Everything you need to know about equity crowdfunding

With equity crowdfunding, you can sell shares of your business to just about anyone in exchange for equity in your business. And no, it’s not just for tech companies.

Essentially, equity crowdfunding offers the company’s securities to a number of potential investors in exchange for financing. Each investor is entitled to a stake in the company proportional to their investment.

Previously, business owners raised such funds by borrowing from friends and family, applying for a bank loan, appealing to angel investors, or by going to a private equity or venture capital firm. Now, with crowdfunding, they have an additional option.

Equity crowdfunding is rapidly gaining in popularity. According to research, the global crowdfunding market was valued at $12.27 billion in 2019 and is expected to reach $25.8 billion by 2026. But as with any mode of investment, investing through equity crowdfunding has its own risks and rewards.

What is equity crowdfunding?

Equity crowdfunding (also known as crowd-investing or investment crowdfunding) is a method of raising capital used by startups and early-stage companies. Essentially, equity crowdfunding offers the company’s securities to a number of potential investors in exchange for financing. Each investor is entitled to a stake in the company proportional to their investment.

Basically, it allows everyday people to invest in your business and in exchange, you offer them equity in your business. Each investor is entitled to a stake in your company proportional to their investment. And these days, anyone can be an investor.

This type of fundraising has always existed, but until recently you could only sell shares of your business to accredited investors, fairly wealthy individuals who met specific net worth and income criteria. Now, your cousin, your neighbor, or almost any member of the public can buy shares as a non-accredited investor, provided you set your business up properly (more on that later).

Equity crowdfunding vs. crowdfunding

Crowdfunding refers to raising money from the public, primarily through online forums, social media, and crowdfunding websites like Kickstarter to finance a new project or venture. In return, these people might get a reward, like a copy of what’s being produced for example, or nothing at all. Project creators on Kickstarter and similar platforms maintain 100% ownership of their work and business.

With equity crowdfunding, the crowd can fund your business or project and in exchange for relatively small amounts of cash, public investors get a proportionate slice of equity in your business venture.

Main types of crowdfunding

There are a number of crowdfunding types which are explained below. This guide provides unbiased advice to help you understand the three most common types of crowdfunding used by profit-making SMEs and startups: peer-to-peer, equity and rewards crowdfunding.

1. Peer-to-peer lending

The crowd lends money to a company with the understanding that the money will be repaid with interest. It is very similar to traditional borrowing from a bank, except that you borrow from lots of investors.

2. Equity crowdfunding

Sale of a stake in a business to a number of investors in return for investment. The idea is similar to how common stock is bought or sold on a stock exchange, or to a venture capital.

3. Rewards-based crowdfunding

Individuals donate to a project or business with expectations of receiving in return a non-financial reward, such as goods or services, at a later stage in exchange of their contribution.

4. Donation-based crowdfunding

Individuals donate small amounts to meet the larger funding aim of a specific charitable project while receiving no financial or material return.

5. Profit-sharing / revenue-sharing

Businesses can share future profits or revenues with the crowd in return for funding now.

6. Debt-securities crowdfunding

Individuals invest in a debt security issued by the company, such as a bond.

7. Hybrid models

Offer businesses the opportunity to combine elements of more than one crowdfunding type.

What are the risks of crowdfunding?

Crowdfunding investments are risky and speculative. You should do your own research and scrutinize all disclosed risk factors before making an investment decision. There are a number of things you need to be aware of if you’re considering investing.

1. Speculative

Investments in startups, early-stage ventures and emerging technology companies are speculative and these enterprises often fail. Unlike an investment in a mature business, where there is a track record of revenue and income, the success of a startup, early-stage venture or emerging technology company often relies on the development of a new product or service that may or may not find a market. You should be prepared to lose your entire investment.

2. illiquidity

Your ability to resell your investment in the first year will be restricted with narrow exceptions. You may need to hold your investment for an indefinite period of time. Unlike investing in companies listed on a stock exchange, where you can quickly and easily trade securities, you may have to locate an interested private buyer to resell your crowdfunded investment.

