Also referred to as crowd investing or investment crowdfunding, equity crowdfunding entails raising capital from the crowd. In return, public investors get a proportionate slice of equity in the business venture. Essentially, inventors or entrepreneurs sell a stake in their project to several investors in return for financing.
Contrary to traditional investors such as angel investors and venture capitalists, equity crowdfunding opens the door to a broader pool of potential backers, the crowd, who invest in a project through specialized online platforms. Also, contrary to other forms of crowdfunding, this model offers a more conventional fundraising method by offering financial securities to investors.
Primarily, equity crowdfunding applies to early-stage firms that are yet to be listed on a stock market. However, it’s rapidly gaining popularity, and here are all the reasons as to why.
What Is Equity Crowdfunding?
As already outlined, equity crowdfunding targets a broader group of investors. Also, there are less stringent and streamlined entry criteria for both companies seeking funding and investors. Also, most platforms don’t charge any entry fees to register or maintain membership as an investor.
Nonetheless, and as per most platforms, one has to be over 18, and there are certain limits on how the funds investors can set up for a project depending on their income and net worth. Consequently, investors must provide their identity income and asset verification to sign up with a particular platform.
Equity crowdfunding allows individuals seeking funding to sell securities in different forms. Most investors prefer equity in the company form, considering it’s more viable to lock in profits. Other options include debt, revenue share, and convertible notes. As you can imagine and akin to the traditional investors, potential backers are aware that early-stage businesses have a high risk of failure and will most likely commit to a promising and alluring opportunity.
In a nutshell, individuals seeking funding approach a registered equity crowdfunding platform. Most importantly, it’s best to consider websites that leverage the JOBS Act and Regulation A benefits. Then, once the platform approves a business, make your pitch. This might be a time-consuming endeavor and the most critical aspect of your campaign. Also, you have to determine the equity stake and share price in your pitch.
It’s worth mentioning that you will have to submit essential information such as an effective business plan, financial statements, and forecasts. Progressively, intrigued investors will contribute to your cause.
Once you hit the financing target or after the end of your campaign, the platform might perform some final vetting before releasing your funds. Bear in mind platforms are bound to deduct a percentage from the raised amount. Investors get a share of your business and will continue to advocate for the company.
Benefits of Equity Crowdfunding
Equity crowdfunding offers a win-win situation to both investors and entrepreneurs.
Benefits to Investors
Through equity crowdfunding, investors and, in some cases, unaccredited investors can be a part of a potential project and share the success. As a result, there is the possibility of an establishment becoming a unicorn and providing lucrative returns for investors.
Other notable benefits of equity crowdfunding to investors include:
- Investors can participate with low minimum investment thresholds. Some platforms allow backers to contribute a low of $50 to a project.
- Investors can gain part-ownership of a firm. Once the venture becomes successful, its value increases, and the backers’ shares will be worth more than what they initially put in.
Benefits of Equity Crowdfunding for Companies
The most significant benefit of equity crowdfunding is that startups and SMEs can raise large amounts of money. Even better, quicker than other types of crowdfunding. Equity crowdfunding offers a more streamlining and feasible alternative than the lengthy and challenging process for entrepreneurs seeking funds from banks or a handful of wealthy investors.
The following are other advantages:
- Entrepreneurs retain control of their business. Unlike venture capitalists, equity crowdfunding doesn’t result in a dilution of power in a company. Instead, you will have a trustworthy brand of part owners willing to charge your venture for success.
- Crowdfunding platforms offer opportunities for emerging and promising startups to improve their market visibility. With the support of your backers, it’s an ideal method to raise awareness for your products/services and, as a result, build brand loyalty.
- Unlike other lending options such as banks, you don’t require collateral or a credit score to acquire funding.
Cons of Equity Crowdfunding
Akin to any model of investment, equity crowdfunding does have its drawbacks for investors and entrepreneurs. First and foremost, considering that it’s relatively new, some investors and entrepreneurs have dubbed equity crowdfunding as complex and somewhat unwieldy. That explains why still it’s not yet prevalent in the business realm considering the benefits it brings along.
Other risks with equity crowdfunding include:
- With a high number of investors, there might be increased pressure on the founders of a project. For instance, founders might have to hire an investor relations liaison or communication staff.
- Off late, scammers are setting dubious ventures to allure equity crowdfunding from first-time investors. However, most platforms are curbing such incidents by scrutinizing and working diligently to verify the information provided by those seeking funding.
- Returns on equity crowdfunded projects take time to materialize. Also, as mentioned, startups have a high risk of failure, and eventually, it may turn out to be capital erosion instead of wealth creation for investors.
- Equity crowdfunding investments are highly illiquid, considering there are no secondary markets for investors to sell their shares.
Popular Equity Crowdfunding Platforms
All in all, equity crowdfunding is progressively setting up as a viable financing option because it provides a compelling concession for investors and founders. Moreover, contrary to some opinions, it’s highly transparent.
Tentatively, there are about 950 renowned equity crowdfunding companies globally. We factored out the best options for entrepreneurs and prospective investors.