Translating an innovative concept into a thriving business is a complicated and unpredictable proposition. For entrepreneurs without the resources to fund a startup out-of-pocket, it’s essential to secure adequate financing – often before the nascent company has any revenues – or even a marketable product – to speak of.
Traditional banks are often reluctant to fund vulnerable startups with what they perceive as unproven ideas. And though there are numerous nontraditional startup financing options, not all are suitable in all situations.
What Is Equity Crowdfunding?
Since the 2012 passage of the JOBS Act, which loosened longstanding federal restrictions on how and from whom companies can raise money, equity crowdfunding has been a viable option for U.S.-based startups and small businesses. In that time, it has also become a potentially lucrative (though risky) opportunity for investors.
Like traditional crowdfunding through such platforms as Kickstarter and GoFundMe, equity crowdfunding allows entrepreneurs, early-stage companies, and nontraditional investment funds to raise substantial amounts of money. Each contributing individual gives a relatively small amount – typically at least $1,000, but sometimes less.
The key difference is that equity crowdfunding is an investment arrangement. During an equity crowdfunding round, an entity issues equity – shares of company stock – to participating investors on a proportional basis. Less frequently, early-stage crowdfunded companies may raise money through a combination of equity and debt, or debt only. However, debt arrangements are more common for later-stage companies.
In any equity crowdfunding round, the entity’s valuation is a function of the dollar amount raised against the amount of equity offered, independent of company fundamentals. For instance, a funding round that raises $1 million in exchange for 20% of a company’s total share count values that company at $5 million.
If the company or entity grows, each investor’s stake may appreciate in value. When a successful company sells itself to another firm or launches an IPO, shareholders may realize a substantial return on their investment. On the other hand, shareholders in unsuccessful ventures stand to lose part or all of their investment.
Equity Crowdfunding Platforms
In the months and years following the passage of the JOBS Act, numerous equity crowdfunding platforms – such as Wefunder and Localstake – have arisen to complement a smattering of existing platforms (AngelList and EquityNet both preceded the JOBS Act). Though each operates on a slightly different model, all aim to connect individual and institutional investors with previously unavailable investment opportunities. Investors generally have to register, often simply with a social media account, and verify their identity, income, and assets.
Some equity crowdfunding platforms, particularly real estate platforms such as PeerRealty and CircleUp, act as intermediaries between investors and companies or funds engaged in active fundraising rounds. They typically hold investors’ funds in escrow until the round ends successfully, then transfer equity to the company.
Others, such as Crowdfunder and Fundable, merely allow companies to advertise fundraising efforts to the general public. In this case, investors either make a nonbinding pledge (basically an indication of interest) or a binding, signed commitment to invest within a specified period of the funding round’s closing. Companies then contact individual investors outside the platform, accept funds via check or electronic transfer, and deliver share certificates.
Still others, such as AngelList and CircleUp, operate investment funds that own shares in multiple companies or asset classes – commercial real estate, for example – offering exposure to an entire asset portfolio with a single investment.
Equity crowdfunding platforms generally earn the bulk of their income from fees charged to listed entities, though investors in multi-company funds often have to pay annual management fees. To boost investor confidence in the available investment opportunities, some platforms also invest their own capital in listed entities.
Restrictions on Offerings
Under regulatory amendments made possible by the JOBS Act, a company can leverage an equity crowdfunding platform to raise up to $2 million in a 12-month period without completing the costly, time-consuming SEC registration process, provided the company accompanies its offer with an audited financial statement. Without an audited statement, the company can raise up to $1 million in any 12-month period.
Before the JOBS Act was fully implemented, equity crowdfunding was limited to accredited investors. The SEC defines accredited investors as individuals who consistently earn more than $200,000 per year, couples with consistent combined income of more than $300,000 per year, and individuals whose net worth (excluding primary residence) is at least $1 million. Accredited investors are still permitted to participate in equity crowdfunding rounds with few restrictions.
Title IV of the JOBS Act, implemented in June of 2015, expanded equity crowdfunding opportunities for non-accredited investors. Investors who earn less than $100,000 per year or have less than $100,000 in net worth can invest up to the lesser of $5,000 or 5% of their annual income or net worth. Those with annual earnings or net worth between $100,000 and $200,000 can invest the lesser of $10,000 or 10% of their annual income.
