What is equity crowdfunding? (Definition, Benefits and Risk, Regulation)

What is equity crowdfunding? (Definition, Benefits and Risk, Regulation)

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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”.

It begins with a startup 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.

Thanks to very low minimum thresholds—sometimes as little as $250—pretty much anyone with a keen eye for a great-looking start up can get involved.

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.

Why is equity crowdfunding different to regular crowdfunding?

It’s important not to mix up equity crowdfunding with regular crowdfunding.

Some people might be familiar with crowdfunding from popular sites like Kickstarter, where you can back anything from a novel smartwatch or a modern-day cooler to a hat made from used coffee grounds, algae, and cactus .

In plain old crowdfunding, the rewards are typically the product itself. For example, the reward for a $36 pledge for the Kickstarter project in the above list is exactly one hat.

By contrast, equity crowdfunding offers equity in the business that creates the product—whatever it is—rather than products.

That way, if the startup business does well, investors will have a long-term stake in the growing company. In other words, their exposure continues long after their money has left their wallet.

On top of this, the equity approach makes it easier to support businesses investors want to see grow but where they are not likely to be a customer .

Someone who never cooks, for example, might still think backing kitchen products maker Mealthy is a good investment. They might not want a MultiPot 2.0 6-quart electric pressure cooker for themselves, but could easily imagine that many people out there in the world would.

Minimum investments also differ 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.

Bottom line is, while there are of course other methods of investing, equity crowdfunding clearly has its own special benefits…

What are the pros 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 (“VC”) firms.

For businesses themselves, equity crowdfunding means not having to cede as much control to those VC 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 startups 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 it happen. And 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.

It’s clear there are numerous benefits to equity crowdfunding for both investors and investees. However, as with anything, equity crowdfunding has its downsides, too…

What are the cons of equity crowdfunding

Equity crowdfunding gives well-run businesses a path to success. However, it can also make it easier for an ill-conceived startup 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 startup 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.

Given all the risks, then, it is worth considering if equity crowdfunding can really live up to its hype.

Should I try equity crowdfunding?

Whether equity crowdfunding is the right move for you depends on a whole host of factors.

First and foremost, as always, it’s important to never invest more than you can afford to lose. All investments carry risk, and equity crowdfunding is no exception.

An advantage of this style of investing makes it possible to chip in only a small amount, which can help to keep the risk to one’s financial stability low.

That being said, if you are looking for a quick return, equity crowdfunding is unlikely to fit the bill. These are start-ups, and—by definition—they are likely to be many years away from profits and, in turn, returns.

It would be better to approach equity crowdfunding as a long-term investment- one that might pay off tremendously in time, but certainly not right away.

Another factor to consider is experience. A novice, who might not know what red flags to look for when assessing a company, should seek reputable advice before considering this style of investing.

Equity crowdfunding would best suit someone who knows that they are doing and can do their own due diligence on fledgling companies.

So, if this all sounding appealing, the next thing to do would be to find a crowdfunding platform.

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 startups 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 startups. Success stories here include people operations platform Zenefits and employee background check business Checkr.

Elsewhere, other big names in the equity crowdfunding world include AngelListFundableCrowdfunder, and EquityNet.

Outside of the US, the UK has Seeders, where financial technology business Revolut raised £3.8 million in 2017.

The startups are seemingly endless, the platforms are popular, and the advantages abundant. As long as investors are willing to put in the work to avoid scams, there’s plenty to gain.

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