Crowd-funded investing for the average Joe?
Legions of small investors may soon unknowingly face a new danger -- crowd-funded investing.
Under the Jumpstart Our Business Startups, or Jobs, Act signed by President Barack Obama last April, small investors will soon be able to make crowd-funded investments by buying shares in startups and small companies via fundraising portals on the Internet. Previously, these shares were only sold to accredited investors with a net worth of $1 million or annual income of $200,000, and a sophisticated knowledge of startup companies.
Now state regulators and investing observers worry that these high-risk investments may result in a trail of losses for smaller investors who aren't used to navigating the less transparent, more complex startup market.
"More than half of all small businesses fail," says Bob Webster, a spokesman for the North American Securities Administrators Association. "Going into a crowd-funded investment, assume that it, too, will fail."
Below, we offer some tips to follow before getting into crowd-funded investing.
Potential for fraud
A crowd-funding gold rush is already happening, Webster says. Sites using the term "crowd fund" in their domain names have skyrocketed from less than 900 before the act was passed to 9,000 currently, Webster says. "A lot of these sites are merely shells waiting for final regulations," he says.
And that's before the Jobs Act has even taken effect. Though it went into effect last year, the Securities and Exchange Commission, which is charged with implementing the law, has delayed issuing final rules.
More than 20 separate Jobs regulations still need to be addressed, says Barbara Roper, director of investor protection for the Consumer Federation of America.
"They cover wide-ranging issues, such as regulating portals that sell crowd-funded shares," she adds. Even so, Roper is concerned that crowd-funded investments may still be "a disaster, even if the SEC does everything right, since many startups fail."
To be sure, NASAA has flagged crowd funding in an investor alert, as the potential for investor fraud also exists, Webster says. "Con artists gravitate toward the newest thing."
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As with many investment opportunities that get a lot of media buzz, crowd-funded investing carries some serious risks.
It used to be that accredited investors with over $1 million in investible assets got to get in on the ground floor at startups through venture capital investments. But thanks to a law passed last year, small investors will soon be able to invest in startups through crowd funding.
But small investors should think twice before sinking serious money into crowd funding. First off, it takes a lot of research to tell the difference between the next Facebook and the next Pets.com, so if you're not prepared to spend some shoe leather researching companies, don't bother.
If you do decide to take a chance on crowd funding, be sure you don't put all your eggs in one basket. Most new companies fail quickly, and you'll want to spread your investments over a few companies to make sure you don't take a total loss on one.
Finally, don't expect to get your money out quickly. Venture capital investments are highly illiquid, and most startups take a long time to return any money to investors.
More investors to fuel startups
Before the Jobs Act, small investors were barred from buying equity shares in startup companies that hadn't yet gone public. Only popular crowd-funding sites such as Kickstarter.com allowed mass small donations to be made to startups but not actually receive an ownership stake.
The Jobs Act is aimed at broadening this small pool of investors and pumping money into new companies starved for capital. Touted as a way to democratize the startup process, the act allows companies to raise up to $1 million from small investors, with investors making less than $100,000 able to invest either $2,000 or 5 percent of their income, whichever is greater, and investors making more than $100,000 able to invest 10 percent of their income. Offerings will be made to investors via online funding portals and broker dealers.
Congress, which wants to keep stimulating the economy, wants to see the final regulations resulting from the act to be released soon, Webster says. "Meanwhile, the SEC is making sure that the regulations are done correctly and not rushed through."
Still, Heath Abshure, an Arkansas securities commissioner and president of the NASAA, says crowd-funded investing is going to be difficult to police. "Only the SEC can review offering documents, which are the main disclosure document for investors, but there are zero additional SEC resources for policing," he says.