Equity Crowdfunding – You can do it too

Equity Based Crowdfunding

“We expect that this is that start of a renaissance of entrepreneurship in the United States.”

This was the reaction of Nick Tommarello, the co-founder and CEO of the Equity Crowdfunding Platform Wefunder, on further liberalization of regulations on Crowdfunding in May 2016; which enabled the average investor to have a partake in the growth pie too.

This article covers the following topics

  1. What is Equity Crowdfunding
  2. Equity Based Crowdfunding vs Reward Based Crowdfunding
  3. Modest beginnings: Crowdfunding and the Credit crisis of 2008
  4. Title II- the advent of platform based equity crowdfunding
  5. Title IV- Equity Crowdfunding for the mighty and the common folks
  6. Title III- Equity Crowdfunding for the non- accredited investor
  7. The relevance of Equity Crowdfunding
  8. Equity Crowdfunding and perks for the average investor
  9. Why entrepreneurs love Equity Crowdfunding
  10. Investors: Before you take the plunge, a few pointers about equity crowdfunding to remember
  11. Entrepreneurs: here’s what you need to remember before going the equity crowdfunding way
  12. Is Equity Crowdfunding really meant for you?
  13. When is Equity Based Crowdfunding not the right choice?
  14. The Future of Equity Crowdfunding

What is Equity Based Crowdfunding

Equity Crowdfunding is essentially a group of people investing in start-ups via an online platform. The investment is done in return for shares in the entity. It is also known as crowd investing, crowd equity or investment crowdfunding (although investment crowdfunding is a broader topic and involves both debt and equity based funding). As this type of funding involves shares and securities, it is subject to a relatively stricter form of scrutiny than other forms of crowdfunding.

Equity Based Crowdfunding vs Reward Based Crowdfunding

Equity Based Crowdfunding is similar to investing in equity- the investor gets to be the owner of the business in proportion to the money invested. Also, they benefit if the business value increases and hence have a personal stake in its success. This makes it different from the normal rewards based crowdfunding method where people give donations etc in return for future discounts, acknowledgement etc. it also enables smaller investors, who otherwise may not have the ability, to participate in growth of start-ups. It is seen that this form of funding is very popular among the start-ups, especially the ones seeking relatively smaller investments.

The first crowdfunding equity platform for upcoming start-ups was floated by Grow VC Group as a private beta in 2009 and on full commercial scale in 2013. One of the first equity crowdfunding platforms for this in the USA was EquityNet while in the UK, there were Seedrs and CrowdCube.

Also, the people participating are investors and hence want a decent Return On Investment or ROI. They will not be looking just at the idea of the project as is the case in crowdfunding but would also keep a check on how the project is proceeding, flaws etc. if the company is not able to provide the required ROI, they would move to the next company. Hence, Equity based crowdfunding method demands more accountability than reward based crowdfunding.

On the other hand, debt crowdfunding is when a group lends funds to start-ups or individuals and gets repaid via interest payments on a regular basis along with repayment of capital. This is informally known as peer-to-peer lending too.

Modest beginnings: Crowdfunding and the Credit crisis of 2008

The Netherlands has been a sort of frontrunner in implementing equity crowdfunding concept. It was one of the earliest adapters where Equity Crowdfunding has been legal for unaccredited investors since 2010 more or less. In the USA, the crisis in 2008 paved the way for the emergence of such funds. Due to the slump in economy, funding became increasingly scarce. This was especially harmful for the early startups. Then came the JOBS Act, 2012 or the Jumpstart Our Business Startups Act in the USA by President Barack Obama. This act made it possible for the average investor to be allowed to invest in such projects and began to roll the way to solve the cash crunch and enable easier access to capital for the entrepreneurs etc.

There are three provisions which were also included in the law – Title II, III and IV. These make it even more convenient to raise capital.

Title II- the advent of platform based equity crowdfunding

Title II changes the context from private placement to general solicitation i.e. using advertising platforms- both internet like twitter, facebook and otherwise. Thus it is platform based equity funding. However there are a couple of restrictions. As the sale of securities is highly regulated, no foreign capital is allowed. Also, there is restriction in terms of the ‘type’ of investor that can be solicited and the entrepreneur has to verify the nature and income of the investors who want to participate. Only accredited investors are allowed to deal in such offerings. For more details, check here, here and here.

As per SEC, accredited investors are those individuals whose net worth is more than $1 million or whose income exceeds $200,000 in the previous two years with similar earning expectation in the present year. Also, a couple comes in the category of accredited investors if they have a combined income of more than $300,000 per annum with similar earning expectation in the present year.

Title IV- Equity crowdfunding for the mighty and the common

Title IV or the Reg A+ is a provision via which funds can be raised up to $50 million over a period of twelve months. This form of funding can be raised from both accredited and non-accredited investors. However, the issuer has to comply with a plethora of regulations and file multiple statements along with ensuring compliance with various state laws of every state where the funds are solicited from. Thus, this pathway is more expensive and fraught with legal obligations. For more details, check here, here and here.

