- Equity crowdfunding is a financing strategy that involves issuing investors ownership in a company in exchange for capital.
- It's a viable alternative to more rigid forms of raising capital and gives entrepreneurs more flexibility in who they do business with and on what terms.
- Although it's a strategy to consider, not every company will benefit from this model. Entrepreneurs who are interested in equity crowdfunding would be smart to weigh the pros and cons.
Startup founders have numerous paths to fundraising – friends and family, angel investors, bank loans, venture capital, etc. Crowdfunding is a newer, increasingly popular form of fundraising. In many ways, it puts the control back into the hands of startup founders, because they can raise capital on their own, bypassing institutional funding and retaining more control over their business.
Read on to learn the basics of equity crowdfunding, including the benefits and how to get started. [Looking for additional funding options?: Best Business Loans for Small Business]
What is equity crowdfunding?
There are many types of equity crowdfunding, but we'll focus on the basics for now. Equity crowdfunding is a security-based form of crowdfunding. Securities are issued to the general public – in other words, a founder is issuing the public shares of their company in exchange for an investment. Investments vary wildly, though many start at a few thousand dollars.
With other forms of crowdfunding, investors are issued rewards. They may invest in a startup or even just an idea, typically in exchange for being the first to receive a product (think Kickstarter). Then there's a donation form of crowdfunding, where investors literally donate funds with no expectation or promise of a reward or a return (think GoFundMe).
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Equity crowdfunding gives startups an opportunity to raise more funds, and it gives the general public an opportunity to invest in a startup's passion project or area of interest with little to no hassle. Investors can simply source companies online; it's that easy. [Related Content: A Guide to Choosing the Right Small Business Loan]
How equity crowdfunding works
You can choose from a wide range of online crowdfunding platforms. These platforms not only give you a framework for collecting investments, but they offer additional features and services, like support, marketing and multiple ways of accepting payment.
These platforms are registered with the Securities and Exchange Commission (SEC). There are limitations on contributions from individuals to protect them from getting "overly enthusiastic" about investments. Companies are limited in how much they can raise, but it's still a hefty sum – up to $50 million in a 12-month period, depending on which tier of fundraising you go for (all of which are regulated by the SEC). Companies must be based in the U.S. or Canada.
Josh Amster is vice president of sales for StartEngine, a popular equity crowdfunding platform. He recommends that startup founders consider various aspects when choosing a crowdfunding platform: "How much does a platform cost? And does it accept forms of payment like a credit card or bitcoin?"
For example, StartEngine brands itself by guiding startups through the process, from onboarding and marketing services to legal and financial guidance. It also has a compliance team and an investor services team. This is the value of a crowdfunding platform: It's a turnkey solution for startups to access capital, and it's a way for the public to get in early – even before the IPO – with the startups of their choice.
Life after equity crowdfunding
What's next for startups once they raise funds via equity crowdfunding?
"Some startups move on to institutional funding or angel investors," Amster said. "But the majority of our clients come back to us and raise a second or third round."
Amster also noted that, while platforms like StartEngine were initially dominated by consumer-facing companies, B2B and SaaS startups have swiftly moved in to take advantage of the process.
"For the public, they're very interested in funding businesses that they are passionate about."
Pros and cons of equity crowdfunding
Pros
Equity crowdfunding is a viable option for startups looking to provide investors and extra incentives to finance their idea. If you’re struggling to communicate your value to VCs but have less trouble explaining it to colleagues or potential customers, equity crowdfunding provides a reasonable alternative.
Although it's up to you to tap into the investors who believe in your idea, more and more money is being raised every year through crowdfunding. One of the major benefits of this type of financing is quick access to capital. If you have an idea with some steam behind it, it's possible to raise millions without going through the arduous process of attracting venture capital.
Giving investors equity in your business can also foster vital partnerships that may help your business succeed. Starting a company is an intense experience, and bringing in investors who understand and support your business could be a good way to foster strong bonds that benefit you later on.
Cons
Although equity investing is a valuable financing option for some, it's not for every company. According to a report published by Startups.com, the average success rate of a crowdfunding campaign is 50%. So, while it works for some businesses, there is still a high rate of failure.
Even though it's an alternative to traditional startup financing, you'll still need to build the momentum yourself and convince prospective investors that you have a solid plan for success. Moreover, while bringing new stakeholders into your company can help, it can also lead to problems. Not every investor is a great business leader. Just because someone has the cash to invest in your business and likes your idea doesn't mean they know what's good for your company. Although you should always take advice and constructive criticism, giving the wrong people too much power over decision-making can have disastrous consequences for your startup.
If you go this route, it's vital to thoroughly vet the investors you're dealing with. Otherwise, you could experience problems down the line.
Equity crowdfunding gives startup founders another financing option for their companies. However, it's not a perfect model for every business. If you are thinking of raising capital through this method, you should think strategically before giving away shares of your company.