or different classes of shares with different rights. Understand what you are buying and what rights you have. In an equity investment, the investor becomes a shareholder, and owns a small part of the business. Whether the shareholder has a vote or not depends on what sort of shares the startup is offering, and you might not have any say in the company's direction. Until the company "goes public" and does an IPO, the only way to get any of your money back is through the private markets: finding an accredited investor (someone rich) to buy your shares, selling the shares back to the company (if the company wants to buy them), or selling the shares to angel Investor or venture capitalist who is interested in the company. It is not as easy as selling shares on the public markets. If you buy debt securities, you are in effect lending money to the company and taking a chance that it will be able to pay you back when the time comes. If the company is very successful and goes public, you will not be able to benefit as much as if you had bought shares, but if the company goes bankrupt you stand a better chance of getting your money back than someone with stock.
2. Be aware of the possibility of fraud
Unfortunately, where there is money, there is fraud. While crowdfunding offers a welcome source of funding to small companies that are unable to get bank loans or access the formal capital markets, it also creates an attractive platform for fraud. Where people invest only small amounts of money, they are unlikely to want to pay lawyers to pursue fraudsters, and class action lawyers are unlikely to think such cases worth their while. That’s where CrowdCheck comes in. We’re a team of experienced professionals who will conduct due diligence for any startup that signs up with us. Due diligence is the legal term for kicking the tires of an enterprise to make sure it exists, its founders are who they say they are, and that it’s doing the business it claims to be doing. CrowdCheck collects this information for potential investors to use to make better- informed investment decisions.
3. Realize that the company may fail
Then there is good old-fashioned failure. The founders may have a falling out, the idea might be good in theory but poor in execution, new competitors might emerge in the market, a global economic crisis might hit, or any number of other things could happen. The ability to fail and bounce back is something our country and prosperity is built on. However, you must consider whether you can afford to lose your all your money if the company fails.
4. Don’t overpay
How do you know if what you are buying is worth what you paid? It’s all about getting the valuation right. Remember that the valuations that you see are produced by the company itself. Think about the assumptions the company made in determining its valuation, think about the industry it is in, and decide for yourself. If the valuation is wrong, when the VCs or angel investors come in and value the company at less than you thought, you will lose money. You may also be “diluted” (end up owning a smaller percentage of a larger company) in later rounds of financing, so you may end up owning less of the company than you originally thought.
5. Educate yourself
Know the industry you are investing in. Research the market for yourself, in addition to reviewing the material the company presents. It's always helpful to do some independent research. If you come across something that you don't think the company has considered, ask the company. Venture capitalists and angel investors who have experience in the industry often provide ideas and feedback to help the company improve when they make their investments.
6. Make sure you can sleep at night
Early stage investing is risky. The potential returns are great, but so are the risks. Invest an amount that is within the legal limits, which range from $2,000 for regular folks to $100,000 for the more wealthy. But it has to be an amount you don’t mind being tied up for an unknown period of time, and that you can afford to lose. Making a profit with your investment could take several years, many years, or never.
7. Be part of the revolution!
Risky as early stage investing can be, it is also a great feeling to know that you have supported a company you believe in, and given support to an idea that, without your funding, would not have been able to get off the ground. That is something you can take pride in - when banks and other established institutions refused to help small businesses, you reached out and gave an entrepreneur a helping hand. Even if you don't get a monetary reward from that, it's a good feeling to know that you are part of the revolution that is happening in funding small businesses.