Equity crowdfunding is the act of raising capital from the crowd through the issuance of securities to accredited investors. Through this funding mechanism investors provide capital to a company, the issuer, in exchange for shares in the entity. By becoming shareholders, the investors benefit from the growth of the company in a way that debt holders do not.
Various exemptions exist in the United States, such as Regulation Crowdfunding (CF) and Regulation A+, that allow issuers to avoid the costly and lengthy process of a full registration with the SEC. 80% of issuers elected to file under Reg CF in 2017.
During 2017, the most common type of security issued under Reg A+ and Reg CF was equity (common or preferred stock) followed by SAFEs.
Crowdfunding campaigns are conducted on a registered platform, which can act as a broker-dealer, investment adviser, an ad/listing service, or a direct issuer.
While crowdfunding itself is not a new concept, the use of online platforms in equity crowdfunding is the real innovation. The transaction process is similar to the traditional method of accessing the equity markets but, thanks to the platforms, the parties involved in the operation experience several benefits:
– Easier method of raising capital when compared to traditional methods, such as an IPO;
– Cost efficient as fees charged by platforms are aligned with or lower than non-crowdfunding options;
– An opportunity for feedback from a wide range of individuals who will ask questions regarding the company and business plan;
– Potentially global reach due to the use of the Internet (this may attract a diverse group of investors as well as customers)
Since equity crowdfunding may be used by startups to raise capital for a new or growing business, investors are exposed to increased risk when compared to investing in the equity of more mature companies. Due to the inherent risk and illiquid nature of early stage investments, the individuals and entities who are allowed to invest in these offerings are restricted.
Due to the fact that equity crowdfunding is still relatively new, the market size has not yet caught up to that of more traditional capital raising methods, such as angel investors and VCs.
The equity crowdfunding industry serves the purpose of connecting investors with business owners looking to raise capital by selling a portion of their company. Since this involves the selling of securities, a detailed plan is necessary before beginning a campaign to ensure the issuer stays compliant with applicable regulations. The following activities likely need to be completed for each campaign. The issuer may complete these steps independently, though they will likely engage the services of a securities attorney, investment banker, or CPA.
i) Feasibility analysis: An analysis to determine if the objective of the company is technically possible, can be completed with the capital being requested, and if the company has the potential to be profitable.
ii) Compliance review: Prior to issuing securities and soliciting investors the issuer must ensure they meet the regulatory requirements of the exemption they are filing under. The burden of proof is on the issuer that they meet the exemption. This is where working with an attorney is well worth the cost.
iii) Preparation of offering documents: The issuer will need to prepare the necessary offering documents and marketing materials before starting the crowdfunding campaign. This may also include a business plan and financial models and forecasts for potential investors to review.
iv) Implement the campaign: Once the issuer has cross the Ts and dotted the Is, the campaign can be started.
v) Receive funding and build something great.
As always, it is recommended to check with a securities attorney prior to issuing any security.
Equity crowdfunding is one of many options in the world of crowdfunding. The following are some of the most common alternative means to equity crowdfunding:
Donation Crowdfunding: The model is based on donations, in which the donors, here called “backers”, altruistically devolve an amount of money for the support of a specific cause, without receiving any rewards or only symbolical ones.
Reward-Based Crowdfunding: The supporter of the campaign receives a reward based on the amount of his or her investment. The reward may be a product, or a service provided by the company promoting the campaign, and its features are usually determined through the involvement of the supporters.
Royalty–Based Crowdfunding: The investor finances an initiative and receives in return a part of the profits.
Lending Crowdfunding: Similar to a bank loan, the investors become direct creditors of the borrower they have funded. Loans are typically funded by many lenders as opposed to just one or a few as one might find when approaching a traditional lending institution.
Venture Capital: Capital provided by firms or funds to startups and businesses seeking growth capital.
As can be seen from the following chart, equity crowdfunding is not the most popular by total funds raised. This could be due to the fact that U.S. regulation only allowed equity crowdfunding in recent years.
In the Unites States, only 5 crowdfunding portals captured nearly 72% of offerings:
Other notable platforms include:
– Funders Club
Mario Mosiello contributed to this report.
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