Considerations for Entrepreneurs
Easier Access to Capital
The JOBS Act removed many restrictions on advertising and eased other rules that formerly limited early-stage companies’ access to capital. Meanwhile, equity crowdfunding platforms allow startups to put themselves in front of thousands of potential investors at once, and streamline the funding process for interested investors.
The result is faster, easier, and less costly access to capital for young companies. This allows entrepreneurs to focus less on regulatory compliance and more on getting their products and services to market.
More Investors to Deal With
The flip-side of easier access to early-stage capital is an increase in the number of investors involved with the firm as it tries to get off the ground. While equity crowdfunding investors typically aren’t involved in day-to-day decision-making and may not exert pressure on the company’s leaders, managing many small investors (rather than a few large stakeholders) can present logistical challenges and costs, such as the need to hire an investor relations liaison or communications staff.
Considerations for Investors
Potential for Return on Equity
For investors, the biggest benefit of equity crowdfunding is simply having skin in the game. Though most startups fail, partially or totally wiping out early investors, many go on to succeed. And a few, dubbed “unicorns” in industry parlance, achieve stunning growth and end up dominating their markets. After all, Google and Amazon were once tiny, insecure startups viewed by mainstream investors with heavy skepticism.
Traditional crowdfunding campaigns offer tangible rewards, such as a facility tour or free merchandise, for those who contribute funds. However, they don’t offer a stake in a potentially successful business.
Oculus VR demonstrates the downside of traditional crowdfunding. Back in 2012, the virtual reality startup got off the ground thanks in part to a traditional crowdfunding campaign that raised $2.4 million from thousands of contributors. Instead of shares in the company, everyone who contributed at least $25 received a branded T-shirt. Barely two years later, Facebook purchased the company for $2 billion, according to TechCrunch. While the company’s private shareholders profited handsomely from the deal, its thousands-strong Kickstarter army got nothing.
Accredited Investor Status
For many prospective equity crowdfunding investors, accreditation remains a significant obstacle to full participation. Though Title IV allows non-accredited investors to participate in equity crowdfunding campaigns, many equity crowdfunding platforms remain closed to the general public.
The reasons for this vary by platform. Some platforms, such as EarlyShares and PeerRealty, impose hefty investment minimums that are simply out of reach for most non-accredited investors due to restrictions on the amount of annual income or assets they can invest. Others, such as SeedInvest, prefer to restrict access to savvy investors, using accreditation as a proxy for knowledge and experience. Before assuming that a particular platform is available to non-accredited investors, read its FAQ section or contact its administrators directly.
Equity crowdfunding involves buying shares in privately held firms. Unlike shares in publicly traded companies, these shares can’t be sold on public exchanges. And though some crowdfunded entities make regular income distributions, the vast majority don’t. Even if the company you’ve invested in survives and thrives, you’re likely to wait years to see a return on your equity crowdfunding investment – typically, either when the company is bought out or launches an IPO.
Some equity crowdfunding platforms, such as PeerRealty, operate exchanges that allow their investors to buy and sell shares on the secondary market. However, such exchanges are typically platform-specific and may only be open to accredited investors. Given the comparatively small number of individual shareholders in any given equity crowdfunding vehicle, the liquidity of any secondary market is likely to be limited anyway. If you don’t have a long investment time horizon or want assurances of liquidity, equity crowdfunding isn’t an ideal investment.
Equity Crowdfunding Sites for U.S. Investors & Companies
These online equity crowdfunding platforms are available to U.S.-based investors and companies. While all platforms accept accredited investors, only some accept non-accredited investors. Many aren’t clear on this point, and a particular platform’s investor requirements may change at any time. Prospective investors should contact their platform of choice to determine current policy.
In all cases, investors need to provide their identity, income, and asset verification to register with the platform and participate in listed companies’ funding rounds. Unless otherwise noted, platforms don’t charge fees to register or maintain membership as an investor.
Founded in 2010, AngelList is one of the oldest and most established equity crowdfunding platforms. It was originally conceived to broker connections between cash-strapped technology entrepreneurs and angel investors – high-net-worth, tech-savvy funders, many of whom earned their fortunes by selling out of their own successful startups.
AngelList revolves around detailed, company-created startup profiles that are visible to the general public. Startups maintain active profiles indefinitely – before, during, and after an equity crowdfunding campaign. However, only registered investors can see if a listed company is planning or in the midst of a funding round. Unless otherwise noted in a particular offering, the minimum investment threshold is $1,000.
