Equity Crowdfunding: Pros & Cons of Funding Options | Nav (2024)

Get to know Equity Crowdfunding

Gerri Detweiler • January 26, 2021

What is Equity Crowdfunding?

Equity crowdfunding is a way for private businesses to fund their companies through money from online investors. With equity crowdfunding, you don’t have to pay back a loan or provide a product or service for the money – investors instead get equity ownership in your business.

Investors either get securities, or public shares, of your company and give you money to build it. Equity crowdfunding is a great way for startups and other small businesses to raise funds or capital, and it allows the public (including any friends and family) to invest in your business easily.

When you’re looking for financing to start or grow your startup, you might not qualify for traditional loans or be able to find a venture capital firm willing to invest in your business.

With equity financing, instead of borrowing money from financial institutions, you raise capital from private investors in exchange for equity, debt, or revenue share.

But these don’t have to be Wall Street-level investors: anyone interested in investing in startups can open an investor account on an equity crowdfunding platform and be a part of your startup’s success story!

What Are the Different Types of Crowdfunding?

Equity is just one type of crowdfunding. Each type has its own particular characteristics.

• Rewards crowdfunding
• Debt crowdfunding
• Donor crowdfunding
• Equity crowdfunding

Reward Crowdfunding

With reward-based crowdfunding, entrepreneurs don’t have to pay back the funds raised; instead, you give backers some incentive or thank-you gifts like early access to your product, a company-branded t-shirt, or even a trip to meet you and your team. Indiegogo is one example. The incentive should be commensurate with the level of donation. The money you raise this way will be taxable.

Debt Crowdfunding

This one is a bit like a business loan in that your company borrows money that you have to pay back. But rather than borrowing from a traditional lender, your campaign is open to the general public, and private investors can contribute toward the total amount you’re trying to raise. A popular example is Kiva, which offers 0% loans to small businesses through a form of debt crowdfunding.

Donor Crowdfunding

With donation-based crowdfunding like GoFundMe, you don’t have to pay the funds back at all. Backers donate to your business or cause. (This can be a good option for nonprofit organizations.) Donation levels may include perks or rewards, but that’s not required.

So why equity crowdfunding? It may be that one of these other types of crowdfunding is a better fit, but bringing on investors can carry benefits we’ll go into shortly.

How Does Equity Crowdfunding Work?

Imagine you are going on Shark Tank and you want Mark Cuban to invest in your startup. Now imagine that instead of pitching the Sharks, you’re pitching an entire audience of prospective investors and asking each to put money into your company.

That will give you an idea of what it might take to be successful in raising funds on equity crowdfunding platforms. Even if you’re not gearing up to pitch an investor on national television, the more prepared you are with answers to questions potential investors will have, the more money you can raise.

You can be sure that private investors on crowdfunding platforms (or elsewhere) will want to know:

• How you will use the money you raise
• Your profit margin
• Your cost of goods
• Your target market
• What makes your business unique

Investors will want to understand why you are qualified to run and grow your business. You will need to come up with research on your industry, competitors, and future growth of the market in addition to the typical business plan and financial projections for loan applications. And you’ll need to be able to answer questions such as those above in order to attract investors.

Once you’ve submitted your crowdfunding application to a crowdfunding platform, it will be reviewed. If approved, it’s up to you to create a campaign that is appealing and informative for investors. Engage through photos, infographics, and videos, as well as ample data.

Anyone signed up as an investor on the platform can invest in your campaign. You may not receive any funds until you meet your goal, so be aware of that when setting your fundraising goal.

How Does Equity Crowdfunding Work for Investors?

From the investor perspective, the process for equity crowdfunding is a bit different. You can sign up as an investor on crowdfunding sites like StartEngine. Some may have criteria for who can be an investor and how much you can invest annually.

Once you find a crowdfunding campaign you’re interested in, you can invest in it. There may be a minimum investment, so check that first. Also carefully read through all the material on the campaign so you understand if you’re getting private equity, revenue share, or something else.

Who Can Invest in Equity Crowdfunding?

One of the best things about equity crowdfunding is that anyone can invest in your company. It’s open to more than just venture capitalists and private equity firms. All anyone needs to do to invest in equity crowdfunding is have access to the internet and $100. You don’t need a broker-dealer to invest, and the business doesn’t need to hold an initial public offering (IPO), thanks to regulations set forth in the JOBS Acts of 2012. First time investors may find equity crowdfunding to be a less complicated or less intimidating alternative to traditional investment opportunities.

