Deal Quality: Investing in Crowdfunded Securities – What You Need to Know



A couple of weeks back, CI held a webinar with two investment platforms, Rialto Markets and Republic,  which both sell securities online. The topic of discussion was deal quality and the different types of securities issuers pitch when pursuing an investment crowdfunding offering.

First, an individual investor must clearly understand that ALL investments hold an element of risk. That is how it works. Some investments hold a lower degree of risk (like a government bond) while others have a far higher degree of risk.

A riskier asset is expected to deliver a higher rate of return than a less risky asset – if things go right. In general, debt securities are less risky than equity securities and investments in early-stage firms are highly risky. If you decide to back a startup or early-stage firm there is a good possibility the company will fail and you will lose all of your money. Or, perhaps, it will bounce along and you may never generate a decent return. Professional investors take this into consideration before committing their money and you should too. Holding a diversified portfolio of investments can mitigate your downside. It is your decision and your money, so always consider the pros and cons of any security offering.

Next, you MUST read all of the offering information including an Offering Circular, a prospectus light type document that is qualified by the Securities and Exchange Commission, under Reg A+. Or an Offering Memo submitted for a Reg CF offering, a notice filing that is not qualified by the SEC. A Reg D offering usually includes a private placement memorandum (PPM) made available to accredited investors interested in the offering.

There is great information in these documents that highlight known risks, shares company performance, and outlines expected products and services. These documents will provide the details of the securities being sold. So read them.

You should also understand that many platforms do not do any or limited evaluation on deal terms. Diligence is focused on anti-fraud measures, making certain there are no bad actors and the language is accurate and compliant. You as the investor must determine whether, or not, the deal terms suit your expectations and tolerance of risk. Additionally, while some platforms may shy away from listing offerings that may have an outlandish valuation, as an investor you must understand that a valuation provides a hurdle point at which time your investment may (or may not) make sense. This also depends on any future dilution – where other investors join in diluting the value of your investment.

Currently, the most popular securities issued on securities crowdfunding platforms tend to be equity, convertible securities, SAFEs (Simple Agreement for Future Equity), and debt offerings.

Equity securities, or common shares, denote ownership in a company and may, or may not, come with certain rights like the ability to vote on certain corporate actions. Equity is issued in a priced round where the company has a valuation.

SAFEs or Simple Agreements for Future Equity are founder-friendly securities that do not need a valuation. Many young companies shy away from providing a valuation on a firm that has little history on which to base a valuation. Typically, an investor in a SAFE will convert into equity at the next priced round for a discount. Not all SAFEs are the same, so read the specifics.

Convertible offerings, usually debt, are what many VCs prefer because they can convert into equity at a future date but holds a higher status on the cap table. As well, these do not need an issuer to set a valuation on the company.

Debt can be short or long-term, similar to a bond or bank loan, and can incorporate many unique characteristics. Usually viewed as less risky than equity, returns may be lower.

Online capital formation platforms also offer digital assets, revenue share/royalties, litigation funding, and more. Certain platforms have moved into the collectibles space – be they digital (NFTs) or perhaps something more tangible like wine, or artwork. Most digital assets are digital securities and file the necessary documents with the SEC.

Another very important point is that a great company, or asset, does not by default equal a good investment. Again, deal terms count. Read them. Understand them. Accept there is a risk of loss.

In our webinar, CI joined with Joel Steinmetz, COO and co-founder of Rialto Markets and Mario Claudio Lattuga, Director, Diligence & Legal Operations at Republic. We asked for their opinions on deal quality and deal structure from the point of view as an offering platform. Rialto Markets is a FINRA-regulated Broker-Dealer. Republic operates both a FINRA-regulated Funding Portal as well as a Broker-Dealer.

During the conversation, both Lattuga and Steinmetz helped to provide insight into what online capital formation platforms do and what they do not.

One questioner inquired about securities offerings that sounded promissory. Lattuga said you issuers must avoid doing that as regulators do not like to see statements like that.

Asked about valuations, Steinmetz said if an investor believes the valuation is too high then it might not be right for them. He suggests that investors look at the industry, and look at comparisons while adding that early stage valuations are very difficult.

Lattuga suggested that investors also look at the reputation of the platform, see if they have a diligence process, see if they are actually providing some sort of scrutiny on deals, vetting them for outright fraud and harm which is their obligation, but also conducting some diligence.

“Are they just letting anyone on?” This is something you should know before investing in an offering listed on a platform. Lattuga added that some of their issuers have gone on to raise money from really big investors – a good indicator of a quality firm.

Steinmetz said you should buy the story, not just the stock but make certain it is a company that can really grow. “Make certain they have gotten all of the component parts that show they are serious.” This applies to all exemptions, Reg CF, Reg A+, and Reg D.

“If they did it the right way, and they are a company that has a good story to tell and looks like it is going to be able to go to the next level … now days, companies are staying private for more than thirteen years. Twenty years ago, it was four years … they are going to be private for awhile, so make sure their next round is an up round and they are going to get some positive growth. Those are good investments.”

If you are interested in investing in private securities, this is a great video to watch and learn from the platforms that are helping companies raise money online. As stated before, it is your money so make investment decisions that align with your goals as well as your ability to shoulder the risk.




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