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In this guide, CEO of NextFin, Sacha Bright gives hit tops tips on how to make informed decisions when equity crowdfunding, and how to remain risk aware.
Equity crowdfunding, as with any other type of investing has the opportunity to make you money, but equally the risk to lose it. The risk is considered higher because a large percentage of small and growing businesses fail, or change from being a growing business to a more sedentary business (remaining at one level, never exiting, never growing). However, it is equally as true that when a company does well, the returns can be phenomenal - as the company BrewDog highlights.
Professional investors, such as venture capitalists and business angels expect just one in every 10 of their small business investments to do well and deliver fantastic returns. Indeed, many would say that they would expect just one in 20 such companies to do that. These are professional investors who do their research, understand the business and the sector before investing and have a pretty good idea of the types of management structures that are poised to work or fail because they have years of experience.
Yet, even they expect very few of their portfolio companies to do well. So why invest at all?
The answer is that when these companies do well the returns make it worthwhile. The professionals seek to mitigate the risk of investing in smaller unlisted companies by diversifying across sectors and getting involved in the businesses themselves – sitting on the Board and providing assistance to help make success happen.
They also utilise tax mitigation structures like Enterprise Investment Schemes (EIS/SEIS) to minimise loss and off-set their tax liabilities.
To begin with, do your research. How have other companies in this sector/market performed? Is there a higher than average default rate (businesses that close) for instance than in other sectors? Or indeed is there a recent example of a real success in this sector? If there is, this may explain interest in the company from others – the hot new thing – but doesn’t mean that it is a foregone conclusion that it will do well.
Try to look at diversifying. If you have an investment in a green energy company do you really want another one? Whilst it might feel like the more companies you invest in with one sector offers the greater opportunity for success, what this also does is expose you to sector risk. Think about what happened to the Banks in 2008, they all suffered. This happens to sectors all the time, albeit for different reasons; sometimes the sector itself suffers and all the companies within it – regardless of quality – suffer too. In smaller unlisted companies and start-ups that sector risk is amplified because they are not yet established.
Is the investment story compelling? Do you believe that this team and this product or service can cut through and do well? Why do you feel that way? When you understand what it is about this story that compels you it can help you to judge if it will compel others too.
What are the professionals doing? The equity crowdfunding platforms should let you know if professional investors are taking a stake in a company and if so on what terms. Sometimes following the professionals is an indication of strong fundamentals for the sector or the company, but remember the professionals expect failure, so this is not a rubber stamp of success by any means.
Ultimately having the right information to hand means that you are able to make an informed decision. At NextFin we believe informed decisions are the right decisions. This is why our analyst summaries are offered free to our users and you can access the full independent crowdrating reports on our website.
Authors: Oliver Murphy & Sacha Bright
Disclaimer
To the best of our knowledge, the information we have provided is correct at the time of publishing. Sacha Bright is not a solicitor or accountant and we recommend that you seek professional advice on any topic discussed.
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