Investing Directly With Companies | Beware And Proceed With Caution

For many, angel investing is entirely new. People don’t know where to begin, and some start tossing money at companies immediately. This is not the best way to start.

Investing directly with companies is not necessarily a bad thing, but there are some things to be aware of.

This post is all about investing directly with companies and will cover the following:

• Is it a good idea to invest directly with companies?
• When might you want to invest directly?
• Why are registered broker-dealers and portals considered a better way to go?
• Are direct investing deals scams?

By the time you’ve finished reading this post, you should have a better understanding of if, when, and why you might want to invest directly and why you might want to use a registered entity.

After you’ve finished this article, you might want to check out Security Types | It’s Not Just About Tossing Money At A Company too.

I will be creating several courses to cover topics such as this one and other related to angel investing on AngelPowwow.com. I don’t have an eta, but they are in the works. Please check back from time to time to see what’s new.

THIS POST MAY CONTAIN AFFILIATE LINKS. PLEASE SEE MY AFFILIATE DISCLOSURE FOR MORE INFORMATION.

Let’s get started…

Is Investing Directly With Companies A Good Idea?

The answer to that is, “It depends.” It all boils down to the trustworthiness of the company as well as their ability to build the business successfully to and exit event. The focus of this post is really about the trustworthiness part. The other aspects that lead to a company’s success are better suited to be discussed in a post on due diligence.

As far as trustworthiness goes, it would be best if you were sure that the founder(s) is/are not trying to pull off a scam. Here’s the reason this is so important:

If a company is raising under Regulation A+ and their statement has been filed with and approved by, the SEC, they are then able to market their securities directly, without using a registered agent or broker-dealer. The reason that this is a critical issue to take note of is that the company is not required to perform any extra due diligence, nor are they subject to quarterly regulatory reviews regarding the offering.

Conversely, SEC and FINRA entities are and thus, can be considered an extra vetting buffer in your due diligence effort. Most can be viewed as a neutral party (even though many do receive a cut of the raise, so they do have some skin in the game). If the registered entities fail to perform this additional due diligence, they can have their licensing revoked or even receive harsher penalties.

Now, let’s talk about when you would want to invest directly…

When Would I Want To Invest Directly With A Company?

There are times when you might want to invest directly, even though you don’t have that extra buffer. Everyone has their reasons, but here are a few that I think might tip the balance:

Personal Connection

You know the founder. You trust them on a personal level and believe in their vision. This falls under the friends and family round. If you have this kind of connection, the chances are that the founder has already reached out to you. If not to ask you directly for money, at least to share their idea with you and gauge your reaction.

Belief In The Pitch

Sometimes an “OMG, why hasn’t anyone done this yet. It’s so obvious.” moment comes along, and it’s just a no-brainer, virtually impossible to fail. This might be one of those times when the founder thought, “Go through a middle man and pay the fees associated with it? I know this is going to be a winner. I’ll just raise directly”. Now, don’t get me wrong; most founders probably think this about their idea. Still, some simply resonate with people, and, in such cases, investing in one of these deals is perhaps the smart move. I consider this to be one of those “gut feeling” investments, even though I would still perform my usual due diligence.

The Pros Outweigh The Cons

There are times when you might be on the fence regarding an opportunity. The idea seems solid, your due diligence has you leaning toward investing, but there are some cons, one of them being that you have to invest directly vs. through a trusted funding portal or broker.

I’ve run into this situation a couple of times. My advice, make the good-old pros and cons list (something you should be doing with all opportunities anyway). Fill the list out. Add weights to the results (i.e., One con may carry less weight than another. Assigning levels of pros and cons, say 1-5, will help you build a scoring system to evaluate the overall pros and cons totals).

You can then total up the columns and use the scores to help you make your decision. Depending on your investing posture, you might want to come up with a threshold to help you decide when the pros and cons are a bit too close for comfort (i.e. If I were a more conservative investor, I might set a threshold requiring that the pros score at least ten more points than the cons for me to invest. Anything closer and I move onto the next deal).

Now, let’s talk about the “better way to do it”…

Why Is It Considered A Better Idea To Invest Through Registered Broker-Dealers and Portals?

In a nutshell, these entities are required to perform some extra due diligence and are subject to quarterly regulatory reviews. Also, as an entity whose well-being and success hinge on providing a trustworthy service and keeping customers happy, it’s in their best interest to provide you with reputable deals.

Platforms such as SeedInvest, Republic, StartEngine, and the like are considered reputable entities to work with. They work hard to build their reputations and can be trusted. Now, that doesn’t mean every deal they offer is a good one. No one knows the future. Just because an opportunity is on one of these platforms doesn’t mean it’s a sure thing.

Another thing to consider is that Reg-A offerings, whether they’re offered directly or through a registered entity, include a peculiar provision… When a company raises money via an A+ offering, they have an option to let previous shareholders sell their holdings up to 30% of the offering raise. It’s basically a cashing out mechanism (or what some may call insider dumping), all while raising new funds.

While companies can do this, you do have some protection. In form 1-A, companies are required to tell you that they are doing this and what exactly shareholders are allowed to sell. The catch is that most investors don’t read this document and aren’t aware of what’s happening.

Scams seem to be everywhere these days. Are all direct investing deals a scam? Read on to find out…

Are All Direct Investing Deals A Scam?

Not at all. This article is just to point out potential issues to be aware of.

For the most part, most founders are on the up-and-up. That said, sadly, there are scammers out there, and a few of them are looking to take advantage of this potentially lucrative loophole. It’s up to you, the informed investor, to do your due diligence and decide if the opportunity is legit or a cash-grab scam.

The hard part is vetting the opportunities and making that decision. A few things to consider are:

• Does the founder have the skill set to build the company?
• Do they have previous exits under their belt?
• Is the opportunity too good to be true?
• Is the founder answering questions correctly (i.e., do they sound like they know what they’re doing and providing appropriate answers)?
• Is there only a single active raise, or are they raising on multiple platforms simultaneously (this is a red flag)?

I’m sure there are other considerations, but I think the list above is a good start.

Conclusion

I hope this post has been insightful for you. In the end, only you can determine if a particular deal is a good fit for you and your investing style and comfort level.

Personally, I don’t think that direct investments are a bad thing. Still, I do consider the direct option as a ding on the cons list (unless I have inside connections – i.e., friends, family, or trusted associate, etc.). I have skipped two opportunities so far because of this issue. The direct investment option made me feel very uncertain about them, so I moved on. They may still go on to a successful exit, but I wasn’t willing to take the risk.

I’d love to hear your thoughts on investing directly with companies. Have you skipped a deal because of it? Is there another fact that you want to share? What weight do you give to direct investment in your pros and cons list? Do you think the “Beware And Proceed With Caution” warning is warranted or ridiculous? Let me know by commenting below.

Thank You,

Scott Hinkle

AngelPowwow.com