Equity crowdfunding occurs when private companies raise capital from the public through the sale of securities. These financial instruments can include shares, convertible notes, revenue shares, debts, and tokens. Today, equity crowdfunding is an important part of the global financial markets because it provides SMEs a more cost-effective strategy to raise capital versus traditional IPOs.
Interestingly, equity crowdfunding is a relatively new investment tool. President Obama enabled equity crowdfunding back in 2011 when he signed the JOBS Act, but it wasn’t until the last five years that the practice became popular. One of the reasons it took so long for equity crowdfunding to gain popularity is that it took until May 2016 for key regulations to come into effect.
How Does Equity Crowdfunding Work?
Equity crowdfunding works very similar in function to the popular crowdfunding website, Kickstarter. Basically, investors seek out private firms that meet their criteria. Once a suitable investment is found, an investor visits a funding portal website that gives them access to the opportunity and its details. Here, investors are able to explore different equity crowdfunding investment opportunities for the firm.
Key Differences from Kickstarter
Unlike Kickstarter, investors don’t receive early access to a product or service for their contributions. Instead, investors in equity crowdfunding campaigns seek to make a profit for their participation. In most instances, investors receive shares, rights, and other benefits for their investment.
Different than Stocks
It’s important to understand why equity crowdfunding provides entrepreneurs with different opportunities compared to trading shares on the stock markets. For one, equity crowdfunding firms are private companies and in most instances, startups. In the past, IPOs were the only form of crowdfunding a company could engage in. This practice restricted access to the markets for SMEs for many entrepreneurs.
Many companies simply lacked the funding to cover the huge financial and legal requirements needed to host an Initial Public Offering (IPO). In turn, only the largest firms could generate the funding needed to launch an IPO successfully. Consequently, studies show that IPOs continue to see a decline in use as more affordable options are now available.
Additionally, these practices left investors out of the loop as well. Many IPOs are only open to accredited investors. Accredited investors make at least $200,000 per year, or can show over $1 million in assets. Notably, your assets must exclude your home. As you could imagine, this system left your average investors shut out from the most lucrative investments.
Thanks to the rise of equity crowdfunding platforms, now everyone has access to these valuable opportunities. Prior to the rise in internet crowdfunding platforms, investors were mostly VC and angel investors. These were the only individuals that had the funding to both make a major investment and wait for the mandatory lockup period before receiving returns.
No Lockup Period
Notably, investors that participated in private equity crowdfunding before the 2016 regulations implemented had to wait to access their funds for a designated lockup period, similarly to IPOs. During this time, investors were unable to trade or cash out their investment. This lock-up left investors exposed to major losses. Thankfully, the new regulations opened the door for secondary trading of these financial instruments via Alternative Trading Systems (ATS). In this way, ATS provide much-needed liquidity to the market.
Benefits of Equity Crowdfunding
Aside from the obvious financial gains equity crowdfunding brings to the table, there are plenty of other reasons why a firm would follow this strategy. For one, businesses gain strong brand support from investors. Each investor in your firm acts as a brand ambassador for your company. Since these investors need you to succeed in order to make a profit, they will often diligently spread the word about your business and products.
There are also managerial aspects that make equity crowdfunding a more attractive option to consider. For one, an entrepreneur raising capital via equity crowdfunding has total control over the offering. The entrepreneur can chose the valuation, how much capital to raise, what to sell, how much to sell, and at what price. They can even specify a minimum funding goal to ensure the firm receives enough backing to proceed with its plans. In comparison, a company engaged in an IPO is beholden to its investor’s terms.
Keep it Reasonable
Of course, with all of this flexibility also comes new responsibilities. Only companies that can produce a reasonable valuation and terms see success in the equity crowdfunding space. Investors are looking for great opportunities with minimal risk.
Crowdfunding Regulations and Rules
There are some key requirements a company must first meet prior to launching an equity crowdfunding campaign. First, the firm has to be privately owned and not listed on any stock exchange globally. Secondly, all investors must prove their identity and that they are over the age of 18. Additionally, many equity crowdfunding campaigns include limits on how much capital an individual can invest based on their income and net worth.
Currently, each region has its own equity crowdfunding regulations in place. In the US, there are two main types of equity crowdfunding campaigns – Regulation Crowdfunding and Regulation A+. Both provide SMEs with a more efficient and less-costly alternative than hosting an IPO.
Regulation Crowdfunding allows companies to raise up to $1.07M annually. Currently, these companies can start raising capital for free after filing a Form C with the SEC. Importantly, if the firm seeks to raise more than $107,000, an independent CPA must review the company’s financials for the past two fiscal years.
Regulation A+ companies can raise up to $50M annually. Companies that seek to go this route must first undergo a financial audit for the past two fiscal years. Additionally, they must hire a securities attorney in order to create a Form 1-A. This form must get submitted to the SEC for qualification. Unfortunately, the qualification can take some time to complete. On average it takes 3-5 months at the minimum.
