How Crowdfunding is Different than Stock Market Investing:

Stock Market Investing

Public markets offer accessibility, transparency, and liquidity. Investors buy shares of public companies through a regulated marketplace, with prices determined by market demand.

Liquidity

Public company shares can be bought and sold any time their market has trading hours, meaning it’s a “liquid” market.

Now, that doesn’t mean you’ll get the price you want.

All liquidity is not created equal.

How many shares a company trades each day determines how hard it may be to unwind a particular investment.

A company with a small “Bid/Ask Spread” will get you a lot closer to the offered price than a company with a large Bid/Ask.

It can also affect how long your order takes to fill, or IF it will fill.

But ultimately, you should be able to get out of a given position within a reasonable period of time.

Meanwhile, with crowdfunding, shares are generally not liquid (although there are some exceptions we will get into in a future post).

These are longer-term investments, often requiring years before you might see a payday.

And that assumes that the company doesn’t go out of business in the meantime.

When you do get to an exit point with a private company, this will typically take the form of an acquisition, or a public offering.

We told you last time that a company’s IPO is usually a payday for its earliest backers.

When that happens and you’re a crowdfunding investor, YOU get to be one of those sellers!

Returns

From a return standpoint, one less exciting feature of investing through the stock market is that, with a few exceptions, many of the companies available for investment on the stock market are later-stage, larger companies.

And that means, most of the time, you’re going to be looking at smaller annual growth rates for investing in these companies than you might get putting your money into something earlier stage.

While these companies are not likely to go out of business, they also might not make you a whole lot of money.

And to reduce risk, many folks invest in funds that hold positions in a number of these companies, but this also cuts their return chances further.

Now, there are also lots of earlier stage companies traded on the stock market as well.

And those companies theoretically should have lots of upside relative to the larger ones.

That said, it’s absolutely critical to realize that most small companies—whether they are on the stock market or still at the private stage—carry very large amounts of risk.

Many early-stage companies fail, and when they do, the folks who invested in them typically lose everything they put in.

But if you’re going to invest in smaller companies, why not just do it through the stock market, and at least keep some liquidity?

Short Sellers

For one thing, these “penny stocks” are not only much riskier than larger companies because they’re more likely to fail, but also because they are frequently targeted by “short sellers”.

Short sellers believe that a given company is a bad investment, and its price is going to fall.

And since a free market needs both buyers AND sellers, short sellers are allowed to bet against a company’s shares.

We don’t need to get into the technical details of how that works. The important takeaway is that the end result of short seller activity is that it puts downward pressure on a company’s share price, for no good reason other than the fact that “the shorts” are selling the shares.

While short sellers do serve a useful market function by helping identify frauds and other bad actors, there is nothing stopping them from targeting good companies as well.

And many short sellers are essentially market bullies.

They tend to stay away from bigger companies, who have big investors with billions of dollars in cash behind them, because they can defend themselves.

But guess who doesn’t have these kinds of resources to back them up?

Smaller earlier-stage companies.

As a result, even if you happen to find a small company on the stock market that has great potential, you can often still lose money because they just happen to get “targeted by the shorts.”

This form of legal market manipulation is a major risk for investing in the small, publicly traded companies that compare best to private deals.

But shorts are a problem that private deals don’t have.

Because the company’s shares essentially don’t trade, it’s impossible for short sellers to bully them.