OtherEquity Crowdfunding: Is it Safe or Dangerous for Small Investors?

We’re pleased to bring you a guest post by Matt Morse, a serial entrepreneur and businessman with more than 25 years of successful experience investing in stocks, startup companies, and real estate. He is the founder and CEO of CrowdLever.com, a reward- and donation-based crowdfunding platform based in Portland, Oregon. CrowdLever is a national leader in the crowdfunding categories of small business development, local nonprofits, schools and community-based fundraising. Here’s Matt:

Equity crowdfunding, or microfinancing, has become the talk of the town in 2013. What does it mean, exactly? Instead of getting a T-shirt for your contribution to a crowdfunding campaign, you can actually get a stake in the business in which you’re investing.

Although reward- and donation-based crowdfunding (i.e. T-shirt for cash contribution) is now widespread, equity crowdfunding has been limited until recently to Accredited Investors and the wealthy. The JOBS Act of 2012 promised to change all that, though entrepreneurs and investors are still awaiting further clarification from the SEC.

Though the prospect of equity crowdfunding is exciting, many worry that investments won’t be adequately vetted or that amateur investors won’t understand the risks involved in investing in a new business venture. Hence, the million-dollar question: Is microinvesting via online equity crowdfunding safe or dangerous for the average small investor?

Built into this question is the suggestion that microinvestments are intrinsically riskier than other types of investment. I disagree. Let’s consider three traditional “savvy” investors.

1. Hedge fund investors. Hedge funds are a great investment (if you can get in) because they are run by the smartest folks on Wall Street and these guys have access to lucrative investments, right? Well, not really. Hedge funds fail and close regularly because they make big bets; sometimes they have good years and sometimes they have bad years. Consider this: An investor with a diversified stock portfolio who has been in a coma for the last 12 months has a better track record for 2013 than the folks betting on hedge funds.
2. Active stock pickers: Their track record in recent years is all over the board. Some have done well; others have failed. In fact though, only 5% of active stock pickers have beat the market this year. That’s one out of 20.
3. Angel investors: Angel investors rigorously review new investment opportunities, confirming every variable, market size, technological application, etc. Sometimes they brag about an early investment in Facebook, Twitter or Dropbox. Less discussed is that the average success rate over the last 20 years for Angel investors is about 5%, or again, one in 20.

Now back to our original question: Is equity crowdfunding safe or dangerous for the small and inexperienced investor? Maybe yes, maybe no, but it isn’t intrinsically better or worse, safer or more dangerous, than many other types of investment.

All investing, whether it is in stocks, bonds, a big business or a small business, involves risk. All investors need to assess risk, review the investment opportunity, and analyze the potential reward. Five years from now, when business historians look back at the early days, they will probably conclude that equity crowdfunding has been fabulously successful for some, a good idea for some, and an abject failure for others. (In other words, similar to any other type of investment, and for that matter, real life.)

Worst-case scenario? You lose your money. Best-case scenario? You get a lot more than a T-shirt.