3. No voting rights

Investment instruments hosted on Republic are typically held via the Crowd SAFE, which does not provide voting rights to investors. Investors may receive voting rights if that instrument converts to stock, but crowdfunding investors’ voting rights will mostly likely be diluted when the company raises additional funds. In addition, crypto-assets typically do not have voting rights and owning a token will not give you influence over the token maker or seller.

4. Cancellation restrictions

Once you make an investment, you can cancel the investment at any time and for any reason up to 48 hours before the campaign deadline. Some campaigns may have multiple deadlines around rolling closes. Investors should pay attention to notices companies provide regarding rolling closes.

5. Valuation and capitalization

No exchange or other secondary market is expected for securities sold under Regulation CF. Companies fundraising via Regulation CF are often early-stage startups and are unlikely to have substantial operating or financial histories. There is limited–if any–information for valuing securities offered through Republic and there is a substantial risk that the price of securities purchased on Republic may exceed their value and any amount for which they may eventually be resold. Furthermore, securities sold on Republic may provide investors with inferior terms than similar securities provided by a company in other offerings.

6. Limited disclosure

The company must disclose information about itself, its business plan, the offering, and its anticipated use of proceeds, among other things. It’s important to note that an early-stage company may be able to provide only limited information about its business plan and operations because it is still developing its operations. The company is also only obligated to file information regarding its business annually, including financial statements. Under certain circumstances the company may cease to publish annual reports and investors may have no information rights.

7. Investment in personnel

An investment in a startup, early-stage venture or emerging technology company is also an investment in the founding entrepreneur(s) and/or the company’s management. Being able to execute on the business plan is an important factor in determining whether the business will be viable and successful. A portion of each investment may be used to fund salaries. Investors should carefully review any disclosure regarding the company’s use of funds.

8. Possibility of fraud

There is a risk that a company raising in the Republic engages in fraud. Republic vets the companies we host, but there is no way to control the actions of a company once a campaign ends and Republic cannot verify everything.

9. Lack of professional guidance

Many successful companies partially attribute their early success to the guidance of professional early-stage investors (e.g. angel investors and venture capital firms). These investors often negotiate for seats on the company’s board of directors and play an important role in providing additional resources, contacts and experience in assisting early-stage companies in executing on their business plans. An early-stage company primarily financed through crowdfunding may not have the benefit of such professional investors.

How does equity crowdfunding work?

Navigating the equity crowdfunding landscape can be pretty confusing. Typically, securities and those who offer securities to the public must be registered and subject to regulation. Securities regulation protects investors by ensuring that investors obtain the information they need to make an informed decision, and that issuers are held accountable for any misrepresentations or fraud.

But equity crowdfunding is considered an exception. In recent years, regulatory bodies have allowed registered platforms to act as an intermediary between crowdfunding issuers and your investors. But that means you can only raise financing this way by signing up for a registered equity crowdfunding platform in your country or region. (Note: how much money you can raise through these platforms also depends on the country and region that you’re in.)

While the structure of your offer, including the equity percentage and the type of securities you will sell, is a bit complicated and best done with the help of your lawyer, the process of actually creating a campaign is fairly straightforward. Here’s a general overview of how the process works in the:

1. Sign up for a registered equity crowdfunding platform. Set up an offer on a registered equity crowdfunding platform and begin raising funding in exchange for real, legal shares in your company.
2. Make your pitch. Once accepted by your platform, you have to prepare your crowdfunding pitch. This is the most time-consuming part of the process and may involve frequent iterations to keep interest going. You’ll have to determine what the equity stake is and the share price in your pitch, too.
3. Provide essential information. You’ll have to submit to background checks by the platform and provide essential company information to prospective investors. That includes financial statements and forecasts, a credible business plan, and so on.
4. Funds are released to you. When you’ve either hit your financing target or when the campaign ends, the platform will perform some final vetting before releasing funds to your business.
5. Shares are released to your investors. In exchange for the money, investors get a share of your business. These shares give investors voting rights in your company.
6. Pay platform fees. Since these platforms are handling the legal compliance on your behalf, they make their money through fees. This can be a percentage of the amount raised plus transaction fees, or maybe even equity. This varies from platform to platform.
7. Investors continue to be advocates for your business. The perks of having several investors with a stake in your business is they’ll promote your business like it’s their own because it is.

