Invest Like You're on Shark Tank
As dads say, “Don't be afraid to invest in things that separate you from the ground and friends.”
Executive Summary
Private companies with growth potential who’d like to sell a portion of their business have a new way to raise capital and attract fans. Selling a portion of your business can help brand affinity and drive long-term customer loyalty. Allowing retail investors to invest in private companies comes with its risks, but can be a great way to diversify your portfolio from traditional stocks. In today’s world, by the time those companies’ stocks you invest in have gone public, private institutional investors have made a bulk of the money, leaving retail investors to pick up the scraps.
Recent regulation has opened access for companies to gain funding through non-traditional means. Why is this important? There are only so many institutional investors in the world, and that capital can only get allocated so efficiently, thus I believe this helps fill a gap in the capital markets.
Enabling investors to partake in helping funding small companies they believe in and with whom their values align can create flywheel effects for those companies. Why is this important? Loyalty programs are great, but having investors that are likely more willing than a traditional customer to evangelize your product is a huge multiplier effect for your business as word of mouth is still key nowadays.
But you need to remember where you are on the risk/reward spectrum. Why is this important? Don’t expect most investments to yield “Uber-like” returns.
#1 - Recent regulation has opened access for companies to gain funding through non-traditional means
From a regulatory perspective, ‘equity crowdfunding’ is the latest opportunity for retail investors to gain access to private capital. Regulators were forced to move as sites such as Kickstarter and others give investors ways to participate in new startups, but with little legal protection. As recently as 2015, the concept of ‘Reg CF’ (early stage) and ‘Reg A’ (late stage) funding were born which allows private companies to sell stock, though there are limits on how much equity companies can sell in these arrangements. In general, the top three platforms (Wefunder, StartEngine, and Republic) alone account for over 80% of 2020 total Reg CF deal flow in terms of the amount of capital raised.
How much can retail investors invest in these offerings? With Regulation A+, a non-accredited investor can only invest a maximum of 10% of their annual income or 10% of their net worth per year, whichever is greater. There are no restrictions for accredited investors.
With Regulation Crowdfunding, non-accredited investors with an annual income or net worth less than $107,000, are limited to invest a maximum of 5% of the greater of those two amounts. For those with an annual income and net worth greater than $107,000, he/she is limited to investing 10% of the greater of the two amounts.
Investors usually have to invest a minimum, $100 or more, to gain access to the funding round. An example of an offering from StartEngine below.
#2 - Enabling investors to partake in helping funding small companies they believe in and with whom their values align can create flywheel effects for those companies.
This new type of investing also creates a great flywheel for companies as they look to grow. These investors are much more likely to be advocates for your brand by either (i) spreading the word, or (ii) purchasing your product. Companies can ultimately create lots of operating leverage through this type of fundraising. Much more leverage than what a traditional loyalty program alone can give your business. If you have good word-of-mouth, then it means that people are talking about your company, it means that they like your products, and that they like your products enough to tell other people about them. In turn, that probably means that some of those customers like your company enough to actually want to own a part of it. When your customers love your product and the service you provide, then they may want to own a part of what you are building, to share in your success, and to invest their own money into being part of it.
Another reason to consider equity crowdfunding is its gaining popularity. According to data from McKinsey & Company, the value of alternative investments worldwide increased 125% between 2005 and 2013. Unsurprisingly, the number of campaigns on equity crowdfunding platforms like StartEngine has also increased significantly. In 2017, we saw over 38,000 pitches to private investing participants. Based on data from Statista.com, experts predict we’ll see 67,000 proposals by 2024. In other words, this sector is on fire, necessitating at least a rethink on portfolio growth.
#3 - But you need to remember where you are on the risk/reward spectrum
Before you invest in anything, you should be aware of the risks. According to Forbes, “90% of startups fail.” While you can deploy analytical methods to find the viable 10%, the raw odds absolutely do not favor you. At the very least, you could be looking at holding your position for many years without any accrued benefits. Therefore, it’s imperative that you do your due diligence on any venture. Don’t be afraid to ask questions — the more difficult, the better. And above all, don’t take anything at face value until you’ve verified it for yourself.
Personally, I wouldn’t expect “Uber like returns” when investing in the companies on StartEngine. But I do think there are good businesses out there that either are (i) not as sexy for large institutions to invest, or (ii) are a similar to a successful company but just in a different market.
Two investments I’ve made on StartEngine were for Grady’s Cold Brew coffee and Tapville. My thesis for Grady’s Cold Brew was simple: The shift to remote work has moved coffee consumption from on-the-go to at home, temporarily for some, and permanently for others. My hope is Grady’s can capitalize on that trend, and they have an AWESOME product that I drink every morning. Tapville’s thesis for me was two-fold: (i) a local Chicago company that had self-serve restaurants and breweries. (ii) They were looking to expand beyond physical locations and open up mobile locations. The mobile locations saw a huge increase during 2020 Covid, and continue to be a hit for festivals.
Interesting Ideas This Week