There are three main ways to invest on AngelList:
- Specific Companies. Registered investors can contact companies in the midst of funding rounds and arrange direct investments outside the AngelList platform. Companies typically have a target funding amount and closing date. Once the funding amount or closing date passes, the opportunity is no longer available to investors.
- Funds. AngelList oversees a handful of funds focused on broad startup sectors, such as consumer technology and enterprise technology. Funds typically hold stakes in at least 100 individual companies. Like publicly traded index funds, they’re not actively managed.
- Syndicates. Syndicates are managed funds overseen by notable venture capitalists and angel investors. Syndicates can have anywhere from 5 or 10 to well over 100 startups, depending on the syndicate’s age and strategy.
Separately, AngelList operates a high-end job board that connects developers, engineers, marketers, medical professionals, and other talented job-seekers with early-stage companies looking for help. You don’t need to register as an investor to use AngelList’s job board.
CircleUp connects investors with consumer-facing startups, mostly in the technology, fitness, and food and beverage sectors. CircleUp features company profiles with information about each company’s products, business model, leadership, retail partners, revenue, and more.
Through CircleUp’s DealFlow feature, platform-registered investors can see which companies are actively raising funds, view complete investment prospectuses, and even request product samples, if offered.
There are two ways to invest with CircleUp:
- Direct Company Investments. If a company is actively fundraising, investors can purchase shares directly through the platform.
- Circles. Similar to AngelList’s Syndicates, Circles are index funds that purchase shares in multiple companies – often dozens – at once. CircleUp selects a highly qualified CircleUp member, typically a qualified investment professional with years of industry experience, to oversee each Circle. Circles can cover specific sectors, such as health food, or include a broader mix of companies favored by the lead investor.
In all cases, listed companies set the minimum investment amount – typically $1,000, but occasionally as low as $250 or $500.
Fundable offers rewards-based crowdfunding, a la Kickstarter, as well as equity crowdfunding. For companies interested in equity crowdfunding, Fundable provides hands-on help with onsite profile building, pitch construction, and even business plan development. It also has a relatively low minimum fundraising target (companies can raise as little as $10,000 at a time), so it attracts lots of smaller, less ambitious businesses.
Fundable’s basic company profiles are available to everyone. Registered users can request a prospectus and make nonbinding funding pledges through the Fundable platform. However, Fundable isn’t set up to broker direct investments – money and shares actually change hands outside the platform. Unless otherwise noted, the minimum investment amount is $1,000.
Though it doesn’t formally restrict admission, Crowdfunder‘s listed companies and funds skew heavily toward innovative consumer products, consumables, and social/nontraditional niches (such as green energy startups and African real estate funds). Company and fund profiles are incredibly detailed, with sales metrics, case studies, business plans, third-party analyses, and leadership profiles visible to the public. Registered users can request a full prospectus and audited financial disclosures as well.
As with Fundable, investors make nonbinding funding pledges through the Crowdfunder platform, but the actual funding transaction takes place off-site. Crowdfunder doesn’t explicitly set out an investment minimum, but it’s rare to find offerings with minimums lower than $1,000.
Founded in 2005, EquityNet bills itself as the “original equity crowdfunding site” and claims to hold the only patent for the concept. Its listed entity mix is similar to Crowdfunder, with emphasis on consumer products and social enterprises. EquityNet also appears to attract single-asset projects, such as assisted-living facilities and medical clinics, as opposed to product-based startups or multi-asset funds.
Like Crowdfunder, EquityNet features detailed entity profiles visible to the general public, but requires registration to view full prospectuses and audited financial disclosures. Registered users message listed entities directly through the EquityNet platform to arrange a nonbinding funding pledge or binding commitment. In all cases, funding transactions take place off-site. EquityNet doesn’t have an explicit investment minimum, but it’s rare to find minimums lower than $1,000, and $2,000 to $5,000 minimums are commonplace.
Wefunder‘s co-founders were heavily involved in the debate over the JOBS Act and claim some credit for the crowdfunding-friendly measures that made it into the final legislation. Whereas most competitors require investors to put up at least $1,000 per company or fund, Wefunder accepts investments in increments of $100. Listed offerings range from funds invested in 10 to 15 early-stage companies to individual startups in the biotech, green energy, insurance, logistics, and packaged food segments.
