Equity Crowdfunding 101

The concept of equity crowdfunding is still in evolution phase. While we’ve a long way to go, momentum is building and popularity isn’t likely to slow down anytime soon. Technologies especially internet has made it easier than ever and there are millions of investors in USA alone.

There are dozens of platforms and websites available that help entrepreneurs and investors to get what they want. Let’s start from the beginning.

Equity crowdfunding

What Is Equity Crowdfunding?

A company that is not on the stock market can ask people aka crowd to invest and the process is called equity crowdfunding. Investors get share in the company in return and as they have partial ownership in the company, they are entitled to get profits and losses. If the company does well and makes profit then everybody gets its share and vice versa. The rule of thumb here is you should never invest more than you can lose. In reality, most of the startups fail and in that case the company cannot pay back to the investors.

According to some studies, it usually takes 3-7 years for a complete failure or success for a business and success happens later than failure in most cases. There are multiple cases where an individual investor can get profit on his investment.

  • Company does well, makes profit and everyone gets share of that profit.
  • Company is sold for a lump sum and everybody gets share of that sum.
  • Company does extremely well and makes its way to stock exchange where investors can sell their shares.

Pros and Cons of Equity Crowdfunding

  • First of all, equity crowdfunding has made the whole concept of fundraising easier for everyone. Entrepreneurs don’t have to engage in the tedious process of fundraising but instead they can focus on the most important thing that is business itself.
  • As technologies have made it easier for entrepreneurs to access their investors even from a specific field or region, now complex and niche ideas get spotlight and get funded.
  • One of the biggest advantages of equity crowdfunding is everyone who has an interest in a particular field can invest. It means the whole concept of “rich get richer” has been changed.
  • The process of convincing investors is valuable as it allows entrepreneurs to test their ideas in reality. Equity crowdfunding not only lacks this but it also allows entrepreneurs to put less skin in the game that prevent them to get feedback from the investors.
  • As everyone can invest, investors do not usually get enough data and information to make a smart decision and they also ignore the risks associated with equity crowdfunding.
  • There are tons of crazy ideas waiting to be funded and the market is pretty crowded with such ideas. This kind of ideas raises the rate of failure that obviously put significantly negative impact on the reputation of equity crowdfunding itself.

Crowdfunding - equity vs. donation

What is the difference between equity crowdfunding and donation crowdfunding?

There are two major differences between equity crowdfunding and donation crowdfunding.

In donation crowdfunding, donors may or may not get something in return of their donations but in equity crowdfunding investors get shares in return and they are entitled to collect profit or loss depending on how well company does. Additionally, equity crowdfunding must follow the rules and regulations of the specific governing body in their region. In USA, SEC is responsible for such investments and businesses have to follow SEC rules and regulations regarding equity crowdfunding.

How to choose the target amount?

It is very important to determine the target amount smartly because if you fail to raise that specific target amount, you collect nothing at all. Let’s see all possible scenarios with the help of an example.

Suppose you are going to raise $200,000 for a new business and you came up with that amount by analyzing business needs. You set the deadline of 01-01-2016 to raise that money and as of 01-11-2015 the business has been funded and it collects $200,000.

In second scenario, everything remains the same but your business raises only $160,000 till the deadline but as the business failed to collect the target amount, it collects nothing and the amount will go back to investors.

In third scenario, you set the target amount $130,000 and the deadline remains the same. Your business raises $150,000 before the deadline and the business decides to fundraise additional $70,000 but it only raises $30,000 till the actual deadline. Now the interesting this is business will collect all $160,000 in that case.