Equity Crowdfunding: What Is It & How Does It Work? (2023)

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As a small business owner, attracting traditional investors to help fund your startup can be challenging. For instance, less than 1% of startups receive funding from angel investors and only .05% of startups benefit from venture capital, according to the business crowdfunding platform Fundable.

On a positive note, you may be able to leverage shares of business equity in exchange for capital through a strategy known as equity crowdfunding. Equity crowdfunding isn’t the right approach for every entrepreneur. But if you’re interested in debt-free ways to fund your business, it might be a good fit for you.

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What Is Equity Crowdfunding?

Equity crowdfunding is a unique way to raise capital for your business without taking on new debt. It’s a form of fundraising that attempts to attract investors who are willing to contribute funds toward your business goals in return for a financial stake in the company.

In general, equity crowdfunding is a business funding model that involves collecting smaller sums of money from a larger number of private investors. Would-be investors may be able to get involved for as little as $100. This approach differs from trying to attract sizable investments from venture capital firms or angel investors—a business capital strategy that’s out of reach for many startups and established small businesses alike.

How Equity Crowdfunding Works

Equity crowdfunding is also called regulation crowdfunding because it is regulated by the federal government. Even though you’re not selling shares on a stock exchange, your business is still offering equity to investors in exchange for capital. As a result, the process entails more rules than you would encounter with a simple online fundraising campaign like GoFundMe or Kickstarter.

If you want to use equity crowdfunding to raise capital for your business, following the rules is critical. Otherwise, you could face some unpleasant consequences. For example, failure to follow the rules might force you to refund any investments you receive. In some cases, the U.S. Securities and Exchange Commission (SEC) might even freeze your business’ ability to offer shares to investors for a period of time.

Below are a few of the steps you’ll need to complete in order to sell business shares through an online crowdfunding platform.

  • Work with an SEC-registered broker-dealer (aka a funding portal) to process any investment transactions
  • Accept no more than $5 million per year in crowdfunding investments
  • Follow federal limitations on the amount you accept from individual, nonaccredited investors in a 12-month period (amounts vary based on income)
  • Make any necessary financial disclosures public, based on the amount of funding your business raises

Beyond the legal concerns, you’ll also need to design a compelling campaign if you hope to energize the public and convince others to invest in your business. A good equity crowdfunding campaign should communicate key details to potential investors, including:

(Video) What is equity crowdfunding and how does it work?

  • The amount of money you need to raise
  • How you plan to use the funds
  • Your target customers
  • Your profit margin
  • What makes your business different from competitors
  • Why investors should back you

Equity Crowdfunding vs. Other Types of Crowdfunding

With equity crowdfunding, you can attempt to raise funds from private investors and offer unlisted shares in your company in return. This model differs from offering shares of a company on an official stock exchange. Nonetheless, you will still need to register with the SEC to participate in this form of equity-based fundraising.

Of course, offering shares of your business to would-be investors isn’t the only form of crowdfunding that exists. There are other ways to reward and entice investors through crowdfunding platforms that don’t involve giving up any pieces of your business.

Rewards Crowdfunding

Rewards-based crowdfunding is another fundraising option that may appeal to entrepreneurs who don’t want to take on debt that needs to be repaid. This form of crowdfunding seeks contributions from financial backers and offers some type of benefit as a trade-off.

The rewards you offer to contributors can be as simple or complex as you like. For example, an author might offer copies of their book before it’s published or a massage therapist might reward donations with gift certificates for future services.

Keep in mind that it may take some trial and error to find rewards that motivate people to support your vision. Some entrepreneurs offer different types of rewards according to the amount a supporter contributes as well.

Debt Crowdfunding

Debt crowdfunding is a cross between traditional crowdfunding and a small business loan. With this type of business financing, you’re taking out a loan from a crowd instead of a financial institution or online lender.

When you use debt crowdfunding to finance your business, you’ll have a loan agreement just as you would with a lender. You’ll repay the money you borrow, plus interest, over an agreed-upon number of months. However, you do not have to offer shares of your business to secure this type of funding.

Donor Crowdfunding

Donor crowdfunding, also called donation-based crowdfunding, is a process that involves people contributing money to a cause without expecting anything in return. For example, friends and family members might donate money to support a loved one’s dream of opening a new business. Charities and nonprofit organizations may also use this form of crowdfunding to solicit donations from supporters who believe in the cause they represent.

