Watch out for this latest law

banker xBack in my earlier banking days, I ran a group that vetted deals for Venture Capital or Angel funding. I used to vet hundreds of deals a year to find 20 or so that looked promising enough to invest in. Companies would fly in and give me presentations of their business plans in hopes that I would submit these plans before a group of accredited investors who would then decide whether to fund the company or not. Today there is a similar movement to fund these types of deals, and it’s full of opportunity and danger. I’ll get to that in a minute.

Every deal that I saw looked like the best thing since sliced bread. The next Microsoft, a gold mine on the verge of discovering the next big find, a company whose microchip technology would bring Intel to its knees, nanotechnology companies that promised the lightest, strongest and least expensive components known to man…the next cure for cancer. You get the picture.

Here’s the reality. If two in ten of the companies that ended up on the floor before the investors succeeded in its business plan, we would call ourselves lucky. That’s two in ten of the ones that made it past the cut. If they all presented, it would be something like two out of thirty or forty. That’s not a very high batting percentage. But the ones that executed would more than make up for the losers. The reality is not different today for Venture Capital deals. Twenty percent is a great number. Each Facebook (FB) or Linked In (LNKD) can make up for a ton of losers that don’t make it. The key is to diversify and not put all one’s money into the one that “sounded” the best.

To be able to qualify for these deals one had to be an Accredited Investor. There are a lot of qualifiers to satisfy before one can become an Accredited Investor but basically it boils down to this: you can afford to lose money and it still couldn’t put you in the poor house. Now, just because you have money, does not mean that you’re smart. Most Accredited Investors will lose money in venture deals and it’s not because they are more speculative when they reach the venture level. It’s simply because most start-up companies fail. They do so because they have bad ideas, they’re under capitalized, the officers are looking to pay themselves form the funds raised as opposed to putting it into the company, their technology becomes obsolete faster than they thought, they’re committing fraud… the list is endless. Now, thanks to new regulations you don’t have to be an Accredited Investor to participate in similar ‘venture deals”.

In the next few weeks, new rules will be passed to govern the fast growing “Crowd Funding” movement. This is where individuals join up in an online community to invest in small deals put forth by individuals. They can range from tech start-ups and charitable cause to pipe dreams. And, when the SEC comes out with its final guidelines you will have the ability to invest to your hearts content with some limitations on how much you can invest per deal, probably around $5,000, just to make sure that when you lose your money, you will not be devastated. Of course, you can go crazy and invest in a bunch of deals and they may all fail resulting in the same financial ruin.

Just remember, all of these deals are pitched to sound like “no lose” propositions. They will lose at the same rate or higher than normal venture deals. Those numbers will not change. What is good about the new Crowd Funding deals is that they can be vetted and bought through on-line communities which may do better due diligence than if you were doing the vetting yourself. In the next issue, I’ll tell you where you can look for these deals and what to look out for before handing over your hard earned cash.

To your wealth,

Banker X.

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