Due Diligence for Equity Crowdfunding

equity crowdfunding

Since mid-June, American investors have been allowed to buy shares in other people’s private companies through online crowdfunding portals.

Now, even if you do not meet the income or net worth criteria of an accredited investor, you can back someone else’s entrepreneurial dream, just like the guys on Sand Hill Road. But if you want to do more than lose your hard earned money, you will have to investigate the prospective entrepreneurs and their ventures.

That will be a bit tricky if you are a typical investor. The Securities and Exchange Commission rules will limit the typical American household investing no more than about $2,700 annually through equity crowdfunding. That’s not enough to justify conducting due diligence like Peter Theil. But there are still a few things you can do.

First, you can pick your online platform wisely. If you invest through a portal that screens the venture ideas and posts only the best two-to-five percent, then you will have to do less vetting of your own.

If the ideas you are considering have already gone through an initial screen, then chances are higher that they are worth pursuing than if the site simply uploads everything it receives.

You should also verify that the people who are screening the investment opportunities know what they are doing.

Check out the people who work for the portal. Do they have the right experience to identify good ideas and avoid frauds? If the people selecting the opportunities have worked at a venture capital firm or angel fund, chances are better that they know what to look for in a start-up investment than if they have never made an investment in a young company before.

Second, carefully read the information that the entrepreneur provides.

Your investment might be too small for you to spend much time searching out corroborating evidence, but you can gain a lot by looking at the entrepreneur-supplied information. It’s not that hard to learn to identify bad ideas or scams. As a general rule, if it sounds too good to be true, then it probably is.

If the entrepreneur says the investment is “safe and secure,” stay away. No investment in a start-up is safe; most of them will not return the money invested in them.

If the entrepreneur sounds desperate, wants you to act right away, don’t do it. Good entrepreneurs know their ideas will withstand scrutiny. They want you to look carefully because it will build their credibility.

If the entrepreneur’s story or background can’t be verified, then steer clear. Employment history and school attendance all create a digital or paper trail that the entrepreneur can provide.

Third, draw on the wisdom of the crowd. Pay attention to what other people are saying about the entrepreneurs and the business ideas . The odds will be better if you invest in businesses that other people choose than if you do the opposite of everyone else.

Moreover, consider who the other investors are. If they are successful angels and venture capitalists with a proven track record of successful investments in start-ups, then their views are a better signal than the opinions of people who have never put money into a private company before.

Choosing Photo via Shutterstock

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Scott Shane Scott Shane is A. Malachi Mixon III, Professor of Entrepreneurial Studies at Case Western Reserve University. He is the author of nine books, including Fool's Gold: The Truth Behind Angel Investing in America ; Illusions of Entrepreneurship: and The Costly Myths that Entrepreneurs, Investors, and Policy Makers Live By.

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