Risks of investing in growth companies

  • Written by Josh Daniell
  • Published on

Please understand the characteristics of investment opportunities offered through this marketplace

Never test the depth of a river with both feet - Warren Buffett

Snowball Effect is proud to provide access to early stage equity investments for everyday Kiwis. We're passionate about improving financial literacy in New Zealand and increasing investment into wealth-creating assets.

However, it's crucial for you to understand the characteristics of financial products offered through this marketplace.

Companies making offers through Snowball Effect will range from very early stage businesses with little more than an idea, to more established businesses that may already be profitable. The risk of investing in a business tends to decrease as a business develops and matures. For very early stage businesses, history suggests that perhaps only one or two out of ten will make significant returns for investors. Despite the hopes and belief of the promoters, some will putter along without much happening for a long time. In others the total investment will likely be lost.

Investing in early stage businesses is risky. Overall, investor returns tend to be greater than the amounts invested, but you might not be one of the winners. Some of the other key risks include:

  • Illiquidity - There is no guarantee that you will be able to sell your shares when you want to, or at all. Currently, there is no recognised secondary market for trading shares in companies funded through equity crowdfunding. Buying and selling among existing shareholders is generally lawful, but some companies may not facilitate it. We expect that trading facilities will eventually be authorised, but that is not certain at this time.
  • Lack of returns - Few early stage unlisted businesses pay dividends. They tend to reinvest what they earn in the growth or survival of the business.
  • Dilution - Companies may need more funding to grow or to survive. If they issue further shares, your share of the company will reduce unless you put up your proportion of the new investment.
  • Material events - Early stage businesses are often small and have narrowly focused offerings. This can increase the vulnerability of the business to internal and external threats, and make it harder to absorb material events such as loss of key staff and customers.
  • Lack of control - As a minority shareholder, you may have little influence on how the company develops. Companies are ruled by simple majority for most decisions. For example, you will not determine who the directors are unless the majority of shareholders who vote on an issue agree with you.

To decrease exposure to the risks, these types of investments should only be made as part of a diversified portfolio. Spread your risks. Only invest money that you can afford to lose.

Remember that you will never get enough information to know in advance how things will turn out. No one, even the directors of a company, can know in advance with 100% certainty just what will make a business fly, and what will bring it down. Even in public offerings for large mature companies, the information available is never enough to be sure how the future will turn out.

Please seek independent advice if you don't fully understand the characteristics of this marketplace or the information in an offer.