There are many online platforms available for donation-based crowdfunding campaigns. A few examples include GoFundMe, CrowdRise and Fundly.

Equity Crowdfunding Sites

Because the SEC regulates equity crowdfunding, you must use an SEC-registered funding platform if you wish to solicit funds from the public in exchange for equity in your company.

Despite the regulatory hurdles, there are a number of equity crowdfunding platforms available. As a small business owner, this is good news. You can review several sites to find the option that is the best fit for your situation.

Below are nine equity crowdfunding sites to consider.

Pros and Cons of Equity Crowdfunding

As with any form of business funding, there are positives and negatives to consider where equity crowdfunding is concerned.

Pros of Equity Crowdfunding

  • Equity crowdfunding offers a business funding solution if you cannot qualify for sufficient financing elsewhere due to credit issues, revenue limitations or other lender requirements needed to qualify for a business loan.
  • There’s no debt to repay.
  • By working with a larger number of investors, you might be able to raise more money.
  • As a business owner, you can structure crowdfunding campaigns so that you retain the majority of your business equity and only offer a small portion to investors.
  • You may be able to attract nontraditional investors to support your business goals.
  • You can gain visibility and build excitement before you even launch your new business.

Cons of Equity Crowdfunding

  • You give up a portion of your company’s future profits in exchange for cash now.
  • Per SEC guidelines, you must disclose your company’s financial details to potential investors, and that means almost anyone can access that information.
  • There’s a risk of public failure if your equity crowdfunding campaign isn’t successful.
  • Equity crowdfunding platforms charge fees and may keep a percentage of the funds your business raises (often 5-15%) in the form of commission.
  • Traditional investors likely won’t be interested because it can be tough to resell the shares of smaller companies without taking a financial loss.
  • Crowdfunding campaigns may be time-consuming, and there’s no guarantee you’ll generate enough funding to make the time commitment worthwhile.

Alternatives to Equity Crowdfunding

Equity crowdfunding can be a great way to raise capital for some entrepreneurs. However for some businesses, it isn’t the right approach, and for others, it may only be one piece of the overall funding puzzle. If you need an alternative to equity crowdfunding, or a way to supplement the funding you raise, one of the three options below might be worth considering.

Business Loans

Small business loans are a more traditional way to generate the capital you need to start or grow your business. There are many options where small business loans are concerned as well—from affordable U.S. Small Business Administration (SBA) loans to online business loans that may work well for new businesses and others who have trouble qualifying for traditional financing.

Business Credit Cards

Business credit cards offer a flexible way to borrow money for your startup or existing business. If you have good personal credit, there are numerous business credit card options that may be easier to qualify for even if your business is new.

Investors

If you have a promising startup business, you may be able to attract funding from venture capital firms or angel investors. While trying to work with accredited investors isn’t the right move for every new business, if you’re successful you might be able to get enough funding to take your startup to the next level.

FAQs

What does equity mean in crowdfunding? ›

Equity crowdfunding is the process whereby people (i.e. the 'crowd') invest in an early-stage unlisted company (a company that is not listed on a stock market) in exchange for shares in that company. A shareholder has partial ownership of a company and stands to profit should the company do well.

Do you have to pay back money from crowdfunding? ›

Interest and repayment free investment. If you choose a payment or service-based campaign, you will get funding from the public investors without any obligation to pay back their contributions. If you offer rewards, of course those must be honoured but crowdfunding can clearly offer a cheaper route to funding cashflow.

What is the benefit of equity crowdfunding? ›

Essentially, equity crowdfunding offers the company's securities to a number of potential investors in exchange for financing. Each investor is entitled to a stake in the company proportional to their investment.

What is the difference between crowdfunding and equity crowdfunding? ›

Crowdfunding refers to raising money from the public (i.e., the "crowd"), through online forums, social media, and crowdfunding websites. Equity crowdfunding involves exchanging relatively small amounts of cash allowing investors to own a proportionate slice of equity in the business.

Can you make money from equity crowdfunding? ›

Cons. Although equity investing is a valuable financing option for some, it's not for every company. According to a report published by Startups.com, the average success rate of a crowdfunding campaign is 50%. So, while it works for some businesses, there is still a high rate of failure.

