Equity Crowdfunding: Definition, Advantages, and How To Do It
Starting and building a business requires money. Entrepreneurs typically turn to banks, grants from development funds, angel investors, and venture capitalists — but it can be challenging for a new, unproven business to persuade lenders or outside investors to hand over capital.
The online era offers another option: equity crowdfunding. Through the support of customers, fans, and strangers who believe in what founders are building, crowdfunding has generated financing for millions of businesses and projects. Here’s how it works, and how you can use it to raise capital.
What is equity crowdfunding?
In equity crowdfunding, businesses turn to the public to raise capital — typically many small investments from a large number of individuals — in exchange for a stake in the company. Generally, each investor is entitled to an equity stake that’s proportional to their investment: If you invest more money, you’ll receive a bigger stake.
This exchange of equity sets the process apart from general crowdfunding on platforms like Kickstarter. There, founders and creators might offer funders a reward, product, or thank you note while they retain full ownership of their business or project.
Equity crowdfunding has been around for years, but until recently it was limited by federal securities laws to accredited investors, with the goal of ensuring investors understand the risks. Accredited investors are wealthy individuals or private companies that meet specific net worth and income criteria set by the US Securities and Exchange Commission (SEC).
In 2015, US regulators declared equity crowdfunding to be an exception to these securities laws, letting companies that use this process accept non-accredited investors. Regulators permit equity crowdfunding platforms to serve as intermediaries between companies seeking funding and investors, including non-accredited investors. Although there are still limits — for example, how much money you can raise — this lets you reach a much wider pool of potential investors.
Like any method of raising capital, equity crowdfunding offers both potential benefits and possible drawbacks.
Crowdfunding can offer benefits to help you get your company off the ground. These include:
1. Broader pool of investors
For small businesses and medium-sized businesses, a major benefit of equity crowdfunding platforms is they open the door to a much broader pool of prospective investors. Rather than being limited to institutions like venture capital (VC) firms, private equity firms, and traditional lenders, you can raise money from a wide range of individual investors. This includes customers, friends, family, fans, or anyone else interested in supporting your business.
2. Retention of company control
When angel investors, VC funds, and other seasoned professionals invest in a company, they typically invest significant amounts and therefore receive significant stakes. This can dilute founders’ ownership and control over the company. Traditional investors like VCs may also require conditions like taking a board seat, regularly reviewing financial statements, or having a say in management decisions. In crowdfunding, you retain management control and don’t need to give board seats to outsiders.
3. Potential to raise money more quickly
Loans and VC deals can take months or even years to complete. Equity crowdfunding sites make it possible for you to go from underfunded to fully capitalized in as little as a few weeks. Online platforms make it easy for your backers to help you attract funding by mentioning your campaign to friends and acquaintances or posting about it on social media.
4. Diversification of capital
When you crowdfund, you automatically diversify your sources of capital, making you less dependent on any single source of funding. If a single, individual investor decides not to participate in a future round of fundraising, it matters less because many others may be willing to participate. In contrast, if a bank lender or VC backer declines to provide additional funding as your business expands, your business might be headed for trouble.
5. More opportunities for non-tech companies
Crowdfunding platforms can help a wide array of businesses access capital. VC backers often prioritize funding early stage companies in the tech industry that they believe have outsized growth potential. This means they pass over businesses that may have strong growth prospects but none of the buzz associated with tech.
6. Avoids debt and interest expenses
Borrowing to fund your business means taking on the obligation to repay the debt as well as incurring periodic interest expenses. Interest payments can drain your business’s resources, making it harder to achieve profitability. Depending on the type of debt, you may need to come up with a large lump sum payment when the debt matures.
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