Sherwood Neiss

Crowdfund investing is a new funding opportunity for small businesses and startups that holds tremendous potential, but it's not a free-for-all. Entrepreneurs, business owners, and investors alike should know the legislative boundaries set by the JOBS Act (which opened the door to this funding resource in 2012), the risks involved in this type of funding, and the potential rewards it offers both to companies and their supporters.

If you’ve seen the movie The Social Network, you understand the need to protect your intellectual property. When using crowdfund investing strategies, you need to protect yourself and your business. You can do so in several ways: Don’t tell anyone about it. This strategy is foolproof, but it means that you can’t run a crowdfund investing campaign.

On average, 50 percent of investments in early-stage companies fail. So, the risks of crowdfund investment seem pretty clear: You can lose some or all of your money. Among the failures, 50 percent of early-stage companies run out of cash before they can succeed. The other 50 percent of failures suffer from poor management decisions, poor hiring decisions, poor use of funds, and so on.

Crowdfund investing doesn’t compete with or replace the need for professional private money. Crowdfund investment campaigns have funding caps that are significantly lower than most venture capital and private equity investments. Instead, crowdfund investing runs parallel to private money, funneling funds to types of businesses that previously didn’t stand a chance of receiving private support.

Crowdfund investing is possible because of the passage of the JOBS Act. So, what exactly did the JOBS Act legislation change in the U.S. financial regulatory system? And how do these changes stand to benefit business owners and investors? Promoting emerging growth companies The JOBS Act created a new category of companies called emerging growth companies (EGCs) and gives small, growing companies a five-year window in which to become fully compliant with accounting regulations.

If you’re an unaccredited investor, you can’t invest every dime you’ve got in crowdfund investment campaigns. (An unaccredited investor has a net worth less than $1 million excluding primary residence, and hasn’t earned more than $200,000 for each of the past two years.) Doing so would be a nightmare for your portfolio (you’d be doing the opposite of diversifying), and it also wouldn’t be legal.

In the private market, securities (either debt or equity) tend to be illiquid (meaning harder to sell) because there may not be an established market for those securities. As a result, when you commit to crowdfund investing, you must think differently about how and when you hope to get your money back and/or see a return on your investments.

A company wants to grow, so it runs a campaign to raise the necessary capital via crowdfund investing. What exactly will it do with the money being raised? The question is obvious, but you have to make sure you get a concrete answer. Look at the campaign proposal and how much the company wants to raise. Carefully review its plans for using the funding.

Can crowdfund investing reduce the necessity of relying on credit cards? Very possibly — if you can plan far enough ahead to anticipate your upcoming expenses and spot future opportunities for growth before they’re in your face and begging for cash. Whereas credit cards are quick fixes that often wreak long-term financial havoc, crowdfund investment campaigns demand longer-term planning and commitment.