Posted by Neha De
December 7, 2020 | 5-minute read (918 words)
Pitching your business idea to venture capitalists may not always be possible — or even fruitful — if you are a small business owner or first-time entrepreneur. However, a somewhat newer method of raising funds, called equity crowdfunding, can help you find both accredited and non-accredited investors (such as everyday consumers) willing to back your business.
Equity crowdfunding allows entrepreneurs, early-stage startups and non-traditional investment funds to raise money from the public (or the “crowd”) through the sale of securities (debt, shares, revenue share, convertible note, etc.) in a private company (a business not listed on any stock exchange).
The biggest advancement for equity crowdfunding regulation occurred in the U.S. when the Jumpstart Our Business (JOBS) Act was introduced in 2012. The law loosened longstanding federal restrictions on how and from whom businesses can raise funds — it allowed the participation of both accredited and non-accredited investors, making equity crowdfunding a practical option for American small businesses and startups.
The law also puts limitations on the amount of capital that can be raised by businesses, as well as on the amount that can be invested by each investor. Organizations can legally raise funds up to $1 million during a 12-month period through equity crowdfunding. And if they need a larger investment, they can raise the money in installments over several years.
In 2015, the U.S. Securities and Exchange Commission (SEC) further relaxed the regulations through a wide regulatory amendment known as Regulation A+, which substantially increased early-stage startups’ offering capacity and brought equity crowdfunding opportunities to small-time retail investors, thereby expanding the pool of eligible investors.
How Equity Crowdfunding Works
Equity crowdfunding is a viable option for companies with strong growth potential. It’s ideal for business owners wanting to take their organizations to the next level by offering more products/services or expanding markets. Equity crowdfunding has no debt component — instead of making payments toward a business loan, companies looking to raise funds assign shares of their company to investors.
The process takes place on a secure, online crowdfunding platform, such as AngelList, CircleUp, Fundable, Wefunder, SeedInvest or Crowdfunder. On a platform of their choice, entrepreneurs need to set up an online profile, which includes their pitch and such detailed business information as business history and financial statements. This allows the investors to evaluate their growth potential and determine whether the shares of the company they are investing in will appreciate over time or not.
Crowdfunding platforms typically charge a percentage of the capital raised for their services — some may even charge additional fees for such services as accounting to ensure that the paperwork is in order prior to submitting the proposal, among other charges.
Does Equity Crowdfunding Make Sense for You?
So, is equity crowdfunding the right choice for your company? Here are five reasons to consider equity crowdfunding:
- You have easier access to capital: The JOBS Act — and the ensuing regulatory amendments — give early-stage businesses easier, faster and less expensive access to capital by removing several restrictions as well as easing certain rules. This means entrepreneurs can focus more on getting their products and services to market, and less on regulatory compliance.
- There’s very little financial risk: Equity crowdfunding lets business owners explore the market to see whether their businesses have merit without taking on substantial financial risk. It allows them to test the waters and get useful reactions before investing in expensive materials, inventory or development.
- It works as a great marketing tool: An equity crowdfunding campaign is a great way of drawing attention to a company (or its product and/or service) and reaching a large audience (new customers and potentially new investors) quickly. Many crowdfunding platforms also allow business owners to incorporate their social media channels, which can be a significant traffic driver. The campaigns also have a chance to go viral if users share and spread the word to others.
- You maintain total control: Unlike other types of investment, entrepreneurs don’t forfeit control of their companies when raising capital. They decide how much money they need to raise, what the campaign structure will look like and how the business will be run going forward.
- It allows you to build your own community: Equity crowdfunding allows business owners to leverage people who are already looking to support new companies. It also allows them to receive critical feedback from the community of investors, which they can use to validate their ideas and make them even more robust and secure.
Here are the possible downsides of equity crowdfunding:
- Fundraising takes time and money: Making a crowdfunding campaign a success requires a lot of time, effort and money. There is also some investment involved, in order to build prototypes, create persuasive content and market it all successfully.
- The campaign might fail: Not every crowdfunding campaign achieves its goal. And in case of a failed campaign, there might be some bad press or embarrassment to deal with, and there’s no way to get back the invested time or money.
- You may have to deal with copycats: Unless an idea is protected with trademarks, patents or copyrights, someone can always steal an idea or campaign and try to copy it.
- There are several fees involved: There are no free lunches. All crowdsourcing platforms charge a fee for their services, and these are typically not refundable.
Take these pros and cons into consideration as you work to develop your fundraising strategy, and make the determination of whether equity crowdfunding may be the right choice for your business.