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What Is Equity Crowdfunding?

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Equity crowdfunding lets early stage companies raise investments from a ‘crowd’ of investors. In turn, investors get shares in startups that are not yet listed on the stock market. If the company does well, investors earn profits.

This is great because it gives small innovative companies easier access to capital. They get the funds they need and have more freedom to pursue their vision.

Even though they lose out on some of the expertise that traditional investors can offer, platforms provide tons of resources and have partnerships that benefit the startups that they work with.

Keep in mind that early stage businesses make for high risk and high reward investments. They should form part of a diversified investor portfolio to protect against illiquidity, loss of investment, and dilution.

When it comes to investing in businesses, there is never a guarantee. The truth is that most startups fail. To protect themselves, investors considering early stage businesses should focus on industries where they have experience and diversify with other investment types.

Most early-stage equity investments have historically been made by VCs and angel investors, who have experience with investing and business. Now, that privilege has been expanded to include both accredited and unaccredited investors on some platforms.

Equity Crowdfunding for Startups

For high-potential startups that need investors to get to the next level, equity crowdfunding is available in most places in the US and Europe. Even though it can be an expensive process, equity crowdfunding lets you raise investments in a whole new way and puts the power of the crowd behind you.

You Will Need:

  • A plan or business model with information on your company, current traction, market validation, and how you intend to maximize your investment.
  • To put together a Private Placement Memorandum (also referred to as an offering document), a legal document provided to investors when a company sells stocks or securities.

Types of Equity

Equity I: A type I raise uses Rule 506 of Regulation D. It allows a company to raise unlimited capital but prohibits advertising or general solicitation. These are private platforms that only allow self-identified accredited investors, who must go through a waiting period before investing. 35 other investors are allowed, but they must at least be considered ‘sophisticated investors’ who understand the risks involved.

Equity II: A type II raise uses Rule 506(c). This rule allows companies to raise unlimited capital with the use of advertising and general solicitation. In turn, the platform must take responsibility for verifying that their investors are accredited, “which could include reviewing documentation, such as W-2s, tax returns, bank and brokerage statements, credit reports and the like,” according to the SEC.

Equity III: A type III raise or Title III equity crowdfunding allows companies to raise a maximum of $1 million in a 12-month period. It is the only option that allows more unaccredited investors. Check out How to Raise Up to $1M Using Title III of the Jobs Act for more information on this option.

Bonus: Regulation A+.

Pros

  • Access to capital and platform resources
  • Faster growth
  • More freedom than when only a few investors own more equity
  • Popularity, attention from investors who will want to promote your company online and help you succeed

Cons

  • These investors have less experience than Angels of VCs, who often offer mentorship and advice to companies that they invest in
  • It can be hard managing the expectations of investors you won’t meet in person, because generally equity crowdfunding keeps the platform as an intermediary
  • If something goes wrong, you have more investors and more questions to answer
  • Equity crowdfunding can be a complicated process that required startups to find legal assistance
  • Preparations for this type of crowdfunding can cost anywhere from $6K to $20K, with additional costs including audited financials (if you’re raising over $500K)

Equity Crowdfunding for Investors

Investors get access to high-risk high-reward investments and can support startups with low minimum investments, from the comfort of their homes! Since the passing of Title III crowdfunding, now even unaccredited investors can take part in equity investments online (with some restrictions, of course).

Investor requirements

Accredited investors:

  • A net worth of $1 million USD excluding the value of your primary residence or an income over $200K for 2+ years. A combined of $300K is required for married couples.

Unaccredited investors:

  • If an unaccredited investor’s income is less than $200K, they can invest $2K or no more than 5% of their net income per year.

Ways investors can earn returns

  1. Dividends: Money that is received based on the amount of equity an investor owns. Dividends rarely diminish the value of stock, they are simply payouts as a reward for financial support. Compared to traditional investing, communication and payouts are completed through the platform and not the startup itself.
  2. Trade sale: If a startup you have invested in is bought by another company, you will receive a payout based on the amount of equity you own.
  3. Public offering: If a company invested in becomes highly successful and is listed on a public stock exchange, shares can be sold at a predetermined price.

Pros

  • Open and transparent process
  • Easy way to diversify investments
  • Earn returns
  • Invest in innovative, early stage companies

Cons

  • Less control than if you were one of the only investors
  • Securities generally can’t be sold for at least one year
  • High risk

Popular Equity Crowdfunding Platforms in the US

AngelList, CircleUp, Fundable, Crowdfunder, EquityNet, Wefunder, Localstake, SeedInvest, EarlyShares.

Popular Equity Crowdfunding Platforms in the Europe

Companisto, Crowdcube, FundedByMe, Invesdor, MyMicroInvest, SeedMatch, Seedrs, SyndicateRoom

Launching an Equity Crowdfunding Platform

The main way that people launch crowdfunding platforms is via a white label crowdfunding platform. White label crowdfunding platforms provide crowdfunding software that helps investment businesses take things online.

Check out these tips for Starting an Equity Crowdfunding Platform to learn more.

White Label Crowdfunding Platforms: CrowdEngine, Katipult, Crowdfund Connect, CrowdfundHQ, Launcht

Conclusion

Equity crowdfunding is a great way for popular, innovative companies to raise money from a crowd of eager investors. Registered crowdfunding portals make this process as simple as possible with their knowledge and expertise, giving startups the tools they need to get fully funded.

It is also a way for investors to get in on early stage investments in a way that wasn’t possible before. Now, average investors have a chance to earn big payouts if their investments are successful, although there is always a risk of losing your investment.

Feel free to leave any questions or comments below!

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Krystine Therriault

Journalist & Blogger at CrowdCrux
Krystine Therriault is a journalist, blogger, and the community manager for CrowdCrux. She loves learning about new trending projects and dissecting them to bring new tips and information to creators.
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