How to Target Regulated Equity Crowdfunding Deals

All Americans, regardless of income or net worth, can invest in shares of startups and fast-growing small businesses through equity crowdfunding websites, also known as funding portals. It’s an adventurous way for average investors to diversify a small portion of their portfolio into private securities, where the potential returns – as well as the risks – can be spectacular.

Congress authorized securities crowdfunding under Title III of the Jumpstart Our Business Startups (JOBS) Act 2012, which allowed small companies to raise up to $1 million per year in both equity and debt offerings. Subsequently, Congress increased that raise limit to $5 million. The SEC promulgated Regulation Crowdfunding (Reg CF), a set of rules for the operation of securities crowdfunding websites.

Since Reg CF sites launched in 2016, several thousand companies have raised seed and startup capital via those offerings. In 2021 alone, more than 500,000 Americans invested $570 million in more than 1,500 such offerings, according to Crowdfund Capital Advisors.

You’ll find dozens of websites (the most active ones are StartEngine, Wefunder, and OpenDeal), and at any given time the volume and variety of Reg CF equity offerings may be daunting. After you explore a number of crowdfunding sites and get a feel for the environment and what kinds of offerings appeal to you (and why), you’ll need a strategy for narrowing down your prospective deals: Do some strategic targeting.

Strategy 1: Target Industries

You have probably heard the axiom “Invest in what you know,” commonly attributed to Peter Lynch, an extraordinarily successful investor with Fidelity Investments’ Magellan Fund from 1977 to 1990. You have a better chance of earning a good return by investing in an industry where you have knowledge and experience, at least in the first year or two of Reg CF investing. As you gain confidence in your ability to select good deals, you might broaden your scope, for diversification, to industries where you can study and become knowledgeable.

Strategy 2: Follow the Smart Money

Experienced angel investors and venture capitalists, small incubators and accelerators, corporate entrepreneurship programs, and even institutional investors will be cherry-picking some of the best deals on equity crowdfunding platforms. Their participation in an offering is sometimes highly visible. While there is no guarantee that these sophisticated groups will do complete due diligence and apply the same variables that you would apply, this is a very intriguing investment type for those who want to invest but don’t have the time or experience to perform due diligence on their own.

Following “smart money” is one fairly prudent way to invest, although it is never a sure thing — even the most successful angel investors make bad investments most of the time. I don’t want to discourage you from following the smart money, as long as you understand the risks involved in leaving the analysis and due diligence to others.

Strategy #3: Collaborate with the Crowd

Traditionally (before 2016), an angel investor could join an angel group where members could collaborate on targeting deals, evaluating investment opportunities, and, farther down the road, conducting due diligence. But angel groups admit only accredited investors (the wealthiest 3% of Americans).

Equity crowdfunding makes collaboration possible among non-accredited angel investors (the other 97%). When you register on a funding platform, you have an opportunity to ask questions and share ideas with other investors — the crowd — before you decide whether to invest. It is essential that you check out the education and industry experience of the investors whose opinions you take into consideration.

More Crowdfunding Strategies

If you are not comfortable with those strategies, or in addition thereto, try using one or more of the following approaches:

• Target only companies with growing revenue.
• Target companies that own hard assets like real estate, expensive manufacturing or mining equipment, or valuable intellectual property, for example.
• Target companies with headquarters nearby, so you can observe business operations as part of your due diligence.
• Target startups whose founders are serial entrepreneurs, who were involved in growing successful companies in the past. Past success as an entrepreneur is perhaps the best predictor of future success.
• Target companies that offer the types of securities you prefer or that make you comfortable. When I started investing in Reg CF deals in 2016, I looked for stock offerings, rather than LLC shares, convertible debt, or future equity. I won’t get into the reasons here, but I was most comfortable with shares of common stock.

Get help from your trusted professional advisers. We would never discourage you from seeking advice from your financial planner or money manager. They can show you how to target these deals to coordinate with your overall investment portfolio and long-term goals.

Final Thoughts

Keep in mind that advisers not thoroughly familiar with the risks, rewards, and economics of equity crowdfunding will warn you not to invest in them because they are novel. Some of them will fear that you might hold them accountable for losses if they don’t dissuade you from making risky investments. Money managers and stockbrokers may also have an incentive to advise against Title III deals. They do not earn commissions on crowdfunding transactions.

Before you start browsing offerings, of course, you should verify that you are using a crowdfunding platform registered with the SEC (Securities and Exchange Commission) and FINRA (Financial Industry Regulatory Authority). You can find a list of registered funding portals and broker-dealers on Finra’s website.

We think you’ll also like:

• Evaluating Deal Terms in Crowdfunding Investments Part 1: Straight Equity

• Evaluating Deal Terms in Crowdfunding Investments Part 2

[Editors’ Note: To learn more about this and related topics, you may want to attend the following on-demand webinars (which you can listen to at your leisure and each includes a comprehensive customer PowerPoint about the topic):]

• Raising Capital: Negotiating with Potential Investors

• Best Practices Regarding Technology

• Crowdfunding from an Investor’s Perspective

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