Did you know that your ability to diversify your investments can move way beyond stocks and bonds? Today, investors have access to an incredible array of alternative investments. You can invest in anything from Marine Vessel Deconstruction to Litigation Funding at the click of a button. While these unique avenues may not interest you, technology has further leveled the playing field between Main Street Investors and Private Equity firms by allowing retail investors to invest through equity crowdfunding or startup investing. While equity crowdfunding remains risky with a high failure rate, the return multiples of just one successful startup can be upwards of 300x. Now, before you run off and invest in the latest startup, it’s important to perform your due diligence. We have created a 5-step Due Diligence Checklist for your equity crowdfunding investment.
Equity Crowdfunding is the where a person invests money into a private, startup with the goal of returning a major multiple if that company is acquired or goes public.
This is by far the most popular of all crowdfunding categories with market size predicted to grow to $114 billion in 2021. There is good reason significant capital being poured into the private market. This is because when it comes to the public vs. private market, the return from the private market is outperforming the public by more than 2-1.
If you are truly considering a startup investment, there are excellent equity crowdfunding sites dedicated to creating education around investing in startups. One of the best I have come across is crowdwise.org. This site takes a deep dive into creating a successful strategy around equity crowdfunding and is full of great educational materials.
However, if you are looking for a great place to start your equity crowdfunding due diligence, then look no further than our 5-step due diligence checklist:
Look at 3 things in the market – SATURATION, VALIDATION, PENETRATION.
Saturation – You may come across the best CEO with a great team and a great idea but if the market is already heavily saturated with a ton of like ideas, the startup most likely will not succeed. Conversely, you may find a company with just a good idea and a team “in development”. But if that market is wide open without many competitors, that could be a great investment opportunity.
Validation – If there is market share available, has there been any widespread validation in existing ideas? A great example is AirBnB. They saw that there were over 20,000 temporary housing listings on Craigslist in one week in New York and San Francisco alone. This was more than enough market validation for them to create an incredible investment opportunity.
Penetration – If there is market and an idea has already been validated, what makes this product unique? Is this product going to be able to beat existing competitors? What makes this better than the rest?
Many of these startups will not have huge margins and very little, if any, profit. Some may even have some substantial debt. However, one indicator of early traction is if the company already has paying customers. If a company is already showing significant customer growth, this is a great indication of future success.
Do not even consider an equity investment in this company if this is something you would not personally use yourself. Now, obviously, there are products that you can invest in and never use, such as an Enhanced Military Augmented Reality Simulator, but even then, you should feel confident that you understand what the product does and have some relative understanding on the details of the company.
The CEO of the company must have the X factor. That means, she/he must go beyond financials and product acumen and display a true passion and energy for what they are developing. Startups are not easy and there is a high rate of burnout. If the CEO does not have a true passion for the product, then it is best to pass on this equity investment.
Believe it or not, there is a big difference. And as I mentioned before, it always comes down to the market. A founder can have a great idea on paper but if it truly isn’t solving a problem for the target market, it’s going to fall flat. Clearly understanding the problems the product is looking to solve is a priority for your equity crowdfunding investment.
Being invested in an incredible landscape of technology in this new information age is exciting. As equity crowdfunding becomes more mainstream, startups will become an integral part of an investment portfolio. Taking the time to understand what it takes for a startup to be successful starts with your due diligence.