Wefunder’s comprehensive listings include detailed sales metrics (often including easy-to-parse graphs and charts), summarized business plans, interviews with leadership, and a “Why We Like This Company” section written by Wefunder staffers. Thanks to an integrated question-and-answer system, registered users can communicate directly with company founders or executives, too. All funding transactions (including in multi-company funds) occur off-site as of mid-2015, but Wefunder has indicated that this will change in the future.
Localstake connects investors with revenue-generating small businesses operating in their home state. Listed companies tend to be involved in consumer-facing enterprises, such as brewing, food production, and apparel manufacturing. Minimum investment thresholds typically range from $250 to $500.
As of mid-2015, you can only invest in-state. If there aren’t any Localstake-listed companies in your home state, you can’t use the platform.
Localstake offers two investment options. Companies either offer equity, as on other equity crowdfunding platforms, or revenue share loans. Revenue share loans have open-ended maturities and return fixed amounts to each investor – typically an amount equal to 1.5 times principal. For instance, a representative loan offered to an individual investor might have a $1,000 principal, a total repayment amount of $1,500, and a five-year maturity – equating to a 10% annual return on investment.
The borrowing company makes monthly payments on each investor’s loan, based on loan principal and the company’s revenues that month. Repayments continue until the rate of return has been reached.
SeedInvest is a more buttoned-up platform that caters to savvy investors, mostly venture capitalists and angel investors, and explicitly limits participation to accredited investors. Though its company profiles are mostly invisible to the general public, registered investors have access to a wealth of descriptive and financial detail about each listed entity, plus direct access to founders or executives.
The majority of listed companies are individual technology startups, though there are some options from other sectors, as well as a handful of multi-company funds. SeedInvest has an escrow system that allows folks to invest in companies directly through the platform, though some funding transactions may occur outside the platform (at the discretion of each participating company). Though SeedInvest doesn’t set an explicit investment minimum, minimums below $5,000 are rare.
EarlyShares is dedicated exclusively to commercial real estate crowdfunding opportunities, including multi-asset funds and discrete properties. For instance, you can invest in a retail complex in Las Vegas or an office building in Raleigh.
Due to the high value of the assets involved, most opportunities require minimum investments of anywhere from $5,000 to $25,000. Depending on the listed entity’s preference, investors either make binding commitments or nonbinding pledges. In either case, the transaction occurs off-platform.
PeerRealty also focuses exclusively on real estate, mostly commercial and multi-family residential. Most opportunities are specific projects, such as already-completed apartment buildings and planned or under-construction office buildings. Multi-property portfolios are available as well. Note that investing in planned or under-construction projects may present additional risks.
Most PeerRealty opportunities require minimum investments of $5,000, and occasionally higher. Funding transactions typically take place through the platform’s escrow system.
PeerRealty is one of the only equity crowdfunding platforms that operates a secondary exchange where current investors can sell their shares to other PeerRealty investors. This provides investors with some liquidity, though PeerRealty doesn’t guarantee an active market for shares in any particular project or property portfolio.
Oculus VR isn’t the only wild crowdfunding success. According to Crowdfund Insider, home automation company SmartThings raised $1.2 million in startup capital via Kickstarter. With a killer idea and strong leadership, it grew rapidly. Barely 24 months after its first Kickstarter campaign, the firm sold itself to Samsung for $200 million. Like Oculus’s Kickstarter contributors, SmartThings’ crowdfunders didn’t see a dime of that windfall.
However, for every SmartThings-sized success, there are 100 crowdfunded ideas that don’t go anywhere. Statistically speaking, even if you invest exclusively in multi-company funds overseen by experienced venture capitalists, you’re highly unlikely to ever gain exposure to a company that commands a multi-million or -billion dollar valuation within two years of its official launch. The best you can hope for is to find yourself with stakes in viable companies with solid growth potential.
In other words, equity crowdfunding is a great way for entrepreneurs and small business owners to raise money. For investors, it offers the opportunity to support exciting concepts. However, equity crowdfunding is riskier than investing in established, publicly traded firms with marketable products, experienced leadership, and a history of profitability. Don’t invest any money you can’t afford to lose.
Have you ever used equity crowdfunding to raise money for your business idea or fund a new startup?