What are the four types of crowdfunding? ›

Here's what you should know about crowdfunding. Crowdfunding is when a “crowd” funds a project or business, rather than one or two major investors. There are four different types of crowdfunding: rewards, donation, debt and equity.

Is it good to invest in crowdfunding? ›

In recent years, one of the most exciting developments in the world of investing has been the development of investment crowdfunding. With this new type of investing, there is a chance you could make money from startups, expanding businesses, and even real estate in a way that hasn't been possible before.

How do crowdfunding investors get paid? ›

You get returns from shares in case of business acquisitions and IPOs, and dividends from annual profits if a business succeeds; Debt-based investments are typically done through notes, bonds and a portion of loans. Interests start accruing from the date of initial investment through the date that the loan is repaid.

Should you invest in equity crowdfunding? ›

What are the risks? Equity crowdfunding is considered a high-risk investment. That's because start-ups and less established businesses have a higher failure rate. While crowdfunding platforms are required to run checks to a "reasonable" standard if fraud or insolvency occurs, you may not be able to get your money back.

How much equity should I give away in crowdfunding? ›

A general rule of thumb is giving away between 10-20% equity during a seed round. This may likely be to angel investors who are willing to put in checks right at the origin of a company during the early stages.

Is crowdfunding a good way to raise money? ›

Crowdfunding can offer entrepreneurs a way to start raising money needed to start a business, speed up the product development process, or fund business growth with access to a network of potential investors and customers.

Do you get dividends from crowdfunding? ›

Equity Crowdfunding is where multiple people commit to investing in an unlisted company or project in exchange for equity in that project or company. In other words, money is exchanged for shares or a small stake in a business or project, meaning investors get their returns through profits, or dividends.

How do I start crowdfunding equity? ›

Here's a general overview of how the process works in the U.S. and in Canada:
  1. Sign up for a registered equity crowdfunding platform. ...
  2. Make your pitch. ...
  3. Provide essential information. ...
  4. Funds are released to you. ...
  5. Shares are released to your investors. ...
  6. Pay platform fees. ...
  7. Investors continue to be advocates for your business.
1 Jul 2021

Why is crowdfunding a good idea? ›

Eight advantages of crowdfunding: it can be a fast way to raise finance with no upfront fees. pitching a project or business through the online platform can be a valuable form of marketing and result in media attention. sharing your idea, you can often get feedback and expert guidance on how to improve it.

How long does it take to get money from crowdfunding? ›

For successful projects, the funds will be sent 14 days after the project's deadline, to the bank account originally linked to the project. Depending on your financial institution, it could take an additional 3-14 business days from this point for the funds to appear in your account.

How much do you need to invest in crowdfunding? ›

Investment amounts range widely, starting as little as $100. Investors often can track their investments via a dashboard online. In addition, you'll receive an annual report and, in some cases, quarterly updates on the company.

How much money can you make investing in crowdfunding? ›

Companies can raise up to $1.07M per year through Regulation Crowdfunding. And investors can invest in startups they love, or founders who catch their eye. Why is this a potential opportunity for our readers to build wealth?

What percentage do crowdfunding sites take? ›

A platform fee is when a crowdfunding site takes a percentage of all the money your raise through your fundraiser. Typically, crowdfunding platform fees range from 0% to 12%.

Is crowdfunding a donation or investment? ›

Crowdfunding is a way to raise funds for a specific cause or project by asking a large number of people to donate money, usually in small amounts, and usually during a relatively short period of time, such as a few months.

Does crowdfunding really work? ›

From a company's perspective, crowdfunding can be a great way to raise funds quickly. While it requires a lot of work, promotion, and attention to have a successful crowdfunding campaign, over 90% of startups on Republic have raised successfully.

What is the most popular type of crowdfunding? ›

Rewards crowdfunding is the best-known type of crowdfunding—thanks to popular rewards-based crowdfunding platforms like Kickstarter. With the rewards crowdfunding model, a business offers investors (better known as “backers”) rewards in exchange for contributing to that business' product or project.

What is an example of crowdfunding? ›

Crowdfunding sites generate revenue from a percentage of the funds raised. The SEC regulates equity-based crowdfunding ventures in the United States. Kickstarter, Indiegogo, and GoFundMe are among the most popular crowdfunding platforms.

