Why Investing Crowdfunds Might Not Be A Good Idea

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Many investors have a dream to find that Microsoft, or Google, or Amazon when they are just starting up, and put some investment in them. The idea of investing in a great start-up that becomes a unicorn can be appetising, but in the past, it was not easy at all, because most people don’t have the money to provide the funding.

Now, there are some interesting crowdfunding platforms, that allow retail investors to put a bit of money to contribute in funding start-ups. Some platforms I know of are Crowdcube, Seedrs and GoFundMe. These are great, because it’s a way to get exposure to alternative form of investments without needing so much money to participate.

However, making money from this investment is not as easy as it might seem. First, investing in start-ups is highly risky. Most start-ups fail, a few might just about survive, and only in rare occasions that a start-up investment generate great results. Normally, investing in start-ups require you to spread investments across many many start-ups. However, retail investors do not have that much money that they can spread their risk.

Second, investing in such platform is a highly illiquid form of investment. Often, you would have to wait years to have a CHANCE of getting back some profit. That is if the company decides to give back some money to investors — which is unlikely for start-ups. This means you can only put money that you know you won’t need at all.

Those reasons above are common risk in investing in any start-up. However, there is another more important reason why crowdfunding platform is usually a not a good way to invest your money.

The problem with crowdfunding investing is that the best start-ups would not need such platforms to raise capital in the first place. They would have been already funded by specialist venture or start-up funds designed to make high-returns for the investors.

This leaves the crowdfunding platforms only with start-ups that probably don’t have good prospects. I do not know statistically the returns that investors make from these platforms, but I don’t believe they are any good.

The start-ups on the crowdfunding platforms are usually those that big venture capital funds don’t think will succeed, so they need the unsophisticated retail investors to help them. But if those big funds with experiences in helping start-ups don’t think they are worth investing, then how can we think otherwise? Don’t get me wrong, maybe some of those may actually succeed, but they would be very few and would probably not give the spectacular returns you were hoping for.

Furthermore, these start-ups typically need several rounds of funding. When you invest in one round, you get a share of the company. When the company uses up that money, and they need more, they will do another round of funding. When they do this, your share becomes more and more diluted as you share less in the company.

With all that being said, some investments in start-ups can be a great way to save on tax if you are high-income earner with nothing better to do with your money. In the UK, there is the SEIS scheme that allows an investor to get a tax refund up to 50% of the value of the investment they make in small start-ups. So if you have a lot of money, you don’t have better opportunities, and you have an eye for good ideas, the crowdfunding platforms may be a good idea to invest your money.

The principle you should stick to is that if something is too good to be true, it probably is. And any form of investing that would generate high return would not be easy. So if you think you found an easy way to make lots of money — like these platforms, you are probably mistaken.