Risks of Private-Company Investment

Risks of Private-Company Investment

Equity crowdfunding, like any investment, bears a certain amount of risk. Being aware of these potential risks can help you be more of an astute investor, less of a blind risk-taker.

Are all companies on Equitise’s platform built the same?

Gone are the days when crowdfunding was a tool used only by early-stage companies. Traditionally, equity crowdfunding was associated with young businesses, those generally carrying higher risk. Equity crowdfunding is evolving, however, and companies worldwide are beginning to view it as mainstream finance. Over the past year, Equitise has offered investors access to companies in the seed stage of development, right through to mature, established players.

What does that mean for you? 

The wide range of investment opportunities now afforded by equity crowdfunding platforms is great for the investor in terms of choice and variety, but requires deeper understanding of the investment opportunities.

As a general principle, the inherent risks associated with any investment tend to correlate to the returns they can generate; high risk ventures can see high returns, however they can also face high losses. Let’s break down the main risks you might like to consider before parting with your cash.

  • Liquidity  

For the investor, liquidity refers to how easily you can “cash-out” of your investment. A “liquidity event” – not to be confused with liquidation - describes an exit strategy for investors to monetise their investment, for example an IPO (see our IPO post).

The key consideration influencing liquidity is the company’s stage of development. Early-stage investments require investors to be in for the long-run, whereas investments in more mature companies, in a pre-IPO stage, are likely to see a liquidity event sooner.

For the time being, there is no recognised secondary market for the sale of shares purchased through equity crowdfunding, however watch this space. Developments by authorities are seeing a greater focus being placed on the smaller, high-growth area of business. In New Zealand, the new NXT market (see our NXT post) provides SMEs, which cannot otherwise list on the main board due to their size, earlier liquidity for shareholders.

  • Dilution 

This refers to the proportion of a company your investment represents. Dilution risk exists because a company may require further funds to be raised, diluting your stake. The risk exists in two ways:

Overfunding of the equity crowdfunding capital raise: Often a facility will exist allowing the funding round to enter “overfunding” when an offer receives more interest than anticipated. This causes the stakes of investors already ‘on board’ to be diluted, however this is always capped at a certain level. The details of this will usually be disclosed in the offer documents.

Future capital raises: A company may require further funds to be raised down the track. This may involve the issuance of more shares, which will dilute the stakes of existing shareholders. This concern is mitigated somewhat by the fact that future raises are usually done on a higher valuation than earlier ones.

  • Uncertainty over returns

Equity crowdfunding provides part-ownership of the company, bringing potential financial reward for investors. Returns can flow in the same way as any other equity investment, such as the purchase of shares on a stock exchange. As shareholders in the company, investors have access to possible returns in two ways: dividends company may choose to distribute, and capital gains in their stake.

These returns are far from certain - issuers using equity crowdfunding platforms include new or rapidly growing ventures. Investment in these types of businesses is very speculative and carries high risks. However, even the largest, most-established companies, face events outside of the control and foresight of investors, companies and regulators.

Returns have the potential to be high if investors are diligent and diversify. Including equity crowdfunding in a balanced and diversified portfolio can be part of sensible and prudent investing.

We hope this has given you a useful run-down of the educated risks investors can take. As always, ask questions, read all available information carefully, and seek independent financial advice before committing yourself.

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