Startup founders have numerous paths to fundraising ― friends and family, angel investors, bank loans, venture capital and more. 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. [Are you looking for additional funding options? Check out Best Business Loans]
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, although many start at a few thousand dollars.
With other forms of crowdfunding, investors are issued rewards. They may invest in a startup or 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 donate funds with no expectation or promise of a reward or a return (think GoFundMe).
Editor’s note: Need financing for your business? Fill out the below questionnaire to have our vendor partners contact you with free information.
Equity crowdfunding allows startups to raise more funds and allows the general public 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]
Did You Know?
Entrepreneurs can also raise startup money through debt-based crowdfunding, similar to a 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, such as 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 $75 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 United States or Canada.
Josh Amster is senior 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 initial public offering ― with the startups of their choice.
Tip
As with any service, it helps to do your research first. Before choosing an equity crowdfunding platform, read reviews and see what business owners like you are saying about their experiences.
What happens after a round of 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, business-to-business and software-as-a-service startups have moved in swiftly to take advantage of the process.
“For the public, they’re very interested in funding businesses that they are passionate about.”
Once you’ve finished your initial equity crowdfunding campaign, your business is now accountable to your investors. It’s essential to keep these passionate stakeholders in the loop about what you’re doing with their funds ― transparent communication about your organization’s progress is key. That includes updates such as new company hires or any other purchases or investments you make with investor funds.
When you start earning revenue, you’re also obligated to provide investors with their agreed-upon share of your profit. If you become successful enough to sell your company, you’ll be able to keep your earnings once you pay your funders back. After all, getting afull return on investment is often a key motivation for funding a business.
Pros and cons of equity crowdfunding
Pros
Equity crowdfunding is a viable option for startups looking to provide investors with extra incentives to finance their idea. If you’re struggling to communicate your value to venture capitalists 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 money is being raised yearly 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. The average success rate of a crowdfunding campaign is less than 23 percent. 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 FAQs
Equity crowdfunders receive a share of your company and ongoing dividends from your profits. You also have the option of debt-based crowdfunding, where investors are promised repayment plus interest, similar to a loan. There are also donation-based crowdfunding campaigns, in which funders don’t receive any compensation for their investment and rewards-based crowdfunding that offers individuals some type of gift, such as a product or service from the company, in exchange for their investment.
No equity crowdfunding campaign is guaranteed to yield a return on investment, but there are enough success stories to make the risk worth it. Equity crowdfunding contributors have earned significant profits across industries, especially in real estate.
In addition to the chance you won’t meet your funding goal, you may end up yielding control to investors unfamiliar with the business landscape. After all, if someone is purchasing a stake in your company that means they get a voice in your operations. Sometimes that individual may not be the best informed, even if they’re passionate about your business idea.
Often, this sort of crowd-funding is used for startups and companies in early-stage development, so there can be a high risk of failure. It’s also much harder to sell a share in a business if the investment was made through equity crowdfunding. Conversely, investments made through the stock market typically aren’t locked in — that is, there are far fewer restrictions on selling your shares.
Equity crowdfunding gives entrepreneurs options
Equity crowdfunding gives startup founders another financing option for their companies but 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. Nevertheless, if you don’t have access to traditional funding such as venture capital, equity crowdfunding could be the advantage you need. With careful planning, equity crowdfunding can be a great way to bring your business idea to life.
Natalie Hamingson contributed to this article. Source interviews were conducted for a previous version of this article.
