Equity crowdfunding is a flexible financing option where investors receive shares or equity in exchange for capital. They use the money to fund various business ventures and offer more accessibility. Equity crowdfunding also provides entrepreneurs and startups with more opportunities to gain capital.
Equity crowdfunding (EC) is an online financing method that provides investors with ownership of shares in a company. They receive share ownership in exchange for capital to fund business ventures or investments. EC is a more flexible option for both investors and entrepreneurs. Because it is more accessible to a wider variety of people, it has leveled the playing field for the everyday investor.
What is equity crowdfunding, and how does it work? What are the pros and cons for the average investor? Here is what you need to know.
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What is Equity Crowdfunding?
In general, crowdfunding is using small amounts of capital from many people to finance business ventures. This can take place on platforms like Kickstarter or GoFundMe, for example. Public crowdfunding is wildly successful at bringing people together from various networks by using social media and other online platforms.
Its most significant strength is its ability to help startups gather support from accredited investors and everyday people. Equity crowdfunding differs from other common forms of crowdfunding, like the rewards-based model. In reward-based crowdfunding, investors receive some promise or reward in exchange for capital. This reward could be the product or service that they invested to fund.
However, investors receive equity ownership in equity crowdfunding in exchange for capital. There’s also no debt component for the startup or small business owners.
“Instead of making payments toward small business loans, startup owners can sell shares of ownership or equity in the company to investors.”
Like general crowdfunding, there is a wide range of online equity crowdfunding platforms; in some cases, Crowd Funding platforms are ng investments. They also include other features like marketing tools and multiple payment methods.
Some popular equity crowdfunding platforms include:
How Does Equity Crowdfunding Work?
Equity crowdfunding is regulated by the federal government, which is why it’s sometimes referred to as regulation crowdfunding. Even though you’re not selling shares in your company on the stock market with this method, you’re still offering investors equity in exchange for capital. Because of this, there are more rules to follow than there would be on platforms like GoFundMe.
Following the rules enforced by the SEC is crucial if you want to avoid consequences. For example, failure to comply with the equity crowdfunding rules could result in your business having to refund any investments you receive. Or, even worse, the SEC could freeze your business’ ability to offer shares for a period.
Some of the steps to take and rules to follow to participate in equity crowdfunding include:
- Work with SEC-registered broker-dealers or funding portals to process investment transactions.
- Don’t accept more than $5 million yearly crowdfunding investments through CF portals.
- Follow federal limits on the amount of capital you can accept from individual, non-accredited investors in 12 months. This number is income-based and varies from person to person. Not to exceed 5% of your net worth in a calendar year.
- Make any necessary financial disclosures public based on the funding you raise.
So long as the people investing are based in either the United States or Canada, anyone can invest. This includes accredited investors who meet asset, income, employment requirements, and everyday people — including family, friends, and even business partners. Anyone who firmly believes in your business can invest.
Also, investors don’t have to provide large amounts of capital with equity crowdfunding. In many cases, potential investors can get involved for as little as $100. This is another factor that makes equity crowdfunding such an appealing and accessible option for funding new business ventures.
Equity Crowdfunding Compared to Other Types of Crowdfunding
As a startup or business owner looking to gather capital from investors, you have many different options in crowdfunding. On top of equity crowdfunding, there are several other variations of crowdfunding to choose from, each with its differences and similarities.
Some of the different types of crowdfunding include:
- Rewards crowdfunding
- Debt crowdfunding
- Donor crowdfunding
#1. Rewards Crowdfunding
Rewards crowdfunding provides some benefits to investors in exchange for capital. These rewards or benefits can be anything you’d like. For instance, a hair salon could offer investors gift certificates for future services. Or an author could offer signed copies of their book before the release date.
This is another viable option for startup owners or entrepreneurs who don’t want to take on debt to fund their businesses. However, it’s important to note that rewards crowdfunding only works if you’re offering benefits that interest and motivate investors to support you. This may take some trial and error.
#2. Debt Crowdfunding
Debt crowdfunding is a cross between a small business loan and traditional crowdfunding. With this method, you’ll take out a loan from a crowd rather than a bank or online lender.
This crowdfunding type lets you operate under a loan agreement like a traditional loan. You’ll have to repay the money you owe, plus interest over an agreed-upon time period. Also, with debt crowdfunding, investors aren’t granted equity in your business.
#3. Donor Crowdfunding
Donor crowdfunding is also sometimes called donation-based crowdfunding. In this model, people contribute money to a cause without expecting anything in return. For example, a family member may donate some money to you to support your dream of starting a business. This format of crowdfunding is also standard among charities and nonprofits.
NOTE: GoFundMe and CrowdRise are excellent examples of platforms based on donor crowdfunding.
Pros of Equity Crowdfunding
“Equity crowdfunding is a great way to raise capital without acquiring business loan debt.”
Some of the advantages of pursuing equity crowdfunding include:
- Could raise more money
- Attract nontraditional investors
- No debt
- Generates buzz and engagement
- Allows you to gauge interest in your business
#1. Could Raise More Money
There’s power in numbers. Because you’re working with many investors through equity crowdfunding, the potential to raise more money is evident. EC often outperforms other funding options.
