Equity crowdfunding lets early stage companies raise investments from a ‘crowd’ of investors. In turn, investors get equity in startups that are not yet listed on the stock market. If the company does well, investors have the chance to earn big profits.
This emerging industry is great for entrepreneurs because it gives small innovative companies easier access to capital from non-accredited investors. They get the funds they need and have more freedom to pursue their vision.
Even though they lose out on some of the expertise that traditional, accredited investors can offer, top equity platforms provide tons of resources and have partnerships that benefit the startups that they work with.
Keep in mind that early stage businesses make for high risk and high reward investments. They should form part of a diversified investor portfolio to protect against illiquidity, loss of investment, and dilution.
When it comes to investing in businesses, there is never a guarantee. The truth is that most startups fail. To protect themselves, investors considering early stage businesses should focus on industries where they have experience and diversify with other investment types.
Most early-stage equity investments have historically been made by VCs and angel investors, who have experience with investing and business. Now, that privilege has been expanded to include both accredited and non-accredited investors to make for a more equitable market.
Equity Crowdfunding for Startups
For high-potential startups that need investors to get to the next level, equity crowdfunding is available in most places in the US and Europe. Even though it can be an expensive process, equity crowdfunding lets you raise investments in a whole new way and puts the power of the crowd behind you.
You Will Need:
- A plan or business model with information on your company, current traction, market validation, and how you intend to maximize your investment. To learn more about how to build a great equity crowdfunding campaign, visit this insightful article.
- To put together a Private Placement Memorandum (also referred to as an offering document); a legal document provided to investors when a company sells stocks or securities.
Types of Equity
Equity I: A type I raise uses Rule 506 of Regulation D. It allows a company to raise unlimited capital but prohibits advertising or general solicitation. These are private platforms that only allow self-identified accredited investors, who must go through a waiting period before investing. 35 other investors are allowed, but they must at least be considered ‘sophisticated investors’ who understand the risks involved.
Equity II: A type II raise uses Rule 506(c). This rule allows companies to raise unlimited capital with the use of advertising and general solicitation. In turn, the platform must take responsibility for verifying that their investors are accredited, “which could include reviewing documentation, such as W-2s, tax returns, bank and brokerage statements, credit reports and the like,” according to the SEC.
Equity III: A type III raise or Title III equity crowdfunding allows companies to raise a maximum of $1.07 million in a 12-month period. It is the only option that allows more unaccredited investors. Check out How to Raise Up to $1M Using Title III of the Jobs Act for more information on this option.
Regulation Crowdfunding: Regulation Crowdfunding allows for both accredited and non-accredited investors to participate in a funding round up to $5M. This is the type of offering on platforms like WeFunder and StartEngine. If you’re looking to raise more than $5M, you may want to consider Regulation A+.
Pros
- Access to capital and platform resources
- Faster growth
- More freedom than when only a few investors own more equity
- Popularity, attention from investors who will want to promote your company online and help you succeed
Cons
- These investors have less experience than Angels of VCs, who often offer mentorship and advice to companies that they invest in. Solve this by acquiring a great lead investor.
- It can be hard managing the expectations of investors you won’t meet in person, because generally equity crowdfunding keeps the platform as an intermediary. Solve this by being open to calls to discuss with larger prospective investors.
- If something goes wrong, you have more investors and more questions to answer. Be prepared do dedicate a lot of time to your campaign, especially during the launch phase.
- Equity crowdfunding can be a complicated process that required startups to find legal assistance. Or, you could work with an equity crowdfunding agency with expertise in this area to guide you.
- Preparations for this type of crowdfunding can cost anywhere from $6K to $20K, with additional costs including audited financials (if you’re raising over $500K).
Equity Crowdfunding for Investors
Investors get access to high-risk high-reward investments and can support startups with low minimum investments as low as $100, from the comfort of their homes! Since the passing of Title III crowdfunding, now even unaccredited investors can take part in equity investments online (with some restrictions, of course).
Investor requirements
Accredited investors:
- A net worth of $1 million USD excluding the value of your primary residence or an income over $200K for 2+ years. A combined of $300K is required for married couples.
Unaccredited investors:
- If an unaccredited investor’s income is less than $200K, they can invest $2K or no more than 5% of their net income per year.
Ways investors can earn returns
- Dividends: Money that is received based on the amount of equity an investor owns. Dividends rarely diminish the value of stock, they are simply payouts as a reward for financial support. Compared to traditional investing, communication and payouts are completed through the platform and not the startup itself.
- Trade sale: If a startup you have invested in is bought by another company, you will receive a payout based on the amount of equity you own.
- Public offering: If a company invested in becomes highly successful and is listed on a public stock exchange, shares can be sold at a predetermined price.
Pros
- Open and transparent process
- Easy way to diversify investments
- Earn returns
- Invest in innovative, early stage companies
Cons
- Less control than if you were one of the only investors
- Securities generally can’t be sold for at least one year
- High risk
Key Takeaways & Additional Resources
Equity crowdfunding is an incredible way to empower both startups and non-accredited investors alike to participate in a crowd-based funding model.
It’s an extremely exciting time to be an entrepreneur. Think that equity crowdfunding might be right for you? Book a coaching call with the founder of CrowdCrux Salvador Briggman — our expert team has brought equity campaigns across the industry to life, and we’re ready to go to work for you!
Not quite ready to build your team yet? No problem. We have some great educational resources for you to stay in touch:
- Subscribe to the once-weekly newsletter
- Check out the Crowdfunding Demystified Podcast
- Subscribe to the Youtube Channel
- Find the book: Equity Crowdfunding Explained
We hope that this article was helpful for you! CrowdCrux is here to help if you need us on your equity crowdfunding journey.
