Wrapping Your Head around Equity Crowdfunding

By: Bianca Buliga, Content Curator

You may have recently read “How to Crowdsurf, I mean CrowdFUND Wisely”, a blog post that summarizes the four major types of crowdfunding. For a quick recap, crowdfunding can be simply defined as the collective effort of individuals who network and pool their resources, usually via the Internet, to support efforts initiated by other people or organizations. However, this often transcends financial reassurance and involves mobilizing a crowd of people that believe in a cause enough to assemble, creating a momentum of change-making. The four primary forms of crowdfunding are: equity, lending, reward, and donation, but for the purposes of this article we are going to strictly focus on equity-based crowdfunding.

What is Equity Crowdfunding?

Otherwise known as ‘crowdinvesting’, equity-based crowdfunding enables investors to fund promising startup companies and small businesses in return for equity, or partial ownership of shares. As the startup evolves and becomes more successful, each investor’s piece of the pie increases in value. This contrasts greatly from other categories of crowdfunding, since founders do not relinquish a percentage of ownership in exchange for cash.

Are there different types of equity crowdfunding?

Equity crowdfunding evolved over three phases in accordance with the federal government’s passage of the Jumpstart Our Business Startups (JOBS) Act, which encouraged funding small businesses by easing various securities regulations.

Equity I

Enacted in April of 2012, the initial variation of equity crowdfunding allowed accredited investors to view private investment opportunities only on password-protected websites. Founders could generally raise an unlimited amount of capital from an unlimited number of accredited investors.

Equity II

The second phase occurred in collaboration with Title II of the JOBS Act in September of 2013 and allowed entrepreneurs to publicly advertise their need for funding. Founders who engage in Equity II can raise an unlimited amount of capital from an unlimited number of accredited investors through equity crowdfunding portals that advertise their offerings across the web. It exposes entrepreneurs to a huge audience of potential investors, if entrepreneurs are willing to take necessary measures to confirm the accreditation status of potential investors.

Equity III

Rolled out in May of this year, Equity III allows unaccredited investors, in other words 99% of all investors, to contribute to equity crowdfunding. Allowing equity crowdfunding platforms to offer and sell securities online, entrepreneurs enjoy the ability to reach out to over 50 million Americans for financial support. For the latest and greatest on how Title III of the JOBS Act works with equity-based crowdfunding, refer back to our recent guest blog post by Kristen Gluch, Director of Content Development for USEED.

Pros and Cons of Equity Crowdfunding

Because it raises the largest sum of money per campaign of the four categories, research shows that equity crowdfunding is most effective for startups wanting to establish a sturdy foundation. In fact, a 2014 Forbes article says that equity-based crowdfunding raises 40 times more money per company than any other type of crowdfunding in the marketplace.

Potential drawbacks of this approach include a longer timeline and limiting securities and financial regulations, which can create headaches for many aspiring entrepreneurs. Although all early-stage investing can be risky for investors, equity crowdfunding poses the unique challenge of protecting each investor’s piece of the pie. If the company fails, the investors can lose some, or even all, of their investment. Investors should only consider equity crowdfunding as part of a larger and diversified investment portfolio.

Getting Started

If equity crowdfunding seems like the right choice for your venture, here are a few suggestions to keep in mind in order to maximize your success:

Solidify Your Business Model

Once your business model and accompanying deck is organized, they can serve as powerful fundraising tools. When you set your priorities and a solid framework for operations, you will gain more traction within your investor pool. Determine your company’s valuation and how much equity you will need to part with in order to reach your fundraising goal. Preparing in advance will enhance your professionalism and will assure investors of your credibility.

Assemble an Experienced Legal Team

Connect with a skilled attorney right away! There is a lot of research to be done on the different variations of equity crowdfunding, and each title has different rules regarding regulatory compliance and limitations. It is ESSENTIAL to understand how to protect your company, and to assemble a team that can lead you through burdensome paperwork and legal frameworks.

Find the Right Crowdfunding Platform

There are an endless number of platforms that could be a good option for you ranging from SyndicateRoom to Equity Net, but there are some important questions to ask before committing. What are each platform’s protection policies against fraud? Is there a large vetted investor population? What tools does each platform provide you with? Not all platforms are equal – find the one that serves your company’s needs best.

Understand Your Audience

Rather than targeting ALL investors, focus on investors in your specific industry. Investors are far more likely to support your cause if they have an intimate understanding of the industry. Many platforms even allow you to sort investors by their industry or unique interests.

To conclude, equity crowdfunding is an excellent opportunity to partner with investors who support the same causes you do. Investors benefit by being directly involved in the venture’s growth, and the company benefits by growing without sacrificing creative control. By 2025, it is estimated that $34.4 billion will have been raised by equity crowdfunding portals – an astounding 12 times the amount raised in 2012. Without a doubt, equity crowdfunding is already an unstoppable force generating waves of change in our local economies.

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