But before you pursue equity crowdfunding, it’s important to know that it’s not free. Although it can also have incredible benefits for your business, mounting a campaign does cost money. Some of the costs may include:

• Legal and compliance fees
• Fees charged by the equity crowdfunding platform (could be flat or a percentage)
• Consulting and business plan fees
• Marketing and advertising for your campaign

The benefits of crowdfunding

1. It’s more efficient than traditional fundraising

When you’re an early-stage company focused on building your business and attracting seed capital, you might not be able to afford all the time and attention that pursuing traditional financing demands. Compared to applying for a loan or seeking out accredited investors yourself, setting up a successful crowdfunding campaign on Fundable or another platform is far more efficient and effective in getting your message out to the right people. With the right platform, you can tell your business’s story, produce a quick video, set up some enticing rewards, and benefit from having everything in one centralized location where potential backers can find you.

2. It’s a place to build traction, social, proof, and validation

A strong, highly visible crowdfunding campaign can provide validation and social proof that’s vital in charting your path forward. When potential customers show interest in your startup’s product or service, you’ve generated social proof demonstrating that other people believe in what you’re doing. Once early adopters vet and buy into your idea, others are more likely to follow suit. Social proof is translated into traction whether it’s a large number of backers, pre-orders, or media attention that’s invaluable as you pitch to other investors.

3. It’s an opportunity for crowdsourced brainstorming to refine your idea

Hear your would-be backers poking holes in your business plan or asking some tough questions? Take it in stride and accept it as free, crowdsourced brainstorming. The basis of a startup is finding some important, unmet need that your customers have, and deciding to be the one to do something about it. Thus, it’s important to seize any opportunity for customer feedback and consider it in planning your startup. One of the greatest things about crowdfunding is how close it gets you to your customers, giving you a chance to engage them and field questions, complaints, feedback, and ideas. You never know—your company’s next great idea could come from somebody who isn’t even on your payroll.

4. It gains you early adopters and loyal advocates

The people that power your idea’s social proof are your early adopters and potential brand advocates. They’re the people who believe in your story, product, or service, enough to stake their money on its longevity and long-term success. These early adopters are key to the success of your crowdfunding campaign and the momentum you keep after closing, being the ones most likely to share your vision with friends and family and promote it through their social networks.

5. It doubles as marketing and media exposure

Press coverage will create more eyes on your campaign and create lasting brand awareness for your startup. This can come in the form of a feature story on a popular news station, blog, or print publication, and is a great way to bring in backers outside of your personal network. A good feature story or Twitter mention can create a powerful snowball effect, putting you in touch with major investors you might not have otherwise reached. Whether they read about your new product on a popular blog or hear about your innovative campaign from a friend, a successful crowdfund is a great way to capture new investor interest.

Crowdsourcing has grown into an excellent way for entrepreneurs and early-stage companies to validate their business, find capital and early adopters, and get the exposure they need to grow. To recap, some of the most powerful ways a crowdfunding campaign can help build more startup momentum than other financing methods are:

• It’s more efficient than traditional fundraising.
• It generates traction, social proof, and validation.
• It’s an opportunity for crowdsourced brainstorming to refine your idea.
• It gains you early adopters and loyal advocates.
• It doubles as marketing and media exposure.

Is equity crowdfunding right for you? 

Equity crowdfunding is by its very nature extremely transparent. The crowd gets to know everything about your business and comment on it. That means you have to be comfortable sharing really specific details about how your company operates.

You also need to be in tip-top shape financially and legally so you can demonstrate to your potential investors that you have a strong company that operates ethically and has a clear business plan. As a bonus, being organized in this way will have plenty of other benefits for your business: it may protect you from legal hassles in the future and could open doors for other types of financing as well.

So, if you feel like you keep walking into closed doors in your search for business funding, you might find the equity crowdfunding door wide open.

Final thoughts

Investing through equity crowdfunding carries risks such as the greater risk of failure, fraud, doubtful returns, vulnerability to hacker attacks, and mediocre investments. But it also offers rewards like the potential for huge returns, a greater degree of personal satisfaction, the opportunity to invest like accredited investors, and the prospect of stimulating the economy through business and job creation.