Crowdfunding Is Here; What You Need to Know
Thursday, May 19, 2016

Effective this week, just about anyone in the U.S. can play the role of venture capitalist. New crowdfunding rules went into effect on Monday that allow non-accredited investors to risk up to $2,000 or 5% of their annual income or net worth (whichever is less) in a start-up company during a 12-month period. Those with annual income and net worth equal to or above $100,000 can invest up to 10% of annual income or net worth during a 12-month period. The Securities and Exchange Commission has a summary of the crowdfunding rules.

Previously, investments in such companies were limited to accredited investors. Accredited investors have high net worth and/or large incomes. The Jumpstart Our Jobs (JOBS) Act of 2012 established new rules with the intent of giving smaller companies greater access to financing. In doing so, the JOBS Act created a mechanism for smaller investors to lose their cash.

I looked at several crowdfunding platforms. Wefunder had the biggest selection of offerings, with 20 companies. The next-largest selection was on Start Engine, which listed 17. It’s still early, so I expect the number of offerings on various crowdfunding platforms to grow. I don’t have enough familiarity with the platforms to suggest which to focus on or avoid, so I encourage you to do your own due diligence before opening an account with one. Stick with only those that are registered with the SEC and FINRA and be sure to look on their websites for the CRD Number or ask them for it. Information about the companies operating the platforms should be available on the SEC's Investment Adviser Public Disclosure website.

There was a surprising amount of variety in terms of the type businesses seeking to raise capital via the crowdfunding platforms. Products and services included a biodegradable toothbrush, a social media app for dog owners, a platform linking venues and event planners with musicians, a manufacturer of mountaineering tents and a Seattle company offering donuts, fried chicken and whiskey. Some product quality testing might be required for that last one…

Could a crowdfunded company turn into the next big thing? Perhaps, but it’s not very likely. The failure rate for start-ups is high. As such, you should approach these companies with a high level of skepticism. Consider where they are in terms of business development, if they have an actual product currently being sold, what their revenue and profitability trends are and how competitive their industry is. You should also find out how the proceeds from the offering will be used, what rights as a shareholder you will have and how the company will keep you informed.

Then, determine the proposed valuation. If a company is offering a 0.01% ownership stake for $2,000, it’s implying that its valuation is $20 million ($2,000/0.01% = $20 million.) This is math you may have seen done by the celebrity investors on “Shark Tank.” They run the numbers based on the requested funding amount to see if it is reasonable. Compare the offering amount to actual revenues (sales / assumed valuation). Then take a step back to simply ask if the number is reasonable from the standpoint of common sense. While doing so, realize your assessment will be far more art than science.

Keep your guard up for both marketing and sample bias. The companies seeking crowdfunded investment dollars will do all they can to make their prospects sound great. Your job, as an investor, is to be Joe Friday and seek out just the facts. Having a prepared checklist of what you want to know before looking at any investment can be extremely helpful. Also, be cautious of any buzz you hear. Just because you know people who use the product or service or would be very interested in it doesn’t tell you anything about the actual size of the potential customer base or the company’s chances of success.

Most importantly, only invest money you’ve set aside for gambling. This is speculation, not investing. You will lose everything on most crowdfunded investments. Any money you cannot afford to lose should not be spent on a crowdfunded investment.

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The Week Ahead

Just 16 members of the S&P 500 will report earnings next week as first-quarter earnings season winds down. Included in this group will be AutoZone (AZO), Hewlett Packard Enterprise (HPE) and Intuit (INTU) on Tuesday; Costco Wholesale (COST) and HP (HPQ) on Wednesday; and Dollar General (DG) on Thursday.

On the economic front, the May PMI Manufacturing Index Flash and April new home sales will be released on Tuesday. Wednesday will feature March international trade. April durable goods orders and April pending home sales will be released on Thursday. Friday will feature the first revision to first-quarter GDP and the final University of Michigan consumer confidence survey.

Federal Reserve Chair Janet Yellen will speak publicly on Friday. Also making public appearances next week will be St. Louis president James Bullard, San Francisco president John C. Williams and Philadelphia president Patrick Harker on Monday; Dallas president Robert Kaplan on Wednesday; Bullard and Governor Jerome Powell on Thursday.

The Treasury Department will auction $26 billion of two-year notes on Tuesday, $34 billion of five-year notes and $13 billion of floating two-year notes on Wednesday and $28 billion of seven-year notes on Thursday.

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AAII Sentiment Survey

Optimism for a short-term rise in stock prices is below 20% for just the 30th time in the 29-year history of the AAII Sentiment Survey. At the same time, more than one in three individual investors now have a downbeat view about the short-term direction of stocks.

Bullish sentiment, expectations that stock prices will rise over the next six months, declined 1.1 percentage points to 19.3%. This is the lowest level of optimism recorded by our survey since February 10, 2016 (19.2%). It is also the 28th consecutive week and the 61st out of the past 63 weeks that bullish sentiment has been below its historical average of 39.0%.

Neutral sentiment, expectations that stock prices will stay essentially unchanged over the next six months, declined 1.7 percentage points to 46.6%. The rise keeps neutral sentiment above 40% for a 10th consecutive week. It also keeps neutral sentiment above its historical average of 31% for a 16th consecutive week and the 68th out of the past 72 weeks.

Bearish sentiment, expectations that stock prices will fall over the next six months, rose 2.8 percentage points to 34.1%. Pessimism was last higher on February 17, 2016 (37.8%). The historical average is 30%.

As noted above, there have only been 30 weeks over the survey’s entire history with a bullish sentiment reading below 20%. Since 1990 optimism has only dipped below 20% nine times, with this year accounting for three of those occurrences (January 13, February 10 and this week). Such low levels of optimism have been historically followed by rising stock prices: The S&P 500 has averaged a 12.6% 26-week return following the 27 occurrences prior to year. The sole exception was March 10, 2008, when the S&P 500 fell by 11.7% over the following 26 weeks. A listing of all 30 sub-20% bullish sentiment readings and the S&P 500’s subsequent 26- and 52-week returns can be seen on the AAII Blog.

Giving individual investors cause for concern is the slow pace of U.S. economic growth and uncertain global economic growth, terrorism and global unrest, lackluster corporate earnings and the prevailing level of valuations. Some AAII members, however, are encouraged by sustained domestic economic growth, expected corporate earnings growth and still comparatively low energy prices.

This week’s special question asked AAII members for their opinion about the current pace of economic growth. Nearly half of the respondents (49%) described growth as slow and an additional 22% described growth as poor or inadequate. Just 11% said growth was either good or as good as could be expected given the prevailing political and/or macroeconomic backdrop.

Here is a sampling of the responses:

  • “Far too sluggish.”
  • “It’s still slow and won’t change until wages start to increase across the board.”
  • “Pace of economic growth is excessively slow. Snails are faster.”
  • “Slow due to uncertainty about regulations, the election, Brexit and China.”
  • “Too slow, but steady; needs tax reform and fiscal stimulus from Congress.”

This week’s Sentiment Survey results:

Bullish: 19.3%, down 1.1 points
Neutral: 46.6%, down 1.7 points
Bearish: 34.1%, up 2.8 points

Historical averages:

Bullish: 39.0%
Neutral: 31.0%
Bearish: 30.0%
Take the Sentiment Survey.

Local Chapter Meetings
AAII Local Chapter Meetings offer you a variety of presentations from expert speakers who will give you their view on the world of investing. A bonus of attending a Chapter Meeting near you is the opportunity to meet other AAII members who share your interest and enthusiasm for investing. You can even share the Chapter experience with your family and friends by inviting them to attend Chapter Meetings with you!