New Rules Let Investors Buy Shares of Crowdfunded Startup Firms

Steve Branton is a financial planner at Mosaic Financial Partners, in San Francisco. Here’s an excerpt from our recent interview with Mr. Branton (pictured at left):

What do the crowdfunding rules allow? Someone making less than $100,000 per year or with a net worth of less than $100,000 can now invest the greater of up to $2,000 per year or up to 5% of their income or net worth (whichever is less). If both income and net worth are $100,000 or more, the cap is 10% of income or net worth, whichever is less, up to an annual cap of $100,000. Your house doesn’t count toward your net worth.

What kinds of businesses are raising money this way? Companies are limited to raising $1 million per year. So this might be a way for smaller, local enterprises, such as retailers or restaurants, to raise money—companies that are visible in the local community, but not necessarily businesses an investment bank would lend to or do a stock offering for. It’s a misconception that they’ll all be tech start-ups.

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How can people invest? Through online portals. These portals extend the reach and access of investors by eliminating the middleman. Before, venture capitalists restricted information about these types of investments. Now it won’t be limited to back-room presentations accessible only to wealthy individuals.

Just because people can invest, does that mean they should? We consider crowdfunding to be a high-risk, speculative investment. Most start-ups are out of business in three to five years. In a traditional stock offering, you’ve got a lot of educated, talented experts vetting the company’s books, legal risks, proprietary information and competitive advantage. The average person doesn’t know how to examine a company for long-term profitability, and companies don’t have to provide as much information as a company going through an initial public offering. The financial accounting is not as robust. Also, venture capital funds typically invest in a basket of companies—they know that one or two won’t do well. Mom-and-pop investors won’t have this diversification.

For those who give it a go, how should this type of investment fit within their overall portfolio? Most investors should limit speculative investment to 5% to 10% of their portfolio. They need to think less about hitting the jackpot and more about whether, if they lose the entire investment, their financial plan will fail in the long run.