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Equity crowdfunding has helped launch many businesses from mediocrity to notoriety. With it, businesses have gained the needed funds to go to the next level by allowing people to invest in their business in exchange for equity. But if you’re thinking about pursuing equity crowdfunding, you may want to think twice — especially if you need the funds fast.Here’s the full rundown on how equity crowdfunding works, potential sources of equity funding and the pros and cons of this funding approach to consider.
What Is Equity Crowdfunding?Equity crowdfunding is when an unlisted company that is not on the stock market allows investors (both accredited and unaccredited) to purchase equity. Should the company do well, the investor would make a profit. However, if it were to fail and go out of business, the investor would lose all of their investment. Crowd equity funding got its start in the U.S. when President Obama signed the Jumpstart Our Business Startups Act in 2012. Since then, it has played a key role in funding for startups.There are two types of equity crowdfunding: accredited crowdfunding and open-access regulated crowdfunding. These are not to be confused with reward-based crowdfunding or loan crowdfunding. With reward-based crowdfunding you don’t give up any equity, but instead offer rewards for capital received. With loan crowdfunding, you borrow from the “crowd” instead of a traditional lender. The debt must be repaid but often also comes with rewards.Equity crowdfunding differs from all other forms of small business crowdfunding because with it you are actually selling a percentage of your business.
Accredited CrowdfundingAccredited crowdfunding is when a company raises money from accredited investors who have a high net worth, which means they either have a net worth minimum of $1 million, or they make at least $200,000 a year ($300,000 if filing jointly).
Open-Access Regulated CrowdfundingOpen-access crowdfunding allows anyone to invest in a company in exchange for equity. Both accredited and nonaccredited investors alike may invest in a company running a campaign through an open-access regulated crowdfunding site.
What Type of Business Can Use Equity Crowdfunding?Any type of business can take advantage of equity crowdfunding — it isn’t limited to new startups or certain types of businesses. Whether you have a product you need help funding, or you’re a veteran restaurant owner, you can create an equity crowdfunding campaign. Businesses of all kinds have found success with equity crowdfunding.
Who Can Invest In Your Business?Who can invest in your business depends on what site you register with. There are many sources of equity funding. Some sites only allow private equity funding, whereas others allow anyone to take part.With accredited investors, you’ll likely receive much greater funds at a single time, but those investors may want a say in how you run your business. With public investors, you’ll have so many investors that no single person will hold a majority.
Where Can You Find Potential Investors?Online platforms are often the best choice for finding potential investors. Some sites that you could use include:
Each site charges different fees, and some only work with certain types of businesses. While it’s certainly legal to run a campaign on multiple sites, it can be difficult to manage. Each campaign can require hundreds of hours of prep work and promotion. To be successful, your best bet is to focus all of your energy on one campaign at a time.
What Are the Pros and Cons?All major financial decisions require you to weigh the pros and cons, and equity crowdfunding is no different. Here’s what you should consider before jumping in.
|Pros of Equity Crowdfunding||Cons of Equity Crowdfunding|
|Huge amount of investors||Open the door to copycats|
|Low fees||High failure rate|
|Remain in control of your company||Takes a lot of time to create a campaign and promote it|
|Get feedback on your business and product||Could be giving up greater profits for yourself down the line|
|Could get promotion on social media from investors who believe in your business|
|Get proof of concept|
Pros of Equity CrowdfundingEquity crowdfunding can open the door to a huge pool of investors — accredited or not. Because you have access to such a large amount of people, if they take an interest in your company it’s akin to getting market validation. Though your company may see hard times, you will at least know there is a need and an interest for what you have to offer. Furthermore, many successful crowdfunding campaigns end up getting promoted by the investors themselves, creating a snowball effect of buzz and interest. For many companies, crowdfunding has been the reason behind their success.While you may end up selling a majority of your company, no one person is a majority shareholder after an open access crowdfunding campaign. This enables you to still make the vital decisions needed to take your company where it needs to go without needing to consult shareholders. There are fees involved with crowdfunding, but the amount isn’t much. Depending on which platform you use, the fees are normally 3% to 6% of the amount you raise. Those amounts are deducted when the campaign closes, so it’s nothing you have to pay out of pocket. In the end, crowdfunding can be a cost effective way to raise money and awareness without accruing any debt.
Cons of Equity CrowdfundingNot every company that undergoes the crowdfunding route is successful. In fact, only 23.4% of companies reach their crowdfunding goal, according to data published by The Crowdfunding Center. When you take into account how much work it takes to create a successful crowdfunding campaign, this can be a lot of wasted time, money and effort, all of which could have been better spent on your business itself. Crowdfunding campaigns don’t just generate money after they’ve been created. It takes a lot of promotion and social networking to make it successful.The other dark side of equity crowdfunding is that you’re putting your business at risk of being copied. Until you’ve actually patented any unique products you’re selling, another business might come along and replicate everything you’ve done. Plus, if they understand the manufacturing process better than you do, it’s even possible they could get their product on the market before you.Lastly, when you sell equity, you are reducing the amount of profit you yourself will make one day if your business takes off. Though the money needed to start a business can be great, there are other alternatives on the market that don’t involve you giving up any part of your business.
Alternative Funding Options for StartupsEquity crowdfunding is possible, but the odds of success aren’t great. Smart business owners pursue multiple paths to accruing capital in addition to crowdfunding, such as startup business loans.Before you pursue equity crowdfunding, ask yourself why you need the money. Small business funding is more diverse than many people realize. In fact, there are many types of small business loans that you can take advantage of to propel your business, such as equipment loans or SBA loans. Though you’ll pay interest on any amount you borrow, that interest could very well be dwarfed by the profits you’d lose if you sold too much of your business to outside investors.If you’re interested in getting small business funding, you can shop for multiple loan products on Lantern by SoFi with only one application.
Photo credit: iStock/jacoblund
About the Author
Lauren WardLauren Ward is a personal finance expert with nearly a decade of experience writing online content. Her work has appeared on websites such as MSN, Time, and Bankrate. Lauren writes on a variety of personal finance topics for SoFi, including credit and banking.