Building a business requires many things. It takes an entrepreneurial spirit and a product or service that meets people’s needs. It also requires money, also known as capital.
In the old days, this meant pitching your business to a bunch of venture capitalists and hoping they like your idea. If a prominent investor didn’t invest in your business, you’d be dead in the water.
Nowadays, you can take advantage of crowdfunding technology to raise money from the general public. Let’s talk about how equity crowdfunding works and what it means for modern entrepreneurs.
What Is Equity Crowdfunding?
Equity crowdfunding is the practice of raising money from online investors to provide capital for a business. These investors obtain an equity stake in the company, which makes them part-owners. Equity crowdfunding works much like crowdfunding for products. A new business creates a profile with information on what they currently do and what they plan to achieve. Unlike traditional crowdfunding, you’ll also have to meet some regulatory requirements, which we’ll discuss momentarily.
Crowdfunding platforms earn money by putting a surcharge on any investments. Some also charge listing fees, processing fees, and other charges. They may also accounting and other services for an additional fee. It’s worth shopping around to find a platform that works for you.
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How Does Equity Crowdfunding Work?
Equity crowdfunding is more complicated than other crowdfunding because it’s so heavily regulated. You’re not selling stocks, but you are selling equity in your business to third parties. This means you must meet the U.S. Securities and Exchange Commission’s (SEC’s) reporting and transparency requirements.
This isn’t just a suggestion. If you fall afoul of the SEC, you could face serious repercussions. At a minimum, you might be forced to return any of your investments. Worse, you could be temporarily banned from offering equities to new investors. This could put your business plans on hold and maybe even put you out of business.
In order to stay in compliance, make sure to do the following things when you’re offering your shares for crowdfunding:
List your company with an SEC-registered crowdfunding platform.
Observe all federal limits on individual investments from nonaccredited investors. This requires you to gather some investor information, since limits vary depending on income.
Make your financial records public, so investors can perform due diligence.
Accept a maximum of $5 million in crowdfunding investments per year.
Regardless of any regulatory concerns, you also have to think about how you’re going to promote your crowdfunding campaign. How do you convince individual investors to put their money into your company, when they can choose from thousands of others? You’ll need to provide the same type of information you’d want to show traditional investors, including:
How much money you need to raise
The products or services you offer
Your target market
Your current profit margin
What makes your business different from the competition
How you plan to use the capital you raise
Is Equity Crowdfunding Legal?
Yes, with certain limitations. For example, the SEC limits equity crowdfunding to $5 million per company per 12-month period. However, it’s legal to accept investments from any investor, whether or not they’re accredited. You can even sell equity to family, friends, and customers who believe in your business.
Equity Crowdfunding Vs. Other Crowdfunding
Equity crowdfunding is similar to other types of crowdfunding in the sense that you’re soliciting money from the general public in exchange for something of tangible value. Significantly, you don’t actually “owe” anything to your investors since they’ve already gotten what they paid for – equity in your company. With other crowdfunding, you’re typically expected to deliver a product or service.
That said, there are important differences between different types of crowdfunding. Here are some other ways to raise money for your business.
Rewards-based crowdfunding allows you to raise funds without selling equity, so your campaign won’t be subject to SEC regulations. Instead of offering equity in your business, you offer some type of perk instead.
Rewards can take almost any form. For example, suppose you’re trying to open a salon. You could offer a free 1-year membership to early backers. If you’re opening a landscaping business, you can offer 50% off for the first 12 months for anyone who funds your business.
With this type of campaign, you’ll need to get creative and come up with something that will appeal to your target audience. It also helps to offer different rewards for people who contribute different amounts.
Debt crowdfunding is similar in many ways to a small business loan. However, you’re borrowing from a large group of people instead of from a traditional lender.
Much like a business loan, you’ll have to sign a loan agreement with payment terms. You’ll have to repay whatever money you’ve borrowed according to the schedule, along with any interest you’ve accrued.
On the plus side, you’re not selling equity in your business, and you don’t have to provide any special perks. On the downside, the interest on your loan is a very real cost.
Donor crowdfunding is also known as donation-based crowdfunding, and it’s exactly what it sounds like. You ask people to give you funding without receiving anything in return. This isn’t viable for most businesses, and no stranger is going to give you free money to pursue your entrepreneurial dream.
That said, donor crowdfunding is a viable route for nonprofits. Nonprofits solicit donations all the time as part of their everyday operation. If people are willing to donate to your cause, you’ll be able to find plenty of funding.
Since donor crowdfunding is so popular for charitable causes, there are a handful of platforms dedicated specifically for that purpose. These include GoFundMe, Fundly, and CrowdRise.
Pros & Cons Of Equity Crowdfunding
Like any other financial process, equity crowdfunding has its benefits and its drawbacks. Here are some pros and cons to consider.
Pros Of Equity Crowdfunding
You might raise more capital by appealing to more investors.
You can attract unaccredited investors.
A platform can funnel your funds through a single channel, simplifying your accounting.
You can raise money even if you have poor credit or can’t qualify for a traditional business loan.
You don’t take on any debt.
A well-structured campaign will leave you with majority control of your business.
The campaign itself can generate publicity for your brand.
Cons Of Equity Crowdfunding
A poorly-structured campaign can leave investors with majority control of your business.
You have to share your future profits with your investors.
It can be hard to attract traditional investors via equity crowdfunding.
Your crowdfunding platform may charge a percentage of your funds, sometimes as much as 15%.
You have to disclose your company’s financial statements to meet SEC requirements. Because you’re making them public, they’re also visible to your competitors.
You’ll have to build a campaign to attract investors, which costs time and money.
If your campaign is unsuccessful, it can be a public embarrassment.
Alternatives To Equity Crowdfunding
As you can see, equity crowdfunding can be an excellent way for many entrepreneurs to raise funds. But for many others, it’s a less than ideal approach. If you’re looking for a different way to raise capital, consider these more traditional options.
You can obtain a business loan from the U.S. Small Business Administration (SBA), from a bank, or even from an online lender. The lender will typically want to know about your business model, and will want to see your financial statements to see if your business is creditworthy. If everything goes smoothly, your company will soon get an influx of cash.
Business Credit Cards
A business credit card is a business line of credit that’s tied to your personal credit rating. You use the card just like you’d use your personal card, but you use it for business expenses. This is good for brand new businesses where the company itself does not yet have a credit record.
If your startup has enough potential, you can apply for funding from an angel investor or venture capital firm. These accredited investors are very discriminating, and even the best business plan can struggle to attract investors. On the other hand, if you’re successful, you can raise staggering sums of money.
How To Start Equity Crowdfunding
Because equity crowdfunding is regulated by the SEC, all equity crowdfunding services must be registered with the SEC. As a result, ordinary crowdfunding sites won’t allow it. You can pitch your product on Kickstarter, but you can’t pitch your equity investment.
Thankfully, several specialized equity crowdfunding platforms have stepped up to fill the gap. Here are some of the most popular choices:
Equity crowdfunding is a logical extension of already-existing crowdfunding technology. There might be more regulatory hurdles, but it’s still an innovative way to raise capital.
It’s also not for everybody. Review several funding options, and compare the costs and benefits for your business. But in the right situation, equity crowdfunding can turn your big concept into a reality.
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