Equity Crowdfunding Explained – What Investors Need to Know

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Written By Chris Graebe

Equity crowdfunding is a unique form of financing that allows startups and early-stage private companies to raise funds by offering company securities to potential investors. 

Unlike popular donation-based crowdfunding (Kickstarter, Indigogo, GoFundMe), equity crowdfunding offers investors a stake in the company in exchange for their financial support.

This innovative approach to business financing democratizes the investment process, empowering everyday individuals to participate in the growth of new and exciting ventures.

Key Takeaways

  • Equity crowdfunding enables startups to raise capital by offering ownership stakes to diverse groups of investors. 
  • This form of financing democratizes the investment process, making it accessible for everyday individuals to support new ventures. 
  • Regulatory frameworks ensure protection and transparency for both investors and companies involved in equity crowdfunding transactions.

How Equity Crowdfunding Works

The JOBS Act (Jumpstart Our Business Startups Act) was instrumental in making equity-based crowdfunding a viable option for businesses. It introduced new regulations that eased the process of raising capital.

Because of this, equity crowdfunding has become a powerful alternative to traditional venture capital or angel investors.

Equity crowdfunding is a way to raise capital for a business by collecting smaller amounts of money from a large number of private investors, typically through an online platform.

It is also different from traditional crowdfunding methods such as donation-based or rewards-based crowdfunding, where contributors receive a reward or a good in exchange for their support.

In equity crowdfunding, investors gain an equity stake in the company, which means they become part-owners.

As an investor, equity crowdfunding platforms let you easily find and evaluate startups to invest in. You can review business plans, financials, and other information on startup profiles to conduct due diligence. These platforms connect you directly with vetted, investment-ready startups in a simple online process.

A quick summary of how equity crowdfunding works:

  1. Startups create fundraising campaigns on SEC-approved crowdfunding platforms. They provide details about their business, financials, use of funds, risks, etc.
  2. Investors browse and evaluate campaigns on platforms. They can ask questions and conduct due diligence.
  3. Investors invest in campaigns online in exchange for equity in the companies. The platforms process the transactions.

Pros and Cons of Startup Investing

Equity crowdfunding opens up startup investing to the masses but comes with some real risks. And when comparing it to other investment strategies, weighing out the pros and cons can help bring clarity in determining if it’s a good fit for you.

Pros:

  • Access to deals in exciting private companies and startups
  • Ability to invest small amounts in a range of companies
  • Platforms simplify investing process and paperwork
  • Chance to invest early and at lower valuations
  • Diversify your portfolio beyond public stocks/bonds

Cons:

  • High risk of losing the entire investment since startups often fail
  • Illiquidity of investment since no secondary market
  • Lack of investor protections compared to public stocks
  • Requires extensive due diligence as fraud risk exists
  • Most companies raise small amounts, limiting growth potential
  • Startups are not vetted as rigorously as VC-backed companies
  • Need to monitor investments and participate in updates
  • Geographic restrictions based on investor and company location

The Role of Investors

In the world of equity crowdfunding, investors play a crucial part in providing the funds that startups and early-stage companies need to grow and succeed. As an investor, your contributions can help companies reach their objectives while offering you the opportunity to earn a return on your investment (via equity) if the company does well.

Let’s look at the various types of investors and their roles in equity crowdfunding.

Individual Investors

These are everyday people like you and I, who are interested in investing in startups. You don’t need to be a financial expert or have a high net worth; anyone can participate in equity crowdfunding and potentially earn profits if the company succeeds.

Accredited Investors

According to the U.S. Securities and Exchange Commission (SEC), an accredited investor is an individual who has a net worth of at least $1 million (excluding the value of their primary residence) or an annual income of at least $200,000 for the last two years ($300,000 combined income if including spouse income).

Accredited investors have access to more investment opportunities, including private placements and certain crowdfunding offerings that may not be available to non-accredited investors.

Venture Capitalists (VCs)

VCs are professional investors and firms that specialize in investing in high-potential startups and early-stage companies. They typically invest a larger amount of money in a company in exchange for equity. VCs can provide valuable resources, expertise, and connections to help companies grow.

Different Types of Crowdfunding Campaigns

There are a few categories of Equity Crowdfunding, all of which are regulated by the Securities and Exchange Commission (SEC). Each of them provides a regulatory framework for startups to raise capital.

The main types of equity crowdfunding are:

Regulation Crowdfunding (Reg CF)

Reg CF (Regulation Crowdfunding) is a type of equity crowdfunding, enabled by the SEC under the JOBS Act, that allows startups and small businesses to raise up to $5 million in a 12-month period by selling securities to both accredited and non-accredited investors through SEC-registered online platforms (Wefunder, Republic, StartEngine).

Regulation A+

Allows companies to raise up to $50 million annually by selling securities to the general public. Requires SEC approval and annual reporting.

Regulation D

This is private securities offerings to accredited investors only. Common exemptions are 506(b) and 506(c). No limit on the raise amount.

Equity Crowdfunding Sites / Platforms

Equity crowdfunding is typically conducted through online platforms (portals), which allow businesses to create profiles and pitch their ideas to potential investors.

