Equity crowdfunding is changing the rules of the financial world. One of the hottest topics that have emerged from this is how to mitigate the risk involved and how to protect the investors. Investing in a venture at an early stage means relying on the entrepreneur's skills in an uncertain environment. Fancy videos presenting brilliant ideas have no value if not implemented by a strong team. Here are 6 pieces of advice on how to do a savvy investment.
Most crowdfunding investors have no experience in conducting good due diligence on their future investments. Furthermore, relevant information is shady and most of the time it is hard to gain access to it. So, what should a crowdfunder should look at before putting their money on the table? Using Dara Albright's terminology, we have proposed several red flags that could create doubt in the pitch promises.
RED FLAG #1 - Management turnover Check the company director's history. If business is good, management tends to stick around. When directors come and go like a train in Victoria Station... well... that's definitely not a positive signal. Most of the time it represents an uncertain business or a non-constructive culture. Also, do not make the error of checking only the recent history of the company. Companies can change names multiple times and a deeper analysis of the business history is often necessary. Google and internet archives (such as Wayback Machine) are powerful tools.
RED FLAG #2 - Irrelevant and out-of-date news What is going on with the business? Is it in good shape? Do not hesitate to use social media or company blogs to see if the business is still active. Not informing the stakeholders and being silent is one of the symptoms of an unhealthy business.
RED FLAG #3 - Shareholder management Speak with the CEO. During a crowdfunding campaign the company will be very active in answering all the questions of the crowd. Think about the investment as a long term relationship. Ask questions about about the company and their past experiences. The investor has the right to know everything about the company and transparency is extremely important. No pitch video will tell you if there is something wrong. However, issues are not always an obstacle for your investment. A open and frank discussion about internal issues might reveal a confident and aware CEO. Remember, the first step in solving a problem is recognising that you have a problem.
RED FLAG #4 - Never ending financial round and capital dependency Too many funding rounds is not a good signal. It highlights the fact that the entrepreneur miscalculated several times the capital necessary to reach the desired goal. Instead of relying on the business sustainability they rely more on the capital injected by investors. Before doing an investment, be aware, do not underestimate the dilution effect of future possible funding rounds.
RED FLAG #5 - Faulty math and financial review Small companies might not have strong financial management. Double check the math of the presented business plan. Even if the financial due-diligence is expected to be done by the crowdfunding platform, a second check should not be conducted. Errors on financial statements might denote a superficial overview. Furthermore, financials might be subjected to adjustments in order to look better during the campaign, even if not particularly significant for small businesses doing crowdfunding.
RED FLAG #6 - No trigger Consider if there are any triggers that might boost business. For example, a trigger might be a patent or export license. If obtained, the company will have a competitive advantage and its value will most likely increase. The investment, therefore, will be in the best position to be profitable. A business with no trigger might be exposed to a more competitive environment and thus more volatile.
This list is definitely a good starting point, but it is by no means a comprehensive list of possible red flags you should look out for. Before you do an investment, do your DD!
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