Understanding Equity Crowdfunding Pros and Cons

Equity crowdfunding allows startups and small businesses to raise funds from a large number of people, typically in exchange for equity or ownership stakes in the company.

This approach can be less expensive than traditional funding methods, such as venture capital, which often come with high fees and strings attached.

One of the biggest advantages of equity crowdfunding is the potential for increased exposure and credibility for the business, as it can attract a large and diverse group of investors.

Investors can also benefit from the potential for higher returns, as they become part-owners of the business and can share in its profits.

However, equity crowdfunding also comes with its own set of challenges and drawbacks, such as the risk of diluting ownership and control of the business.

Investors may also have limited control over the business and its decision-making processes, which can be a concern for those who value transparency and accountability.

Equity crowdfunding is a type of equity financing that involves raising capital online from investors in order to fund a private business.

In return for cash, investors receive equity ownership in the business.

Equity crowdfunding happens on online platforms where businesses create profiles that include their pitches, financial statements and other information.

These platforms may charge a percentage of funds raised for their services, a monthly listing fee, or additional payment processing fees.

You might also need to pay for services, such as accounting, to get the paperwork in order.

Equity crowdfunding is not the same as rewards-based crowdfunding, which gives backers rewards in return for donations.

It's also unlike other types of small-business funding in that it has no debt component.

The democratization of investment is a game-changer in the world of equity crowdfunding. Equity crowdfunding embodies the democratization of investing, fostering economic inclusivity and a level playing field for all.

This means that non-accredited investors can now fund startups, something that was previously only accessible to accredited investors or venture capitalists. Equity crowdfunding has significantly lowered the threshold for investment, granting access to venture investment opportunities that were once exclusive to a select few.

With equity crowdfunding, investors can diversify their portfolios with high-growth startups, making it an attractive option for those looking to spread their risk. This inclusivity has opened up a new avenue for retail investors to participate in the financial backing of innovative startups and emerging companies.

By allowing non-accredited investors to fund startups, equity crowdfunding promotes economic inclusivity and provides opportunities for people to invest in companies that align with their values or contribute to a cause they support.

Equity crowdfunding platforms allow investors to provide patient capital to startups, giving them the time and resources to grow and develop their business.

This type of capital is particularly beneficial for startups that require time to refine their product or service before they can generate significant revenue.

The JOBS Act, enacted in 2012, established equity crowdfunding in the U.S. and initially limited it to accredited investors.

However, provisions like Title IV and Title III later expanded access to non-accredited investors and early-stage startups.

Investors who enjoy researching and understanding new business models, market strategies, and emerging industries are likely to do better in equity crowdfunding.

These investors can conduct due diligence on potential investments, which is essential for making informed decisions.

Equity crowdfunding platforms provide a wide array of startups across different sectors, enabling investors to hand-pick investments based on transparent information and due diligence.

Some equity crowdfunding platforms are developing secondary markets for trading shares of crowdfunded companies, potentially offering liquidity options that were previously unavailable.

This allows investors to potentially exit their investments and realize returns on their capital.

Investing in equity crowdfunding can be a high-risk endeavor. A significant percentage of startups fail within the first few years, which means investors may lose all their money.

Fraud and misrepresentation are also potential risks, as some companies may exaggerate their potential or financial situation to attract investors.

Equity crowdfunding platforms carry their own set of risks, including low liquidity and limited exit options. This means investors may have to wait several years for their investment to pay off.

Some of the cons of equity crowdfunding include the risk of investors wanting a say in your operations if you sell part of your business. You'll also need to spend time creating a persuasive presentation and comply with state and federal security filing rules.

Liquidity Through Secondary Markets is a developing aspect of equity crowdfunding, allowing for trading of shares in crowdfunded companies.

Some equity crowdfunding platforms are creating these secondary markets, offering liquidity options that didn't exist before.

This means investors can potentially sell their shares in a crowdfunded company, providing a way to exit their investment.

Though these secondary markets are less liquid than public markets, they can still offer a way to access liquidity.

There is the potential for substantial returns if the company succeeds, and an equity stake could appreciate exponentially.

Making smaller investments is a smart way to mitigate risks in equity crowdfunding. This approach allows you to spread your risk across various startups, rather than putting all your eggs in one basket.