How do you collect crowdfunding? ›

How to Start A Crowdfunding Campaign?
  1. Start your fundraiser. Click on Start A Fundraiser for free. ...
  2. Share your fundraiser. Share the fundraiser with your friends and family. ...
  3. Withdraw Funds. Funds raised can be withdrawn without any hassle directly to your bank account.

Can you crowdfund to buy a house? ›

It's popular with investors of all ages and interests. Crowdfunding allows you to pool your money online with others to purchase property (or a share of property) as a group, and offers a compelling way to diversify your assets by tapping into real estate investments.

What is the return on crowdfunding? ›

Equity crowdfunding investments on reputable platforms, with terms of 5 or more years, have an average IRR of over 17%. Shorter-term real estate crowdfunding investments have average returns in 10% to 12% range.

Are crowdfunding sites safe? ›

With its safe, secure, and transparent features, at present donation-based crowdfunding is one of the most viable options for patients to raise funds for their SMA treatment.

Who can invest in crowdfunding? ›

Anyone can invest in a Regulation Crowdfunding offering. Because of the risks involved with this type of investing, however, you are limited in how much you can invest during any 12-month period in these transactions. The limitation on how much you can invest depends on your net worth and annual income.

Is crowdfunding a debt or equity? ›

There are two types of investment crowdfunding models – p2p lending and crowd investing. The main distinction lies in the models' core. P2P loans are debt-based while the heart of investment crowdfunding is equity.

Does crowdfunding have interest? ›

The crowdfunding or P2P platform sets the interest rate and risk level, while each investor or lender using the service sets the amount they want to invest and the return they want from it. Lenders and businesses are then matched, with the business repaying lenders through monthly interest payments.

Is equity crowdfunding legal? ›

Is equity crowdfunding legal? Yes. The U.S. Securities and Exchange Commission allows private companies to legally raise up to $5 million in a 12-month period through equity crowdfunding. You can raise funds in increments.

What are the different types of equity crowdfunding? ›

There are essentially three kinds of crowdfunding: reward-based, donation-based and equity-based. Is when you contribute money and get a reward or product in return.

Can you make a return on crowdfunding? ›

Even if the business doesn't fail, any money put into equity crowdfunding is unlikely to pay off in the short term. You will only get your money (plus any potential return) back after the company you invested in either sells to another corporation, or lists on a stock exchange.

Do investors get paid monthly? ›

It is far more common for dividends to be paid quarterly or annually, but some stocks and other types of investments pay dividends monthly to their shareholders. Only about 50 public companies pay dividends monthly out of some 3,000 that pay dividends on a regular basis.

What is a good equity percentage? ›

Employers typically reserve 13% to 20% of equity for their employee option pool. Every company has different cash and talent requirements, which explains the large percentage range.

How do you calculate equity offered? ›

Equity offer calculation. Equity value is the value that can be attributed to a company's shareholders because they provided the stock. The current share price is multiplied by the total number of shares outstanding to arrive at the equity value.

What is the best platform to raise money? ›

9 Best Online Fundraising Platforms
  1. Donorbox. Donorbox is a powerful all-in-one fundraising platform with a quick setup process and plenty of easy-to-use features. ...
  2. GoFundMe. GoFundMe is a well-known online fundraising platform. ...
  3. OneCause. ...
  4. Handbid. ...
  5. Bonfire. ...
  6. Fundly. ...
  7. Soapbox Engage. ...
  8. 99Pledges.
14 Sept 2022

Can I use crowdfunding to start a business? ›

Money doesn't always stretch as far as you think it will, and loans to start your business have staunch prerequisites like credit score minimums and required collateral. That's why crowdfunding for business is popular among aspiring and even experienced entrepreneurs.

What are the factors to consider before investing in equity crowdfunding? ›

Here are four tips to investing in a company through Equity Crowdfunding:
  • Scope the right platform.
  • Be aware of the risks.
  • Valuing the company.
  • Diversification.

What happens if the start up I invest in fails? ›

When startups fail, investors will likely lose most, if not all, of their principal—regardless if they invested at early-stage or later-stage. Losses from money-losing early-stage deals are more extreme than losses from money-losing later-stage deals.

Who regulates crowdfunding? ›

Regulated crowdfunding is also an equity-based crowdfunding platform and it provides investors with a financial return, but the difference is the U.S. Securities and Exchange Commission (SEC) regulates it.

