Investments always come with risk. The subprime mortgage crisis in 2008 for example played a huge role in the recession that devastated many families across America and throughout the world. The Street notes how the crisis was brought about by loan companies taking advantage of vulnerable U.S. clients willing to invest in real estate. This goes to show how important it is to properly examine investment contracts before agreeing to them.
This article will discuss the steps to take in making a thorough review of any investment contract that comes your way in order to avoid risk or scams.
Apply the Howey Test
The U.S. Securities and Exchange Commission (SEC) defines an investment contract as something that “exists when there is the investment of money in a common enterprise with a reasonable expectation of profits to be derived from the efforts of others”. The SEC provides a framework on analyzing whether something is an investment contract through the Howey test, which looks at certain elements that determine the circumstances of the agreement. When reviewing a contract, these are the basic things you need to watch out for:
1. It is an investment of money
This usually manifests in the offer and sale of an asset, whether in the form of real currency (on demand or on credit), a digital currency (cryptocurrency and similar assets), or other considerations.
2. The investment of money is in a common enterprise
A common enterprise is where the fortunes of the investor are linked and dependent on the efforts and success of those selling the investment.
3. There is an expectation of profits from the investment
A key issue in analyzing an investment contract is understanding the terms of how one expects to receive profits from purchasing a certain investment. The realization of profit or other forms of financial returns may come in different ways, such as selling it at a gain in a secondary market, or through methods of realizing the appreciation of the asset.
4. Any profit comes from the efforts of a promoter or third party
This is inherently linked to the above point, wherein an investor understands that they will receive profits based on the actions of the third party that sold them the investment. This happens when the promoter or third party provides managerial efforts that are contingent to the success of the enterprise.
Ask for Financial Documentation
After ensuring that all of these features are met in your contract, the Entrepreneur Handbook recommends asking for supporting documentation both for your ownership interest and projected gains. This makes it clear how much profit you are projected to receive from the investment.
It also gives you an explicit guarantee that you are to gain from the investment if certain conditions are met.
Seek External Review
It’s important that through the process of reviewing an investment contract, you are able to seek assistance from external parties. Legal specialists Special Counsel advise tackling contracts with a second set of eyes so it is examined with an objective lens. This will also make the mentally taxing and time consuming work easier.
Seek help from fellow entrepreneurs, friends, or legal experts. If possible, try to get a page-by-page review of the contract from a lawyer. Ask them to walk you through the document in case there are any parts that seem unclear to you. It’s better for you to ask questions before signing the contract than to have something explained once you’ve already committed to it.
Reviewing investment contracts may seem daunting, but it’s a necessary step in making that investment. Investing is important in providing yourself financial security. Automatic Finances believes it is important to start investing as soon as you can, and that it shouldn’t matter whether the economy is good or bad.
If you want to invest but are having difficulty on how to go about it, remember that there are always professionals you can approach both from a legal and financial standpoint, and that you don’t have to go through this process alone.