These platforms can be thought of as marketplaces, where investors can browse and select investment opportunities that fit their interests and risk profiles.

Choosing The Right Platform

When selecting a platform, you should consider its reputation, effectiveness, and ease of use.

  1. Wefunder: A well-known equity crowdfunding platform with a broad range of startups and is a popular choice for companies looking to raise funds from both accredited and non-accredited investors.
  2. Republic: A leading equity crowdfunding platform that offers individual investors the opportunity to invest in exciting private startups and crypto companies. Republic carefully vets companies before featuring them on the platform, providing an extra layer of due diligence. They have helped over 350 startups raise over $200 million. 
  3. StartEngine: Another platform that enables companies to raise funds through equity crowdfunding. StartEngine has helped numerous businesses raise funds, and it’s a great option for tech-focused companies.

Small Business Loan Through Equity Crowdfunding

Equity crowdfunding offers a unique option for small businesses to get the financing they need to continue their growth. It creates a unique scenario where businesses get funding they might not otherwise get and investors are able to invest in startups they otherwise wouldn’t be able to.

The Fundraising Process

As an investor interested in equity crowdfunding, here are some key things to know about the fundraising process:

  • Startups create profiles on SEC-approved crowdfunding platforms to showcase their business plans, financials, and investment pitches.
  • You can browse these startup profiles to evaluate potential investment opportunities based on factors like the product, team, traction, use of funds, etc.
  • If you decide to invest in a startup’s campaign, you contribute capital in exchange for equity shares in that company.
  • Your investment gives you a proportionate ownership stake and the potential for financial returns if the startup succeeds.
  • Startups go through this process to raise funds without taking on burdensome debt.
  • There are legal requirements around disclosures and investor eligibility that platforms must adhere to.
  • As an investor, you should conduct thorough due diligence before investing to understand risks and make informed decisions.
  • Monitor your investments via investor updates on the platforms to stay informed on your startups’ progress.

Investment Constraints

When participating in equity crowdfunding, it’s important for you to be aware of certain investment constraints. One such constraint is the investment ceiling in a 12-month period. This refers to the maximum amount you can invest in equity crowdfunding campaigns during a consecutive 12-month period.

Depending on your financial situation, the investment limits may vary. For accredited investors, there may not be any restrictions on the amount they can invest. However, for non-accredited investors, the rules are more stringent.

In general, if your annual income or net worth is below $107,000, you’re allowed to invest the greater of either $2,200 or 5% of your annual income or net worth in a 12-month period.

If both your annual income and net worth are equal to or more than $107,000, you can invest up to 10% of your annual income or net worth, but not more than $107,000 in a 12-month period.

These limitations are in place to protect investors like you, especially those who may have limited experience with investing or less disposable income to spend on high-risk investments like startups.

Remember, equity crowdfunding allows businesses to access capital from a wide range of investors, but it’s essential to make well-informed decisions and stay within the mandated investment ceilings to safeguard your financial interests.

Equity Crowdfunding vs Other Forms of Crowdfunding

Equity crowdfunding is a type of crowdfunding that allows businesses to raise capital by selling equity in their company to a large number of investors through online platforms. However, equity crowdfunding is not the only form of crowdfunding available.

Here is a brief comparison of equity crowdfunding with other forms of crowdfunding:

Debt Crowdfunding

Debt crowdfunding is another form of crowdfunding that allows businesses to raise capital by selling debt securities to a large number of investors through online platforms.

Debt crowdfunding is different from equity crowdfunding because instead of selling ownership in the company, businesses sell debt securities that provide investors with a fixed rate of return over a specified period.

Crowdfunding to Raise Donations

Crowdfunding is another popular form of crowdfunding that is used to raise donations for various causes, such as disaster relief, medical expenses, and charitable organizations.

Crowdfunding to raise donations is different from equity crowdfunding because instead of selling ownership in the company or debt securities, businesses or individuals ask for donations from a large number of people through online platforms.

Crowdfunding for Creative Projects

Think Kickstarter or Indiegogo. Crowdfunding for creative projects is a type of crowdfunding that allows individuals or businesses to raise capital for creative projects, such as films, music albums, and video games.

Crowdfunding for creative projects is different from equity crowdfunding because instead of selling ownership in the company or debt securities, businesses or individuals offer rewards or perks to backers who contribute to the project.

Crowdfunding for Charitable Causes

Crowdrise is an example of crowdfunding for charitable causes. Crowdfunding for charitable causes is a type of crowdfunding that allows charitable organizations to raise funds for various causes, such as education, healthcare, and poverty alleviation.

Crowdfunding for charitable causes is different from equity crowdfunding because instead of selling ownership in the company or debt securities, charitable organizations ask for donations from a large number of people through online platforms.

In this video, I break down all the basics of Equity Crowdfunding.

Frequently Asked Questions

How does equity crowdfunding differ from other forms of crowdfunding?

Equity crowdfunding is different from other forms of crowdfunding because it involves investors receiving equity shares in the company in exchange for their investment. This means that investors have a stake in the success of the company and can potentially earn a return on their investment if the company does well.

Other forms of crowdfunding, such as rewards-based crowdfunding, do not involve equity shares and instead offer backers rewards or perks for their support.

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