×

Venture capitalism for the common man

Start up investment
tuk69tuk | Getty Images

Wish you had invested in Apple when it was still in its garage days?

As crowdfunding jumps in popularity, a new federal rule now allows so-called unaccredited investors to put up as little as $100 for a stake in start-ups and small businesses. The SEC's rule, called Regulation Crowdfunding, will help companies raise capital while also let everyday people — and not just the wealthy — in on the action.

Previously, these sorts of investments were restricted to accredited investors, those with a net worth of $1 million, or who met other asset criteria. The rule change, which took effect in May, is a key component of the JOBS Act of 2012, which was designed to open the capital pipeline after access was severely constricted in the wake of the credit crisis.

It's an opportunity to get in on the ground floor, said Ron Miller, CEO and co-founder of StartEngine, an approved Title III portal that has already raised $17 million from nonaccredited investors.

But it does come at a price.

Start-up investing is the riskiest of the riskiest, said Gregg Flinn, chief investment officer at ALTZ Investment Strategies.

"These are smaller companies just starting out, not the Ubers of the world, so there's a significantly higher level of risk," he said. Although the payoff can be huge, up to three-quarters fail, Flinn said.

Yet for many individuals, the opportunity for an equity stake in a start-up or small business may be irresistible. Before, options were limited to backing an idea through a crowdfunding platform like Kickstarter, which only offers a reward in return.

On the one hand, crowdsourcing is just that: letting the wisdom of the crowd determine a company's viability upon which to base investment decisions.

"Collectively we can rely on each other's individual expertise to gain knowledge of the company," Flinn said.

On the other hand, "there's always going to be the risk that things aren't what they seem and this is no exception," said Mark Walsh, associate administrator with the Small Business Administration's Office of Investment and Innovation. "There will be moments when a company doesn't tell the truth. There is no way you can police every dark corner."

Flinn said small investors should limit their exposure to a small portion of their portfolio. He suggests making 15 to 20 investments of up to $500 each over several years. The few investments that do pay off have the potential to create outsized gains. "The return from two investments can outweigh 18 losses," he said.

"These are high-risk, high-return investments, and as such they should represent a small percentage of a personal investor's overall portfolio," Miller said. "I recommend 3 percent to 5 percent of a personal investor's overall portfolio — and within that they should diversify."

"It's no different than what you would do in a traditional stock portfolio, follow the universal advice: Diversification is the key to success," Miller said.

The rules do provide some additional protections. For example, there are strict disclosure requirements about the business and securities offering and limits on the amounts that can be invested.

For example, investors who make more than $100,000 a year generally can invest up to 10 percent of their income, while an investor with income of less than $100,000, can invest up to 5 percent over a 12-month period. There's also a cap of $100,000 on the amount that individuals can invest in a year.

Companies trying to raise funds must file paperwork on their financials, projections and background and register with a portal, Miller said. These portals, like Miller's StartEngine, are required to verify that the start-up's disclosures are truthful and accurate. The portals also provide a platform for individual investors to come together to examine the details to decide whether they want to invest.

Start-ups and small businesses must also file two updates a year (rather than the annual 10-K or 10-Q reports that shareholders are used to) and post them on the investor relation section of their websites.