How Much Money Can You Raise with Equity Crowdfunding?

There are a couple of different types of equity crowdfunding (formed by President Obama’s Jumpstart Our Business Startups Act (JOBS Act)), and each has its own limits for how much money you can raise.
With Regulation Crowdfunding, startups can raise up to $5 million each year. With Regulation A+ Crowdfunding, you can raise up to $75 million a year. Depending on how much you want to raise, make sure the crowdfunding platform you’re considering will allow you to set up a campaign under the appropriate regulations.

Pros of Equity Crowdfunding

Of course, having funds to grow your business is beneficial enough, but let’s look at some other perks of taking on equity partners through crowdfunding.

Good Option When You Can’t Find Financing Elsewhere

Maybe you were turned down for a bank loan because your personal credit scores were low. Or maybe, being a startup, you’re limited in the financing you are eligible for. None of that matters with equity crowdfunding, and many startups find it the best option for financing.

You Can Get a Large Sum of Money

As I mentioned above: with equity crowdfunding, you can raise up to $75 million a year (and every year, if you choose). That’s helpful if your startup needs a large amount of capital to launch or grow.

No Credit or Collateral Required

If you don’t qualify for a traditional business loan because you lack collateral, that won’t be an issue with equity crowdfunding. And if bad credit is holding you back from a business loan, that also won’t be an issue here.

Available to a Wide Range of Businesses

While lenders often prefer to lend to certain types of established businesses that have been in operation for a few years, equity crowdfunding may give you a shot at getting investment capital, provided you can make a compelling case of why you are likely to succeed. However, here, the owner’s track record and the vision for the business will be key to getting funding. For example, you may have success funding a new restaurant if you already have been a successful restaurateur. But if you are new to the restaurant business, it will be tough to find investors willing to take a huge risk on your brand new business.

Also, remember that equity crowdfunding is appropriate if there is a clear exit strategy for the business; in other words, a way for investors to make money, whether that’s through an acquisition or initial public offering.

Cons of Equity Crowdfunding

Equity crowdfunding campaigns aren’t for everyone. Here are a few reasons you may want to choose a different type of crowdfunding or look for a small business loan instead:

Your Information is Public

Not only will your financial records be published publicly, but also you may have to publicize a technology or approach to business that you might prefer to keep hidden from competitors.

Platforms Charge Fees…and There are Other Costs

Naturally, every equity crowdfunding platform wants a cut of what you raise (on average, about 6% of what you raise). But there are other costs too. Those costs include the all-important campaign video, company disclosures, marketing costs, as well as legal and accounting fees. On average, those end up costing about 5.3% of the amount raised according to Crowdfund Capital Advisors, but they will be incurred before the launch.

It Can Be Time-Consuming

While there are campaigns that meet their fundraising goal in hours, like most “overnight successes,” there were likely many hours invested beforehand. In all likelihood, the business owners behind those campaigns spent weeks or sometimes months getting ready to go live. Plan for six months for a successful campaign, and if it goes faster, you’ll be pleasantly surprised.

How Much Equity Do You Give Up in Crowdfunding?

Giving up equity in your company may sound scary, because it means taking ownership away from you and giving it to investors. There’s no set amount of how much equity you’ll give up if you use crowdfunding to get capital for your business. When investors use series A funding, they tend to give away 20-40 percent of their equity.

The Best Candidates for Equity Crowdfunding

So do you even qualify for equity financing through crowdfunding? Here are the qualities of startup companies who tend to succeed in attracting crowdfunding investment from both private and accredited investors:

• Businesses with a great pitch and product that is scalable
• Businesses that can produce 5X or more returns for investors
• Businesses with a robust network of potential investors

The last point is very important: the majority of money raised through equity crowdfunding comes through the personal and professional network of the entrepreneur. If you do not have a network of friends, family, or fans who may invest in your campaign— and a way to reach them— you may have trouble raising money through equity crowdfunding. In addition, when choosing a crowdfunding platform, you’ll want to look at the minimum investment required and make sure it matches your target audience of private investors. It might not be the best option for early-stage companies.