Do you need a business plan for crowdfunding? ›

Finally, you need to include a plan for how you will promote your campaign. Crowdfunding campaigns do not thrive unless their visibility is high. You need people to donate and back your business to achieve your goals.

Does crowdfunding have a future? ›

Crowdfunding connects startups and nonprofits who need funds for their ideas with individuals who have money and believe in them and the industry is projected to grow to over $300 billion by 2025.

Is crowdfunding long or short term? ›

Crowdfunding is a short-term source of finance. To better explain it let us consider the following key ideas in short-term sources of finance. Short term sources of finance allow funding for not more than 1 year. Crowdfunding too takes place over a small period of time.

What do we mean by equity? ›

The term “equity” refers to fairness and justice and is distinguished from equality: Whereas equality means providing the same to all, equity means recognizing that we do not all start from the same place and must acknowledge and make adjustments to imbalances.

What's mean equity? ›

noun, plural eq·ui·ties. the quality of being fair or impartial; fairness; impartiality: the equity of Solomon. something that is fair and just: The concepts and principles of health equities and inequities are important to society as a whole.

What is equity fundraising? ›

Equity investment is the process in which shares in a company are sold, in order to raise money (often to fund its next stage of growth). Equity investors will buy shares for a set share price, in return for a stake in the company, voting rights and a share of future profits.

Is crowdfunding a debt or equity? ›

There are two types of investment crowdfunding models – p2p lending and crowd investing. The main distinction lies in the models' core. P2P loans are debt-based while the heart of investment crowdfunding is equity.

What are some examples of equity? ›

Equity can be calculated by subtracting liabilities from assets and can be applied to a single asset, such as real estate property, or to a business. For example, if someone owns a house worth $400,000 and owes $300,000 on the mortgage, the difference of $100,000 is equity.

Are equities high risk? ›

Equities are generally considered the riskiest class of assets. Dividends aside, they offer no guarantees, and investors' money is subject to the successes and failures of private businesses in a fiercely competitive marketplace. Equity investing involves buying stock in a private company or group of companies.

Is equity real money? ›

The basics of equity

In simplest terms, equity is money — your money — inside another asset like a car, a home or a business. Equity is tied to ownership. No matter the type of asset, equity represents the value the owner would keep after the asset was sold and all liabilities were covered.

How is equity calculated? ›

You can figure out how much equity you have in your home by subtracting the amount you owe on all loans secured by your house from its appraised value.

How do you invest in equity? ›

How can I begin investing in equities? You can open a demat account with a broker firm to invest in the stock market. Or you can approach a financial advisor who will guide you on what to buy, and then purchase the funds for you. Another option is to equity funds from a fund house directly.

How do equity investors get paid back? ›

More commonly investors will be paid back in relation to their equity in the company, or the amount of the business that they own based on their investment. This can be repaid strictly based on the amount that they own, or it can be done by what is referred to as preferred payments.

What are the disadvantages of equity financing? ›

Disadvantages of equity financing
  • Shared ownership – in return for investment funds, you will have to give up some control of your business. ...
  • Personal relationships – accepting investment funds from family or friends can affect personal relationships if your business fails.
20 Dec 2021

How do equity investors get paid? ›

Dividends are a form of cash compensation for equity investors. They represent the portion of the company's earnings that are passed on to the shareholders, usually on either a monthly or quarterly basis. Dividend income is similar to interest income in that it is usually paid at a stated rate for a set length of time.

Is it worth investing in crowdfunding? ›

Like alternative investments, it is risky business, which involves a lot of homework, market insight and intuition on your part. You'll need to find the projects, research them and track their development yourself. But if you're willing to take the risk and put in the hard work, it can be a rewarding route.

Do you get dividends from crowdfunding? ›

Equity Crowdfunding is where multiple people commit to investing in an unlisted company or project in exchange for equity in that project or company. In other words, money is exchanged for shares or a small stake in a business or project, meaning investors get their returns through profits, or dividends.

What do investors get from crowdfunding? ›

It is very similar to traditional borrowing from a bank, except that you borrow from lots of investors. Sale of a stake in a business to a number of investors in return for investment. The idea is similar to how common stock is bought or sold on a stock exchange, or to a venture capital.

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