Early Investing

Did Crowdfunding Just Leave VC Investors in the Dust?

Did Crowdfunding Just Leave VC Investors in the Dust?

Our First Stage Investor members know this, but you may not.

We only issue buy recommendations. Never sells.

By definition, our investment service is one-sided. Because once you invest in a pre-IPO startup, you can’t realize any gains until the company goes public (or someone buys it).

But change is coming.

You’ll soon be able to sell previously illiquid shares.

It will require a different approach than how you manage your startup portfolio – one that gives you more flexibility and the ability to avoid big losses.

You’ll actually enjoy a greater range of options than professional investors to maximize profits and cash out whenever you wish.

It typically works the other way around.

Institutional money is usually first in and first out. It’s why “smart money” and “big money” are used interchangeably.

Easy Come… and Now Easy Go

Portals are experimenting with secondary markets where investors can both buy and sell.

Just like with investing in publicly listed stocks, investors will have two decisions to make: When to buy… and when to sell.

Owning shares you cannot sell is considered a big shortcoming by many investors. So one portal, Boston-based Netcapital, is doing something about it.

I was part of an exclusive invitation-only event hosted by Netcapital where CEO Jason Frishman gave us a sneak preview of the company’s new secondary transfer platform.

It’ll go live about a month from now, helping investors put money into their wallets much sooner than was previously possible.

A New Way to Manage Investments

Imagine that you bought shares of an early-stage company at the beginning of 2017. It just announced that it doubled revenue from the previous year. At the same time, it also announced that it signed up several Fortune 100 companies as customers.

The company’s traction is proceeding better than anticipated.

Until now, besides applauding silently, there was no way to leverage this good news.

You could assume that your paper profits were increasing, but you couldn’t cash out any of those paper profits.

It’s there – but not there.

For some people, that’s fine. They’re more than willing to let their profits ride. After all, they understood when making the investment that this was NOT money they counted on using in the short term.

Nothing wrong with that approach.

But it can be frustrating, to put it mildly. Take a real-world example like Uber. Until SoftBank came in to provide liquidity, seed-stage investors were sitting for years on completely illiquid gains of 360,000%. That means a $10,000 investment would have been worth $36 million.

Those investors are still stuck with limited options for cashing out.

But at least now Netcapital is giving retail investors a choice. They don’t have to sit on their profits for years if they don’t want to.

On Netcapital’s secondary market, you get to choose how many shares you want to sell. And you get to set a price per share.

The platform will match potential buyers to your asking price. If your price is reasonable, more than one match will be found.

But if, for some reason, a match isn’t found, you simply keep your shares. It’s up to you whether you want to try again at a lower price.

Netcapital will also provide you with your own wallet where your cash proceeds will be transferred to. More than anything else, it’s nice to have that extra flexibility…

Perhaps an emergency comes up and you need some extra cash. Or maybe you simply want to skim some profit off a fast-rising investment.

Or, in a scenario that could very well apply to Adam or me, perhaps you know about something that gives you pause. A powerful competitor entering the market. An important person on the team who is leaving. A shift in demand away from what the company offers.

In such circumstances, selling at least some shares would be a prudent move.

More Buying Opportunities

Not only does this platform increase the opportunities to sell, but it also increases opportunities to buy.

You can buy shares of companies exceeding expectations.

And you can buy shares (presumably at deep discounts) of companies falling short of expectations.

Sellers would be selling at a loss but getting back at least some cash on their investments. And buyers would be getting shares at bargain-basement prices, hoping that owners had prematurely given up on companies experiencing setbacks.

And More Opportunities to Mess Up

I expect prices to be all over the place until volume builds. That will probably take some time, possibly years.

Sellers could be tempted to offer high prices, thinking all it takes is one party to agree to buy.

Sellers won’t be holding all the cards, however.

Their universe of buyers in the first 12 months is, by law, limited to accredited investors.

(These are people who make at least $200,000 a year – $300,000 when a spouse is included – or who have a net worth of at least $1 million. You can’t count your primary home in this calculation.)

What’s more, nervous shareowners could be tempted to dump shares at the first sign of trouble and, if their companies are able to right the ship, suffer from “seller’s remorse” afterward.

Of course, these problems aren’t unique to the private startup market. Studies have shown that stock investors in public markets have a great deal of difficulty timing their buys and sells.

And that brings us back to square one…

More options can be a good thing or a bad thing. So be careful. And engage thoughtfully in any secondary trades you make.

StartEngine, another crowdfunding portal, began offering its secondary market in startup shares last fall. We’ll be watching how these secondary market platforms evolve.

I hope they succeed. It’s definitely a step in the right direction.

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