Title III- Equity Crowdfunding for the non- accredited investor

Title III is about US entities/ entrepreneurs being allowed to raise $1 million via an FNRA approved platform and that too from many small investors. Thus this is the non- accredited version. This allows anybody to deal in equity offerings albeit within specified limits based on one’s income.

It is this provision which was allowed in May 2016 and has created ripples in the crowdfunding industry. The rules are innovative and all set to utilize the potential of the common investor which would in turn have a positive impact on entrepreneurship and help bring to life many innovative ideas. Overall they would positively impact job creation, rekindling of the animal spirits and help jumpstart economic growth.

The Relevance of Equity Crowdfunding

Despite the prevalence of traditional sources of finance like Venture Capital and Angel Investors, only a minuscule proportion of the population gets funding from them; with a majority having to look for alternate sources of finance. Typically, only 1% and 3-4% of all small businesses go for Venture capital and Angel Investors respectively and these are the ones that aim for a high rocket-like growth trajectory and aim to become the next Google or Facebook. Rest of the ‘everyday’ businesses like a gym, yoga studio, restaurant etc, are simply interested in growing and want to raise capital for it. Some of them are willing to give up a portion of the ownership to other prospective investors.

Zandvliet, the co-founder of Symbid, believes the crowd is a great due diligence tool. “They actually find out basically everything,” he says. In fact, only a small number of the investors are angel investors or venture capitalists. And they, more often than not, observe the crowd to identify the entrepreneurs with the most potential. “Also, there is no better digital due diligence process than conducted by professionals, friends, family etc. And everybody has an equal say, and this is what truly creates great companies.”

Let us look at the essential details at a glance:

Equity Crowdfunding and perks for the average investor

  1. Traditionally, new venture as an asset class has been difficult for an average investor to get into and has always been dominated by HNIs. Now the bare minimum needed for entry is much lower- as low as $100.
  2. Chances of high returns
  3. Tax benefits
  4. Perks like become part of the testing team etc
  5. Emotional connect with the idea
  6. Personal satisfaction

Why Entrepreneurs love Equity Crowdfunding?

  1. Expansion in scope of fundraising: Availability of more capital
  2. Wider range of entrepreneurs will be able to raise capital and won’t be limited to just the major cities and hubs like silicon valley etc
  3. Shorter time span for raising capital
  4. Opens the door to all sorts of avenues especially for the early stage investment companies
  5. Your customers become not only your investors but also your brand ambassadors
  6. More transparency and accountability needed

Investors: Before you take the plunge, a few pointers about Equity Crowdfunding to remember

  1. Ensure you are comfortable with your cash being locked for some time
  2. How well do you know the business? Need to do a proper research and understand the nuances
  3. Background of the directors, promoters: their history, track record and credentials, how much have they invested (the more the better as they would have a personal stake)
  4. Future plans: does the company intend to raise more funds in the foreseeable future as this could dilute your own investment.
  5. Keep your investments diversified and have a clear understanding of your risk appetite.

Entrepreneurs: Here’s what you need to remember before going the equity crowdfunding way

  1. Ensure utmost importance is given to the presentation and communication aspect of the product as this would directly impact whether you receive the funding or not
  2. Never lost trust: it is the key to success in this world. Example- One entrepreneur who had launched a campaign for a tech startup on the crowdfunding platform was on his way to raising 100,000 Euros when it was found he was cheating on his wife. Sixteen hours later, his fundraising campaign was kaput
  3. Stay in touch regularly after receiving funds
  4. Compliance with regulatory procedures ranging from providing financial statements, review by independent accountancy firms, audit reports etc
  5. Need to research about the equity crowdfunding platform before launching the campaign to see which one caters to their requirements and the kind of services on offer, especially once the campaign is over.

Is Equity Crowdfunding really meant for you?

  1. Firms ignored by VCs and Angel investors
  2. The smaller fish in the pond for which a couple of hundred thousand bucks would make a big difference
  3. Entrepreneurs able to develop an emotion connect with their audience via sharing the story behind it and the dreams that feed its growth
  4. Firms having a customer community
  5. Start-ups familiar with the concept of crowdfunding

When is Equity Based Crowdfunding not the right choice?

  1. If u want to maintain secrecy and keep the product under wraps with no timeline, this option is not suitable for you. Because so many other investors are involved, accountability and transparency are a prerequisite.
  2. If you already have Venture Capitalists and Angel Investors interested in your project and expect to get the funds in a short span of time.
  3. If you do not have a business community following, it might be tough for you to connect with people and raise funds
  4. If you do not have the means to comply with regulatory requirements.

The Future of Equity Crowdfunding

In one sentence, Equity Based Crowdfunding is here to stay. And going by the increasing number of steps to simplify the legislation, Governments all over the world have noticed the potential it has to unlock idle capital and regenerate faltering economies, and are determined to create a conducive environment for it. This is a great opportunity for all those entrepreneurs with the ability to get the attention of their customers and hold it.

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