Individuals who are risk-tolerant and can afford to lose their investment without financial stability issues may find equity crowdfunding suitable. They should be prepared to handle the potential total loss of their investment.

By investing smaller amounts, you can diversify your portfolio and reduce your exposure to potential losses. This can help you sleep better at night, knowing that you're not putting your entire financial stability at risk.

Risk-tolerant investors, who have the capacity to absorb losses, may find equity crowdfunding a good fit.

High-risk investments can lead to significant losses, with a significant percentage of startups failing within the first few years.

Investors in these companies may lose all the money they put in, making it difficult to predict success. The lack of a proven track record is a major concern.

Any party participating in equity crowdfunding must be aware of the associated risks, which include fraud and misrepresentation risks.

Potential investors should be aware that securities purchased on equity crowdfunding platforms are highly illiquid, making exit options limited or non-existent.

Investments in private startups are not as liquid as those in the stock market, and investors cannot usually sell their shares quickly or easily.

The recent popularity of equity crowdfunding can lead to market saturation, where too many businesses compete for funding, or overfunding, where a company raises more money than it can effectively use.

Investors must also be wary of potential fraud schemes in the equity crowdfunding process, which can lead to investment losses.

Tax implications for investments in startups can be unfavourable, with difficulty in claiming losses or higher capital gains taxes.

Fraudsters may use asymmetric information, as well as loopholes in regulations, to deceive investors.

Investors must comply with state and federal security filing rules and have a fiduciary duty to tell shareholders about the health of the company.

Here are some of the key risks associated with equity crowdfunding:

Centralizing your communications can be a challenge, but hosting your fundraise on a funding portal can help.

You can concentrate all of your investor discussion into a single place, which is a huge advantage.

Prior to funding portals, it was a painful exercise of herding cats, constantly updating a bunch of potential investors through emails, meetings and phone calls.

Centralizing your communications isn't just about emails, it's about constantly updating your fundraising profile so that every new detail can be instantly available to prospects.

This proactive marketing is a critical part of fundraising, and it can help you stay organized and focused.

Crowdfunding doesn't find investors for you. It's a myth that posting your idea on a crowdfunding site will magically attract money from strangers.

Successful fundraises are almost always the result of proactive Founder effort, building buzz around the raise, and reaching out to prospects in their personal networks. In fact, there's a direct correlation between the number of outside links to a crowdfund and the success of the fundraise.

Crowdfunding sites may have thousands of millions of potential backers registered, but that doesn't mean they're eager to part with their money. They get interested when they hear a fundraise has momentum and someone shares it with them because it looks interesting.

False positives can be disastrous for startup companies, resulting from poorly marketed crowdfunds that fail to validate an idea.

This can lead to premature conclusions that there isn't a market for the product or service, or that the idea isn't good enough.

In fact, false positives are a common issue, often due to inadequate promotion rather than a flawed idea.

A poorly marketed crowdfund can signal that a product or service isn't viable, when in reality it's just not being presented in the right way.

Equity crowdfunding is heavily regulated, which helps protect investors and businesses. Regulatory bodies like the Securities and Exchange Commission (SEC) in the United States have established rules for crowdfunding that companies and investors must adhere to.

The regulatory framework in place can be complex, creating barriers to investment and fundraising for both companies and investors. This is because navigating the rules and regulations can be difficult.

The first instance of crowdfunding was recorded in 1997, but it wasn't until the JOBS Act was enacted in 2012 that equity crowdfunding became a legitimate way for companies to raise capital. The JOBS Act established equity crowdfunding in the U.S. and initially limited it to accredited investors.

The SEC oversees the regulations, ensuring transactions occur through registered intermediaries. These rules aim to protect investors and maintain transparency in crowdfunding investments. The regulations also establish limitations on the amount of funds that can be raised by companies and on the amount that can be invested by each investor.

Equity crowdfunding is regulated under the JOBS Act, which allows the participation of both accredited and non-accredited investors. However, the regulations also aim to protect unsophisticated or non-wealthy investors from putting too much of their savings at risk.

In Australia, the government amended the 2001 Corporations Act in 2017 to provide a legislative framework for crowd-sourced funding. This allows companies to raise funds from a large number of people, typically through an online platform.

Here are some key regulatory considerations for equity crowdfunding:

The regulatory framework in place can be complex, but it's essential for protecting investors and maintaining transparency in crowdfunding investments.