Importantly, companies are unable to raise funds during this time frame, but, they are able to collect investor information to better rate investor excitement levels. This practice is called “testing the waters” and it’s a powerful tool that enables firms to receive valuable market feedback prior to the official launch of their crowdfunding strategy.
What is Real Estate Crowdfunding?
Importantly, equity crowdfunding platforms have given way to a new way to invest in commercial real estate, real estate crowdfunding. Real estate crowdfunding involves a group of investors who each contribute money to a specific real estate deal. Importantly, this strategy lowers the entry bar for investors and provides real estate owners access to global capital. As such, the practice has exploded in popularity in recent years, especially since the introduction of blockchain technology.
How Real Estate Crowdfunding Works
In most real estate crowdfunding transactions, a developer or experienced real estate professional identifies an investment opportunity. This real estate professional may decide that they don’t want to fund the entire project. This decision could be because of a lack of funds or a desire to utilize other peoples funding to complete the project. Either way, the professional would then open the opportunity to investors.
There are three key players in any crowdfunded real estate investment. All crowdfunding real estate ventures begin with the sponsor. The sponsor is the individual or company that identifies, plans, and oversees the investment. Their responsibilities can include purchasing the asset, organizing needed work, arranging the financing, and handling the eventual sale of the property. For their labors, sponsors require a certain share of any profits they earn.
The second key component of any crowdfunding real estate transaction is the platform. Think of these platforms as the middleman between investors and sponsors. Their primary purpose is to link investors and sponsors. As such, they are also responsible for collecting funds from investors. Along with this task comes a host of other responsibilities such as verifying standards, guarantying that investors meet the requirements for investment, advertising deals to potential investors, and dealing with regulatory issues.
The investor is the final piece of the puzzle. An investor trades their funds for some form of income distributions from the profit the property generates. Additionally, they will receive a proportional payout from any eventual profitable sale of the property. In some instances, certain voting rights are a part of the deal. for example, these rights could include whether or not to accept an offer on the property.
Advantages of Crowdfunded Real Estate
There are some major advantages realized through real estate crowdfunding strategies. For one, there is a much higher potential for increased returns when compared to other major asset classes. Additionally, investors gain access to assets that may otherwise be inaccessible to them. A such, crowdfunding real estate is an awesome way to diversify your portfolio.
Importantly, equity crowdfunded real estate platforms usually focus on a specific property. This is opposed to real estate investment trusts (REITs) that can involve billions in properties. Consequently, crowdfunded real estate investors can enjoy the benefits of single-property investments without the financial exposure of actually becoming a landlord. In the end, these investors get the best of both worlds. They receive an income as well as a targeted lump-sum return without major risk exposure.
Top Crowdfunding Websites
Now that you have a firm understanding of what equity crowdfunding is, and how it benefits the entire market, you are ready to explore some of the top platforms providing these services. Importantly, many of these companies now utilize blockchain technology to reduce the overall costs needed to manage and implement their equity crowdfunding concepts.
SeedInvest was founded in 2012 and launched in 2013. The platform is unique in that it has a stricter acceptance policy. Only handpicked start-ups in upcoming future tech industries gain access to this powerful tool. Specifically, a firm needs to deal with blockchain, augmented reality, 3d printing, artificial intelligence, robotics, or space technologies. Importantly, SeedInvest‘s pickiness has paid off as the firm has successfully helped raise money for over 150 companies to date.
The Austin-based crowdfunding platform Microventures entered the market in 2009. The company focuses solely on late-stage companies as part of its niche market. Late Stage companies are firms that are expected to go public within the next couple of years. As such, these companies are usually well-known players in the sector. For example, you can invest in SpaceX, Lyft, Pinterest, and Robinhood via Microventures. Importantly, the company only allows accredited investors to join because each investment ranges from the $5000 to $50000 range.
WeFunder entered the market in 2011. This San-Francisco-based firm originated from the Y Combinator accelerator program. Importantly, the Y Combinator helped launch some of the most successful ventures to date. These ventures include companies such as Coinbase and Airbnb. Also, due to the fact that WeFunder is one of the oldest platforms in the market, the company participated in writing the JOBS Act with the Obama administration.
Fundable entered the market on May 22, 2012, as a rewards-based investment vehicle. Investors would pledge funds in exchange for pre-orders. In 2012, the firm switched over to a true equity crowdfunding strategy. Notably, Fundable’s equity crowdfunding tools are only available to accredited investors at this time.
StartEngine entered the market in 2014 with the goal to provide more flexibility for entrepreneurs in the space. Unlike most of the competition, StartEngine is laxer on what type of firms and investors can utilize its services. As such, investors need to use a little more due diligence when investing on the platform. Importantly, StartEngine showcased its abilities after successfully raising $10M via a self-hosted STO in 2018.
Equity Crowdfunding – The Future is Today
Today, equity crowdfunding is an essential tool used by startups to access capital markets. Consequently, you can expect to see this style of crowdfunding increase in adoption due to its lower costs and more efficient business model. Thankfully, blockchain technology continues to streamline the entire equity crowdfunding process. If the trends continue, equity crowdfunding is set to overtake the stock market as the premier crowdfunding strategy in the coming decades.