When starting a business, the search for financing can be frustrating.
Banks may not lend to you because your company is “too risky.” Venture capitalists may say you’re not fundable. And angel investors? Well, they’re hard to find.
Is crowdfunding the answer? Kickstarter and Indiegogo can work well—especially if you can offer great rewards and you’re excellent at online marketing. But there’s another way to raise money from the crowd.
It’s called equity crowdfunding.
With equity crowdfunding, you can sell shares of your business to just about anyone in exchange for equity in your business. And no, it’s not just for tech companies.
This guide covers what equity crowdfunding is and why it’s become a popular way to raise funds.
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What is equity crowdfunding?
Equity crowdfunding—also known as crowd-investing or investment crowdfunding—lets startups and private businesses raise capital from the public (i.e., the “crowd”). Basically, it allows everyday people to invest in your business and, in exchange, you offer them equity (think Shark Tank and Dragons’ Den). Each investor is entitled to a stake in your company proportional to their investment.
And these days, anyone can be an investor.
This type of fundraising has always existed, but until recently you could only sell shares of your business to accredited investors—fairly wealthy individuals (or private companies) who met specific net worth and income criteria. Now, your cousin, your neighbor, or almost any member of the public can buy shares as a non-accredited investor, provided you set your business up properly (more on that later).
Equity crowdfunding vs. crowdfunding
Crowdfunding refers to raising money from the public, primarily through online forums, social media, and crowdfunding websites like Kickstarter to finance a new project or venture. In return, these people might get a reward, like a copy of what’s being produced for example, or nothing at all. Project creators on Kickstarter and similar platforms maintain 100% ownership of their work and business.
With equity crowdfunding, the crowd can fund your business or project, and in exchange for relatively small amounts of cash, public investors get a proportionate slice of equity in your business venture.
How does equity crowdfunding work?
Navigating the equity crowdfunding landscape can be pretty confusing. Typically, securities and those who offer securities to the public must be registered and subject to regulation. Securities regulation by the Securities and Exchange Commission (SEC) protects investors by ensuring that investors obtain the information they need to make an informed decision, and that issuers are held accountable for any misrepresentations or fraud.
But equity crowdfunding is considered an exception. In recent years, regulatory bodies have allowed registered equity crowdfunding platforms to act as an intermediary between crowdfunding issuers and your investors. But that means you can only raise financing this way by signing up for a registered equity crowdfunding platform in your country or region. (Note: how much money you can raise through these platforms also depends on the country and region that you’re in.)
There are plenty of equity crowdfunding sites out there right now, but you should do your research to find the right one for your business. In general, FrontFundr is one of the best Canadian portals for equity crowdfunding, and in the US, SeedInvest and Indiegogo are excellent options. And depending on your campaign and how many investors you’re looking for, it may even be an option to use more than one platform.
While the structure of your offer, including the equity percentage and the type of securities you will sell, is a bit complicated and best done with the help of your lawyer, the process of actually creating a campaign is fairly straightforward. Here’s a general overview of how the process works in the US and in Canada:
- Sign up for a registered equity crowdfunding platform. Set up an offer on a registered equity crowdfunding platform and begin raising funding in exchange for real, legal shares in your company.
- Make your pitch. Once accepted by your platform, you have to prepare your crowdfunding pitch. This is the most time-consuming part of the process and may involve frequent iterations to keep interest going. You’ll have to determine what the equity stake is and the share price in your pitch, too.
- Provide essential information. You’ll have to submit to background checks by the platform and provide essential company information to prospective investors. That includes financial statements and forecasts, a credible business plan, and so on.
- Funds are released to you. When you’ve either hit your financing target or when the campaign ends, the platform will perform some final vetting before releasing funds to your business.
- Shares are released to your investors. In exchange for the money, investors get a share of your business. These shares give investors voting rights in your company.
- Pay platform fees. Since these platforms are handling the legal compliance on your behalf, they make their money through fees. This can be a percentage of the amount raised plus transaction fees, or maybe even equity. This varies from platform to platform.
