Equity Crowdfunding is a process in which investors (the ‘crowd’) invest their money in an unlisted start-up company to help them reach their goals. In exchange for this, they receive equity (shares) in the company.
Equity crowdfunding is a new and increasingly popular way of investing, harnessing the power of crowds to turn business ideas into a reality. You might think of it as a way to put yourself right into your very own version of “Shark Tank” or “Dragons’ Den”.
And since equity crowdfunding backers get equity in the company, there’s the potential for remarkable long-term benefits and returns for both the company and its early investor if things go well.
In the past, it used to be that only the very wealthy were able to invest in start-up companies in a process known as venture capitalism. However, while this process does still exist, the introduction of equity crowdfunding has helped open this investment process to a much wider pool of potential investors.
Did you know? Equity crowdfunding can generally have very low minimum thresholds – sometimes as little as $250. This means pretty much anyone with a keen eye for a great-looking start-up can get involved.
How does equity crowdfunding work
First off, it’s important not to confuse equity crowdfunding with regular crowdfunding. You might be familiar with regular crowdfunding from popular sites like Kickstarter, where you can back anything from a novel smartwatch to a modern-day cooler.
In this style of crowdfunding, the rewards are typically the product itself. For example, the reward for a $179 pledge for the smartwatch project in the above list is exactly one smartwatch.
In contrast to this, equity crowdfunding offers equity in the business that creates the product, rather than product itself. As a result, your investment will make you a shareholder, entitling you to partial ownership of the company. This means that if the company does well, you both profit.
Equity crowdfunding begins with a start-up uploading its business case and funding goals to an online platform. Then, from there, anyone can invest as little or as much into that idea as they’d like.
Minimum investments can also fluctuate in equity crowdfunding. While a $250 minimum is low for an investment, the figure might seem quite high compared to the only $24 backing needed to qualify for a 3D-ergonomic eye mask on Kickstarter.
How do I get started with equity crowdfunding?
There are plenty of equity crowdfunding sites out there on the web. Among the best-known is CircleUp, which has helped companies raise more than $390 million collectively. The start-ups themselves set the investment minimum, which is normally $1,000 but can go as low as $250 or $500.
Successes from CircleUp include low-calorie ice cream company Halo Top Creamery, and Beyond Meat (NASDAQ: BYND | FRA: 0Q3), which makes plant-based meat alternatives.
Other big-name platforms include WeFunder, which has raised $110 million so far for its start-ups. Success stories here include people operations platform Zenefits and employee background check business Checkr.
Outside of the US, the UK has Seedrs, where financial technology business Revolut raised £3.8 million in 2017.
The advantages of equity crowdfunding
One of equity crowdfunding’s key advantages is that it is cheap.
Indeed, that $250 minimum investment mentioned before removes a lot of the barriers to investing that prevent many from getting exposure to other styles of equity investment.
Access to these unique start-ups in the first place is another draw, too. This is especially exciting when you consider that all the best ground-floor opportunities used to be snapped up by venture capital firms.
For businesses themselves, equity crowdfunding means not having to cede as much control to those venture capital companies in the first place. This can often result in entrepreneurs having to give up majority control and board positions in exchange for money.
Angel investors – well-funded individuals that invest in start-ups in exchange for equity – can be similarly controlling.
With equity crowdfunding, the entrepreneurs who have the idea in the first place are the ones that make everything happen. That can be perfect for businesses that have a clear path forward.
On top of that, the equity crowdfunding campaign itself can draw attention. For example, such firms often make the news when they successfully engage a large DIY investor base online. This spotlight can help to usher in even more investment.
The disadvantages of equity crowdfunding
Equity crowdfunding gives well-run businesses a path to success. However, it can also make it easier for an ill-conceived start-up to get more attention than it deserves – to the detriment of those sucked-in by the hype.
As always, it’s critical to do as much research as possible on a company before investing.
After all, a big idea might gain media attention and bring swarms of supporters…
But the reality is that many high-profile equity crowdfunding campaigns have gone south.
Rebus is a great example here. The UK claims management firm collapsed into administration not too long after it raised more than £800,000 through equity crowdfunding.
And it is far from the only failure, with a study in the UK finding that one in five of the businesses that used equity crowdfunding platforms between 2011 and 2013 eventually collapsed.
Additionally, with no say in the operations of the business itself, investors have no power to prevent disaster.
While a venture capital firm or angel investor might have the ability to demand more documentation and place conditions on funding to minimise risks, participants in equity crowdfunding have no such power as their stake is so small.
It is these characteristics that can draw in not just bad businesses but also fraudulent ones. For example, it is entirely possible for scammers to create dubious businesses and start equity crowdfunding campaigns to prey on inexperienced or naïve investors.
Moreover, even an honest and successful business could take years to deliver any returns. If the start-up proves troublesome to scale, or it becomes impossible to stick with its business plan, capital may erode.
And then, even if everything else goes swimmingly, there’s still the fear of a security breach for the crowdfunding platform itself.
Hackers are persistent, and are likely to launch constant attacks on crowdfunding sites given the likelihood of obtaining valuable information such as financial details.
Where’s the Value?
It’s an affordable option: equity crowdfunding makes it possible to chip in only a small amount, which can help to keep the risk to your financial stability low.
Play the long game: if you’re looking for a quick return, equity crowdfunding is unlikely to fit the bill. You may have to wait years to see any potential profit.
Do your homework first: if you don’t know what kind of red flags to look for when assessing a company, you should seek reputable advice before investing.
Plenty of choice: the choice of start-ups on offer are seemingly endless and as long as investors are willing to put in the work to avoid scams, there’s plenty to gain.