In May 2016, a law took effect that allows anyone to invest at least some of their cash in startup companies. Until then, buying a stake in a small private business was something only wealthier investors could do. But now, similar to Kickstarter, there are a host of crowdfunding platforms that will allow you to invest in all kinds of startups, from tech brands to food trucks. And unlike with Kickstarter, once you invest, you’ll own a stake in the business and will have the ability to cash out — potentially after making big gains.
It’s all possible thanks to the Jumpstart Our Business Startups (JOBS) act, which allows anyone to invest in certain vetted startups. Vetted, in this case, means the startup has been listed on an online debt or equity crowdfunding portal that itself has been cleared by the Securities and Exchange Commission and the Financial Industry Regulatory Authorityto list startups raising money. These portals must prove that investors’ funds are protected from theft or computer malfunction, and nobody is engaged in unethical acts of pay-to-play.
To protect you from losing your life savings, there are other rules. Per FINRA and the SEC, if you have less than $107,000 in the bank, you can invest either $2,200 a year, or 5% of your income or net worth (whichever is lower). If both your annual income and your net worth are equal to or more than $107,000, then you can invest up to 10% of your annual income or net worth, whichever is lower. These were the rules Congress set up so that regular people without high net worths don’t go all-in on one company.
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So, just because you can, does it mean you should invest in startups?
Not everyone is rushing in. One year into startup crowdfunding, interest has been mixed: “Everyone in the industry thought there’d be more uptake,” Richard Swart, chief strategy officer at NextGen, told Bloomberg. “We all expected these numbers to be 2x to 5x what these numbers were.”
But Swart said in an interview with Mic he believes young investors looking to diversify their portfolios should still consider investing in startups. Is he right? Here is how experts say one should approach this type of investing, including the potential risks and rewards — plus how to get started, if it is the right fit.
Why investing in crowdfunded startups could be smart
If you end up getting lucky and putting your cash into a successful startup that eventually gets bought or even goes public, you could multiply your cash over just a few years. As Swart said in an email, it could “be like an exit from an angel round where an investor would be looking for returns of 10x to 20x what they initially invested.” That would be like turning $2,000 into $20,000 to $40,000. And if you get super lucky, like an early Instagram investor, you might multiply your investment more than 300 times over.
But those are best-case scenarios, and because the area so new, there’s not much reliable data on what kind of average payouts to expect if you invest in a startup. Swart said he’s seen decent, if more down-to-earth returns from startup crowdfunding in Europe. A successful investment in a startup “would be better than an index fund, better than the S&P 500,” he said. For Swart, regulated crowdfunding represents the first time an average investor can enjoy the same high-risk, high-reward opportunities as a private equity investor. “The return on a seed-stage investment can be really high,” he said.
One business now raising money is Cinco TacoBar in San Leandro, California. It was already a highly-rated restaurant and the company is now crowdfunding for a second location. This allowed investors to make loans in a company with a proven track record, and be part of the company’s growing success story.
Companies like Cinco also communicate with the backer about their idea, and what might be done to improve it. For example, here is their running dialogue with their investors. Swart says this connectedness is another reason, besides making money, to invest in startups. “The social logic [to regulated crowdfunding] is that you care about the company doing it,” for example if you’re really into backing a food company, Swart said. “It’s the same logic as Kickstarter or Indiegogo.”