- Investors continue to be advocates for your business. The perks of having several investors with a stake in your business is they’ll promote your business like it’s their own—because it is.
But before you pursue equity crowdfunding, it’s important to know that it’s not free. Although it can also have incredible benefits for your business, mounting a campaign does cost money. Some of the costs may include:
- Legal and compliance fees
- Fees charged by the equity crowdfunding platform (could be flat or a percentage)
- Consulting and business plan fees
- Marketing and advertising for your campaign
Who is equity crowdfunding for?
Contrary to popular belief, equity crowdfunding isn’t just for tech companies—it’s for anyone with a viable business plan. Your bakery, your fashion brand, and even your construction company can qualify to raise money this way, as long as you’re willing to give up some percentage of ownership in your business. There’s a reason crowdfunding platforms continue to grow in popularity. If you’ve got a product or service that tells a great story that regular consumers can get behind, understand, and endorse, then you’re halfway there.
Benefits of equity crowdfunding
The main benefit of equity crowdfunding is you can raise large amounts of money on crowdfunding platforms—and quickly. Once you and your lawyer have structured your share offering and you’ve chosen a platform, you could go from underfunded to fully financed in a matter of weeks. Normally, you’d have to approach each investor individually and pitch them on your idea, which can take years.
The other key benefit is that you retain company control, rather than having an investor who may want to be on your board and have a say in your company’s decisions. And since investors are part owners with a stake in the business’ success, you have a team of dedicated brand advocates from the start. This means a team of people who are sharing your brand with their networks and raising awareness for your products, while building brand loyalty in the process.
Risks with equity crowdfunding
The main risk with equity crowdfunding is that you may end up with lower-quality investments than you would have if you’d raised financing from more conventional sources, like venture capitalists or angel investors. Since the general public is less experienced when it comes to business and investing and they don’t typically meet the net worth of accredited investors, you won’t benefit from huge sums of capital or the business advice that many investors often provide.
Finally, you’ll want to consider how you would manage having so many investors with a stake in your business. It’s important to develop a clear communication strategy for staying in touch with them and empowering them to continue to support your brand, even though it could be years before they see any financial returns.
Next steps: Funding checklist
Before you drop a lot of money on legal fees, there are a few checks you can do to determine if your company is ready for an equity crowdfunding campaign. In other words: is your start-up fundable?
If your business is little more than a concept on the back of a napkin, it might not be the right time. But if you can check off at least half of the items on the list below, then equity crowdfunding could be worth pursuing, especially if you’re looking to raise about $200,000 or more. If you think you’re fundable but you don’t have a business plan, then the absolute next step is to write one. Here are a few tips for writing a great business plan.
Is equity crowdfunding right for you?
Equity crowdfunding is, by its very nature, extremely transparent. The crowd gets to know everything about your business and comment on it. That means you have to be comfortable sharing really specific details about how your company operates.
You also need to be in tip-top shape financially and legally so you can demonstrate to your potential investors that you have a strong company that operates ethically and has a clear business plan. As a bonus, being organized in this way will have plenty of other benefits for your business: it may protect you from legal hassles in the future and could open doors for other types of financing as well.
So, if you feel like you keep walking into closed doors in your search for business funding, you might find the equity crowdfunding door wide open to find potential investors for your business.
Equity crowdfunding FAQ
Is equity crowdfunding legal?
In the United States, equity crowdfunding is legal and regulated by the Securities and Exchange Commission (SEC). In many other countries around the world, equity crowdfunding is also legal.
What is regulation crowdfunding?
Regulation crowdfunding is a type of crowdfunding that involves the sale of securities, such as stocks or bonds, to raise capital.
What is the benefit of equity crowdfunding?
One of the major benefits of equity crowdfunding is it allows a small business to raise capital from a variety of investors rather than having to rely on capital from venture capital firms or other more expensive forms of capital. In addition, raising funds from a large group of individuals who believe strongly in your product can generate significant amounts of momentum and buzz.