Equity Crowdfunding
Equity Crowdfunding: What Is It & How Does It Work?
 Jul 11, 2022
Image: Getty
By Michelle Black and Jordan Tarver

As a small business owner, attracting traditional investors to help fund your startup can be challenging. For instance, less than 1% of startups receive funding from angel investors and only .05% of startups benefit from venture capital, according to the business crowdfunding platform Fundable.

On a positive note, you may be able to leverage shares of business equity in exchange for capital through a strategy known as equity crowdfunding. Equity crowdfunding isn’t the right approach for every entrepreneur. But if you’re interested in debt-free ways to fund your business, it might be a good fit for you.

What Is Equity Crowdfunding?
Equity crowdfunding is a unique way to raise capital for your business without taking on new debt. It’s a form of fundraising that attempts to attract investors who are willing to contribute funds toward your business goals in return for a financial stake in the company.

In general, equity crowdfunding is a business funding model that involves collecting smaller sums of money from a larger number of private investors. Would-be investors may be able to get involved for as little as $100. This approach differs from trying to attract sizable investments from venture capital firms or angel investors—a business capital strategy that’s out of reach for many startups and established small businesses alike.

How Equity Crowdfunding Works
Equity crowdfunding is also called regulation crowdfunding because it is regulated by the federal government. Even though you’re not selling shares on a stock exchange, your business is still offering equity to investors in exchange for capital. As a result, the process entails more rules than you would encounter with a simple online fundraising campaign like GoFundMe or Kickstarter.

If you want to use equity crowdfunding to raise capital for your business, following the rules is critical. Otherwise, you could face some unpleasant consequences. For example, failure to follow the rules might force you to refund any investments you receive. In some cases, the U.S. Securities and Exchange Commission (SEC) might even freeze your business’ ability to offer shares to investors for a period of time.

Below are a few of the steps you’ll need to complete in order to sell business shares through an online crowdfunding platform.
  • Work with an SEC-registered broker-dealer (aka a funding portal) to process any investment transactions
  • Accept no more than $5 million per year in crowdfunding investments
  • Follow federal limitations on the amount you accept from individual, nonaccredited investors in a 12-month period (amounts vary based on income)
  • Make any necessary financial disclosures public, based on the amount of funding your business raises

Beyond the legal concerns, you’ll also need to design a compelling campaign if you hope to energize the public and convince others to invest in your business. A good equity crowdfunding campaign should communicate key details to potential investors, including:
  • The amount of money you need to raise
  • How you plan to use the funds
  • Your target customers
  • Your profit margin
  • What makes your business different from competitors
  • Why investors should back you

Equity Crowdfunding vs. Other Types of Crowdfunding
With equity crowdfunding, you can attempt to raise funds from private investors and offer unlisted shares in your company in return. This model differs from offering shares of a company on an official stock exchange. Nonetheless, you will still need to register with the SEC to participate in this form of equity-based fundraising.

Of course, offering shares of your business to would-be investors isn’t the only form of crowdfunding that exists. There are other ways to reward and entice investors through crowdfunding platforms that don’t involve giving up any pieces of your business.

Rewards Crowdfunding
Rewards-based crowdfunding is another fundraising option that may appeal to entrepreneurs who don’t want to take on debt that needs to be repaid. This form of crowdfunding seeks contributions from financial backers and offers some type of benefit as a trade-off.

The rewards you offer to contributors can be as simple or complex as you like. For example, an author might offer copies of their book before it’s published or a massage therapist might reward donations with gift certificates for future services.

Keep in mind that it may take some trial and error to find rewards that motivate people to support your vision. Some entrepreneurs offer different types of rewards according to the amount a supporter contributes as well.

Debt Crowdfunding
Debt crowdfunding is a cross between traditional crowdfunding and a small business loan. With this type of business financing, you’re taking out a loan from a crowd instead of a financial institution or online lender.

When you use debt crowdfunding to finance your business, you’ll have a loan agreement just as you would with a lender. You’ll repay the money you borrow, plus interest, over an agreed-upon number of months. However, you do not have to offer shares of your business to secure this type of funding.

Donor Crowdfunding
Donor crowdfunding, also called donation-based crowdfunding, is a process that involves people contributing money to a cause without expecting anything in return. For example, friends and family members might donate money to support a loved one’s dream of opening a new business. Charities and nonprofit organizations may also use this form of crowdfunding to solicit donations from supporters who believe in the cause they represent.

There are many online platforms available for donation-based crowdfunding campaigns. A few examples include GoFundMe, CrowdRise and Fundly.

Pros and Cons of Equity Crowdfunding
As with any form of business funding, there are positives and negatives to consider where equity crowdfunding is concerned.

Pros of Equity Crowdfunding
  • Equity crowdfunding offers a business funding solution if you cannot qualify for sufficient financing elsewhere due to credit issues, revenue limitations or other lender requirements needed to qualify for a business loan.
  • There’s no debt to repay.
  • By working with a larger number of investors, you might be able to raise more money.
  • As a business owner, you can structure crowdfunding campaigns so that you retain the majority of your business equity and only offer a small portion to investors.
  • You may be able to attract nontraditional investors to support your business goals.
  • You can gain visibility and build excitement before you even launch your new business.

Cons of Equity Crowdfunding
  • You give up a portion of your company’s future profits in exchange for cash now.
  • Per SEC guidelines, you must disclose your company’s financial details to potential investors, and that means almost anyone can access that information.
  • There’s a risk of public failure if your equity crowdfunding campaign isn’t successful.
  • Equity crowdfunding platforms charge fees and may keep a percentage of the funds your business raises (often 5-15%) in the form of commission.
  • Traditional investors likely won’t be interested because it can be tough to resell the shares of smaller companies without taking a financial loss.
  • Crowdfunding campaigns may be time-consuming, and there’s no guarantee you’ll generate enough funding to make the time commitment worthwhile.

Looking to raise capital through equity crowdfunding?

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