New federal rules allow privately held businesses to solicit equity investments from “accredited investors” — those with more than $1 million in net worth or $200,000 in annual income. The Securities and Exchange Commission is expected to soon release rules that will also allow unaccredited investors to make so-called crowdfunding investments.
While funding private ventures may be a tempting way to try to boost your investment returns, be careful: Investing in privately held businesses, particularly startups and early-stage businesses, is generally far riskier than investing in publicly traded companies.
Here are three things to consider before making an equity investment:
1. Research the business and management team.
If you hear about a business investment opportunity through a web site or an acquaintance, approach it cautiously. Learn as much as you can about it. Search for news coverage of the business and talk to company leaders. Ideally, the management team has a proven track record of starting and running successful businesses. Ask questions: How will the business generate revenue? What successes has it had to date? Have major angel investment groups or venture capitalists invested in the firm? If you have any doubts or can’t get satisfactory answers to your questions, you may want to walk away. Crowdfunding sites vet offers to different degrees, so it’s a good idea to find out what level of due diligence a site conducts before funding ventures through it.
2. Don’t let emotions trump sound judgment.
Some of the most popular crowdfunding campaigns are those with an emotional tug — a startup with an inspirational story or creative business plan. While it’s easy to get caught up in the moment, base your investment decisions on sound financial reasoning. Take time to evaluate how the investment fits into your overall financial plan.
3. Understand the risks.
Devoting a small portion of your overall portfolio to equity crowdfunding may be rewarding, but don’t overdo it. Remember that startups and early-stage businesses have a high rate of failure. Generally, less than 20 percent of a portfolio should be devoted to high-risk investments such as private equity.
Your Wealth Advisor can help you determine how private equity investments fit into your overall financial strategy.
