Why should I invest in private stock with no dividends?
With Title III of the Jobs act, we are seeing companies raising capital from crowdfunding. In many of these cases, they are selling private stock, and will not be paying dividends.
What is my incentive for investing in such a company? Is the idea that at some time in the future, I will be able to find another private investor who will be willing to buy the shares from me at a higher price than I paid for them? How does this stock become monetized?
You nailed the issue by asking about monetizing the investment. Without dividends, your only hope is that the company sells out at some future date and that all investors are rewarded. That's a big "if." It is probably more likely in some industries than others, but the general likelhood is low. Crowdfunding seems more to me like marketing than investing ... trying to make friends and customers feel part of a new venture. There is nothing wrong with that, but remember that investment prospects are low. Do it for fun, do it for prestige, do it for personal fulfillment. Don't do it for investment purposes.
In my opinion, this is a very risky endevour without a LOT of due diligence on each private company. You need to ask what is their exit strategy for investors and if there are required to take certain actions and/or payments if certain benchmarks are hit. No guarantees, but what if things do work out how would you get paid. In other words, you are spot on and even if they make money, how can you be sure they will pay out anything.
That is the problem with privately held stock where you are a minority shareholder with no control.
Hope this helps and best of luck, Dan Stewart CFA®
This is a good question as more and more companies are electing to participate in crowdfunding. Any company which raises money through a stock offering is typically raising the money to help the company become stronger financially. Somtimes it is done in an effort to pay off its debt obligations, but usually it is for expansion of its existing operations or some other form of growth (an acquisition). Using the public markets as an example, when Amazon went public it raised money to fund its growth initiatives, probably raising 100 million dollars or more. The company was successful in becoming far bigger, and is now worth nearly half a trillion dollars. Holders of that stock have seen a ten fold appreciation of the value of it. The same idea holds true for private companies, as if the company becomes bigger and more profitable, the owners of the shares have a more valuable asset. Many private exchanges are set up to help private enterprises raise money or current owners sell their shares. Also, a private entity can be bought by another private company, and if the price paid is more than what an owner paid years earlier, there will be a capital gain. You are correct, the risk is that the company does not do well, or, that the future growth prospects do not pan out as well as management believes they will. I hope this helps answer your question and best of luck with your investment.
Your questions are perfect, they identify all of the problems with investing in small crowdfunding opportunities. Unless you personally know the owners of the company offering stock and you trust them and believe in their business model, you should stay away from crowdfunding investments. There is a limited market for their shares and basically the crowdfunding is just replacing the job of a venture capital firm, but spread amoung many people thus not haveing the influence of a singe venture captial fund. Crowdfunding will make you money only if the business grows rapidly and provides sustainable profits. Then when the company goes public or the owners buy you out will you realize a return on your investment.
Very risky endeavor. It is a widely held truth that only 1 out of 3 business startups are still in business 5 years later, so you need to be prepared to lose all the money you invest in any particular venture. Professional private equity investors know this, and their success depends on spreading their investment dollars around amongst many opportunities. Their hope is that the 2 or 3 that strike it rich will offset the many more which flop or struggle to survive. To answer your question though, your investment is very illiquid, and will be difficult to monetize. Your hope would be that if the firm is successful either a) another investor or owner will buy you out or b) the company will go public or get bought by another firm (long shot...) or c) the company will someday distribute profits as dividends (but why should they!!!) I would largely stay away!