Risks of equity crowdfunding

Before you participate in equity crowdfundingEquity crowdfunding Equity crowdfunding allows new business or start-ups to raise capital by selling many small stakes, usually in the form of shares, to a large number of investors over the internet. In return for their money, investors are given a small stake in a business.+ read full definition, it is crucial that you know and understand the risks associated with this kind of investing. Below are risks that you should be aware of:

  1. High risk of loss – Much of the risk stems from the fact that most businesses that seek financing through crowdfunding are start-ups or early-stage ventures. Statistically speaking, the vast majority of these businesses do not survive past five years. If you investInvest To use money for the purpose of making more money by making an investment. Often involves risk.+ read full definition in a business that does not succeed, you may lose all the money you invested.
  2. Locked-inLocked-in An account that you cannot take money out of until you retire. In most cases, you can’t get a cash payout. Your plan may make exceptions if you have a terminal illness, or a small pension benefit.+ read full definition investmentInvestment An item of value you buy to get income or to grow in value.+ read full definition – There’s also a good chance that you won’t be able to resell your shares in the business you invested in. Unlike a stock marketStock market The collection of markets and exchanges where stocks, bonds and other securities are issued or traded.+ read full definition, funding portals allow you to buy stakes or interests in a business, but not sell them. You will likely have to hold onto your investment until there is a change with the business – like if it goes public on a stock exchangeStock exchange A market in which securities are bought and sold.+ read full definition. This may take many years to happen, or may never happen. Until then, your money is locked in the investment. This is also known as liquidity risk.
  3. Lack of information – You should expect to receive significantly less information about your investment than you would with more traditional investment products. Businesses raising capital through equityEquity Two meanings: 1. The part of investment you have paid for in cash. Example: you may have equity in a home or a business. 2. Investments in the stock market. Example: equity mutual funds.+ read full definition crowdfunding are not required to provide the same amount of information as a public company. You will receive some information, such as an offering document, annual financial statementsFinancial statements Reports that sum up a company’s financial data and tell you how it is doing. The four basic statements are: the statement of financial position (balance sheet, statement of profit or loss (income statement), cash flow statement, and statement of changes in equity.+ read full definition, annual updates about how the money is being spent and notices about key events, like change in control of the business.
  4. No income – Start-ups rarely pay dividends or interest while they are in their ramp-up or growth stages. If you’re investing for income, a crowdfunded venture is not likely for you.
  5. Fewer protections: no approval and limited legal rights – These investments are not reviewed or approved by a securities regulatorSecurities regulator A government agency that enforces the securities act in jurisdiction it has authority over. This act is made up of laws that establish rules for issuing and trading securities. The Ontario Securities Commission is the securities regulator for Ontario.+ read full definition. You also won’t have the same legal rights that you would have had you purchased under a prospectusProspectus A legal document that sets out the full, true and plain facts you need to know about a security. Contains information about the company or mutual fund selling the security, its management, products or services, plans and business risks.+ read full definition or through a stockStock An investment that gives you part ownership or shares in a company. Often provides voting rights in some business decisions.+ read full definition exchange.
  6. No investment advice – Unless the crowdfunding portal is operated by a registered investment dealerInvestment dealer A securities firm that buys and sells a wide range of investments. They are likely a member of the Investment Industry Regulatory Organization of Canada (IIROC).+ read full definition or exempt market dealer, it won’t provide you with information about whether the investment is suitable for you as an investor.
  7. Potential for fraud – Despite checks made by funding portals, individuals with ill-intentions may not be completely weeded out from offering shares via crowdfunding.
  8. Dilution risk – Start-ups could issue new shares to drum up more capital or compensate employees. This comes at the expense of existing shareholders like you as your percentage ownership of the company decreases when additional shares are issued by the company.

Your responsibility as an investor

Only you can decide whether equity crowdfunding is the type of investment you want to make. Every investment decision should be carefully considered and thoroughly researched ahead of time. Equity crowdfunding is just one of several potential investment optionsOptions An investment that gives you the right to buy or sell it at a set price by a set date. The buy right is termed a “call” option, and the sell right is termed a “put” option. You buy options on a stock exchange.+ read full definition available to you. Many investors opt not to put all their eggs in one basket and instead choose different kinds of investments to minimize their risk. This is referred to as diversification.

Before you invest in equity crowdfunding:

  1. Do a self-check on your comfort level with these risks of equity crowdfunding:
    • Can you afford to lose all of your invested money? It’s a real possibility.
    • Are you willing to wait, potentially years, before you might be able to get your money out of this investment, let alone a return?
    • Do you believe you understand the information you have received about this investment opportunity to make an informed decision?
  2. Take time to thoroughly review the offering document. Make sure you understand what the business’s objectives are and the risks associated with investing in it.
    • How is the business going to grow?
    • How will it make money and within what timeframe?
  3. Investigate. You can search the internet for information on the business, the industry, the people managing the business, as well as the viability of the business plan.
  4. Research the portal. You can search the internet for information on the particular funding portal where you see the offering document. Make sure it’s operated by a registered dealer by inquiring with the Ontario Securities Commission or checking CheckBeforeYouInvest.ca.

Additional information about Ontario’s equity crowdfunding initiative can be found on the OSC’s website.

Warning

Participating as an investor in equity crowdfunding is extremely risky, but it can also be a way to support innovation and become part of a community of entrepreneurs.

Caution

The OSCOSC See Ontario Securities Commission.+ read full definition has set out certain rules and restrictions that provide some investor protections because of the high risk nature of equity crowdfunding, but these rules and restrictions won’t protect you from all risks associated with equity crowdfunding. So before you consider any equity crowdfunding investment, know and understand the risks.

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