What retail investors should know about crowdfunding

Starting next Monday, May 16, US investors will be able to buy securities in early-stage companies through crowdfunding.

Under new rules effective May 16, 2016 as part of the JOBS Act, the general public can invest in capital raising by start-up companies through crowdfunding, which generally refers to the use of the Internet by small businesses to raise capital through limited investments from a large number of investors.

U.S. financial regulator FINRA has put out a list of things which it believes that retail investors interested in taking this step should consider, as there are certainly risks that may be involved in investing in these small businesse.

According to Gerri Walsh, Senior VP of Investor Education at FINRA:

Crowdfunding generates a lot of buzz, and the possibility of getting in on the ground floor of the next great startup can be very tempting. But as with any new type of opportunity, investors should step back and first ask the right questions. Investing in unregistered, emerging securities carries significant risk, and investors have to beware the attraction of the shiny, new object and make an informed, rational investment decision.

FINRA’s alert summarizes how equity crowdfunding works, including the income and net-worth requirements prospective investors need to meet and the information available from issuers, broker-dealers and funding portals. The alert also offers tips to help investors determine if crowdfunding is right for them, including:

Ask yourself if you can you handle the risk—and the potential loss of your investment. Startups and early-stage ventures can and do fail. You should be able to afford to lose your entire investment. Also, be aware that you will be limited in your ability to resell your investment for the first year—and may need to hold your investment for an indefinite period of time.

Read and understand the educational and financial information, and all disclosures, provided by the issuer and crowdfunding intermediaries. Ask direct questions about the investment, including worst-case scenarios. Consider seeking another opinion, such as from an accountant who understands financial reports and likely has no vested interest in the investment.

Recognize that fraud is a possibility. Protect yourself by learning the tactics a fraudster might use—and how to avoid them. FINRA has some tips on that here.

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