HOW TO INVEST IN STARTUPS – BUT SHOULD YOU?

I get a lot of interest in IPO’s and high profile public offerings are often what get people interested in investing. And while it is very difficult to buy stocks in the big name companies (Uber, Snapchat, Airbnb, etc) before they go public, it is now possible to get in on the ground floor of many no-name startups. 

The Jumpstart Our Business Startups Act (JOBS) was signed into law in 2012 with the intent of making it easier for startups of all sizes to get funding. It relaxed the rules and allowed almost anyone to “invest” in startups and there are many websites where you can do just that. The intent of the act was to create more jobs by making it easier for companies to gain access to money so they could grow, which is why it was passed with bipartisan support. Whether the JOBS Act really has created more jobs though, is a topic for another discussion.


The Popularity Of Crowdfunding 

By now you know of many websites that use the crowdfunding business model. Kickstarter and Indiegogo are for businesses or entrepreneurs that need to raise money for a product or idea. Lending Club allows those in need of a loan to go straight to the people instead of going to a bank. GoFundMe is where people can give money to others who are in need due to medical emergencies or some other life event.

There are other examples of sites like these as crowdfunding is very popular. Now it seems, the passage of the JOBS act has meant that startup investing via this same business model is gaining popularity as well. Anybody can now “invest” (I use quotes because it is more like gambling than investing) in startups by going to sites like Wefunder, StartEngine, MicroVentures, and SeedInvest. You no longer need to be worth a million dollars to buy into startups that aren’t public and this allows small companies to get funding that they might not have been able to get before the law was passed. 


But The Risk Is VERY High!

First of all I want to say that I would NEVER recommend using any of the above mentioned sites and I would NEVER put my money into those kind of startups. The liklihood that you will never get any money back is super high. I was disappointed that only Wefunder outlined the risk on the front page of its website while the other sites, if they did go over the risks, had them hidden in hard to find places. From Wefunder’s FAQ’s:

Wefunder risks

The simple fact that you must understand before putting any money toward those businesses listed on one of those startup funding sites is that those companies are there because THEY CAN’T GET THE MONEY ANYWHERE ELSE! They need you, the little guy to pitch in to keep their business going.

Bigger startups that have REAL chances of succeeding and eventually going public don’t need your money. The Lyft’s, Snapchat’s, Pinterest’s, etc. of the world can get plenty of funding from investment bankers, venture capitalists, hedge funds and other sources that have big dollars to invest. Those big companies will NEVER be found on a startup site like the ones listed above. 


Will You Get Your Money Back? Will You Make Money?

When any company goes public (IPO) on any stock exchange, one of the things that happens is that the initial investors finally have a payday. Depending on how successful the IPO is, they may get some of their money back, all of their money back, or make a killing. But for the many months/years before the IPO, they had their money stuck in the company with little benefit to them. 

It will be no different with any of the startups you invest in on any those equity crowdfunding sites. You may not be able to get your money out until 1) the company gets bought out or 2) there is an IPO. And for most of the companies listed on those sites, the chances of either payday event happening is very small. That means the money you put into each investment may be stuck there for many, many years. Some of those startups will go bankrupt and you will lose everything. And maybe a few of them will end up making money for their investors but will you be lucky enough to have picked the right ones?

Always remember that those startups can’t find funding from traditional methods and that alone should make you extremely cautious. Just because other people are “investing” in them doesn’t mean you should! Putting money in any of the startups that are trying to find funding on those sites is pretty much like playing the lottery. I would advise to never do it with money you need and you should never expect to get your money back or make money.


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