Equity Crowdfunding Regulation: What You Need to Know

Equity crowdfunding is relatively new and became legal in 2016 through Title III of the Jumpstart Our Businesses (JOBS) Act. This law aims to strike a balance between making investment funding available to small businesses while helping to protect individual investors, some of whom may be unaccredited (unsophisticated) investors. Therefore there are a number of crowdfunding rules and regulations that must be followed.

Under the federal securities laws, “any offer or sale of a security must either be registered with the SEC or meet an exemption.” That includes funds raised through crowdfunding. Regulation Crowdfunding, however, exempts registration requirements for securities-based crowdfunding for companies looking to offer and sell up to $1.07 million of their securities.

This is good news for private investors who want to invest in startups like yours. Anyone can invest in a Regulation Crowdfunding campaign. However, there are stipulations on how much they can invest in equity crowdfunding campaigns during any 12-month period. Limits will depend on the individual’s net worth and annual income. Some crowdfunding platforms will only accept accredited investors (generally wealthier individuals) while others are open to a broader group of investors.

The Best Equity Crowdfunding Sites

If you decide to pursue equity crowdfunding, you’ll have to pick an equity crowdfunding platform. There are many considerations here, including whether the equity crowdfunding portal is:

• Reputable and well-established
• Able to provide the training you need
• Has strong marketing itself
• Attracting equity investors to back campaigns like yours
• Successfully helping other businesses in your space or industry
• Competitive in terms of costs
• Safe and secure

Here are a few of the top equity crowdfunding platforms.

Wefunder

Wefunder bills itself as “angel investing for everyone.” Anyone can invest as little as $100 in campaigns on the site, and the site has helped startups raise nearly $20 million. Startups can raise $50,000 to $5 million. Get started here.

Seedinvest

Seedinvest is picky: it accepts less than 2% of the startups who apply. But that means that the startups who are accepted are more likely to succeed in their crowdfunding goals. Seedinvest accepts startups in diverse industries, from tech and robotics to cannabis and genomics. Get started today.

StartEngine

StartEngine has successfully helped fund over 500 raises and has a community of over 500,000 investors. The platform offers both seed rounds and Series A to C options. Start crowdfunding today.

Republic

Republic lets investors get a piece of the action for as little as $10 per investment, which makes it highly accessible. On average, startups using Republic come to the table with $3 million in VC funding before their crowdfunding campaign. Apply to raise funds here.

Can You Get Rich Off Crowdfunding?

While business owners are looking to raise money for their businesses, individual investors may be looking for opportunities to make money by investing in these businesses. Investing through equity crowdfunding is generally considered quite risky, which is why it is regulated by the Securities and Exchange Commission (SEC). Intermediaries are regulated by the SEC.

As with any investment opportunity, you’ll need to do your own due diligence to determine whether you feel comfortable with the risk you are taking by investing your capital in a business through one of these campaigns. Startup investing is high risk. You should think through what happens if the company is not successful. Can you afford to lose the capital you invest?

This type of investment is often best for wealthier investors willing to take higher risks with the potential of higher returns.

While there’s no guarantee that investors will profit from an equity crowdfunding investment, it is possible.

Alternatives to Equity Crowdfunding

If equity crowdfunding doesn’t feel right for you, explore other financing options.

Business Loans and Lines of Credit

Small business loans provide straightforward financing: you receive a lump sum of capital and then pay it back monthly over time with interest. Both the Small Business Administration (SBA) and institutional lenders like banks and credit unions offer business loans, though they may have stringent requirements for credit scores, time in business, and annual revenues.

Business Credit Cards

Having access to a business credit card allows you to make purchases even if you don’t have cash on hand. A rewards card can also provide perks like travel and cash back.

Venture Capital and Angel Investment

Venture capitalists and angel investors are looking for startups that are promising to invest in. You’ll have to make a great impression with a well-researched pitch deck and lots of financial detail to show that your startup is an appealing investment.

Nav’s Verdict: Is Crowdfunding a Good Idea?

Crowdfunding may be a great way for your company to get much-needed capital for their businesses. Of all the types of crowdfunding, however, equity crowdfunding often requires the largest commitment in terms of both time and money. If you decide to go this route, make sure you spend time carefully researching successful equity campaigns and get good professional advice on how to attract investors.