Similarly, it’s also possible to raise more money very quickly. Word of mouth can travel pretty fast. Because it’s so easy to participate in equity crowdfunding, the likelihood of your business seeing more investments in a shorter time significantly increases.
#2. Attract Nontraditional Investors
One of the best and most revolutionizing features of equity crowdfunding is its availability to anyone. You can invest whether you’re wealthy, an accredited investor, or just an average person.
“The low entry barrier and convenience make equity crowdfunding a viable option for everyone.”
Because this type of funding happens online, it’s effortless for anyone to invest capital by simply logging onto the platform and clicking a button.
#3. No Debt
Debt can be a pain for anyone, especially startup owners and entrepreneurs looking to get a new business venture off the ground. Luckily, with equity crowdfunding, debt isn’t a concern. There are no loan repayments or debt-related credit checks required. This makes it much easier to raise capital without worrying about interest piling up on loans from traditional lenders.
#4. Generates Buzz and Engagement
By opening your business or startup for equity crowdfunding, you can build excitement and generate buzz about your new venture before you officially launch. It’s also great to engage the community around your new business. Equity crowdfunding allows investors to become part of your business, even if they only hold a small share.
Also, because equity crowdfunding lives on online platforms, this can lead to valuable marketing opportunities. Connecting your business and crowdfunding platform of choice to social media, email marketing tools, and traditional media can garner more attention. And in some cases, this attention can lead to more investors and more capital to support your mission.
#5. Allows You to Gauge Interest in Your Business
“Equity crowdfunding is also a terrific tool to test an audience’s reaction to your business or product.”
Suppose people are willing to invest in it before development or distribution. In that case, your business or product idea will also perform well on the market.
This is a quick and cost-effective way to verify your ideas and justify any investments you’ve made in the business planning process. It’s also an excellent time to hear feedback from potential investors on what does or doesn’t work with your business or product. That way, you can make any necessary improvements before launching.
Cons of Equity Crowdfunding
Although equity crowdfunding sounds like a very effective and accessible funding option, it’s essential to consider any potential downsides. Some of the disadvantages include:
- Give up a portion of your business
- Fraud and idea theft
- Time-consuming to get started
- Non-liquid Investment
- Risk of public failure
#1. Give Up a Portion of Your Business
When setting up your equity crowdfunding campaign, you can set the parameters to ensure that you still hold a certain percentage of shares, or the majority, compared to your investors. However, you’ll still be granting investors equity in exchange for capital in this type of funding.
This could be difficult for some entrepreneurs, mainly if you deal with investors who want a say in your business operations. It also means that you’ll be sacrificing a portion of your business’s future profits.
#2. Fraud and Idea Theft
Because crowdfunding happens in the public forum, your business may be vulnerable to fraudulent attacks or idea theft. For example, social media can help extend your reach and gather investors. It’s also prime real estate for scammers looking to set up dubious business ventures to collect funds fraudulently.
Intellectual property rights laws typically protect crowdfunding platforms, but other measures, like applying for a patent and copyright trademark, should also be taken to provide even more protection.
#3. Time-Consuming to Get Started
Starting an equity crowdfunding campaign can take up a lot of time and resources. First, you’ll have to take the time to create a compelling presentation and marketing plan to communicate the value of your business or idea to generate investor interest.
There are also many of the ins and outs of crowdfunding that are crucial to learning, especially considering how important it is to maintain compliance with the SEC. It takes much time to build up an effective equity crowdfunding campaign, and there’s no guarantee of a return.
#4. Risk of Public Failure
In some cases, failure is encouraged to inspire better ideas. However, it’s essential to know that there’s a risk of a public loss when your equity crowdfunding campaign doesn’t perform as expected. Because these campaigns are shared, you can’t necessarily hide your shortcomings. This is important to remember from the beginning to be prepared to face any pitfalls you may encounter in your funding journey.
Leveling the Playing Field for Investors through Equity Crowdfunding
“Equity crowdfunding is the key to leveling the playing field for the average investor, not just limiting opportunities to the accredited few.”
With this funding method, virtually anyone can invest capital into projects and businesses they enjoy. This dramatically broadens the scope of potential investors and provides everyone a chance to make money, hold equity and build a portfolio.
Not only is equity crowdfunding more open and affordable to participate in, but it’s also more accessible and convenient. There’s no barrier to entry in the form of access because these investment opportunities are readily available online. By logging into any crowdfunding platform, you can become an investor in just a few clicks.
But this funding method isn’t just valuable to the average investor. It benefits the entrepreneur, too. You can access a much larger pool of investors with equity crowdfunding, so you’re likely looking at more funding. Equity crowdfunding dramatically increases access to capital for entrepreneurs, which is especially helpful for minority-owned startups that have historically faced challenges funding their ventures.
Equity crowdfunding is an online financing method that involves issuing investors ownership in a company in exchange for capital to fund a business. Equity crowdfunding is a more flexible option for both investors and startup founders.
EC is the key to leveling the playing field for the average investor and not just limiting opportunities to the accredited few. This dramatically broadens the scope of potential investors. It also provides everyone with a chance to make money and hold equity while providing more access to capital for entrepreneurs.