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By Nathan Rose, Assemble Advisory
You may have heard of “equity crowdfunding” in passing, but not really understood exactly what was meant. There are many different types of crowdfunding, so it understandable that there’s a lot of confusion between the different forms. In this equity crowdfunding guide, I’ll tell you what equity crowdfunding is, and why it matters to companies wanting to raise capital.
Let's start this equity crowdfunding guide with some definitions. Think of equity crowdfunding as being a hybrid between Kickstarter and angel/VC funding.
Kickstarter and other such platforms offer up creative projects, causes to donate to, and pre-orders for new products. Conversely, with equity crowdfunding, pledgers become owners, not donors. Shares in the company are on offer.
Investors can even use equity crowdfunding to form a portfolio of early-stage investments – hitherto impossible for all but the very wealthy. If an investor puts money into an equity crowdfunded company and it goes on to be the next big thing, they stand to profit. This is a game-changer.
Some terminology will help understand the rest of this equity crowdfunding guide.
Because equity crowdfunding is an offer of securities, the law needs to change in each individual country in order to make it legal. Before then, only the wealthy could access early stage companies without a prospectus being filed, and only so long as they passed a “sophisticated / high net worth” investor test.
A breakdown of the state of the law in every country is beyond the scope of this equity crowdfunding guide, but in many countries in North America, Europe and Asia, governments have altered their position and allowed ordinary investors the opportunity to access a new asset class.
Equity crowdfunding has recognised that preparing a prospectus is too costly for early stage companies – and practically speaking, nobody reads those long, legalistic documents anyway. Therefore, through equity crowdfunding, ventures can raise capital with a lower level of disclosure.
The decision to raise equity capital (of any kind) is one that shouldn’t be taken lightly, and many companies simply aren’t suited. It will work best for raising growth capital, typically over $200,000+, and giving up roughly 10 – 40% equity. It’s very rare to be used as a vehicle for existing owners to cash-out. Pre-revenue businesses are sometimes possible (but are harder). Revenue-generating and already-profitable businesses are more suited.
Although people associate “equity crowdfunding” with early-stage companies, it’s not necessarily limited to this (at least not everywhere). The lines of what constitutes equity crowdfunding have become blurred since the term was originally coined.
The World Bank thinks equity crowdfunding could be as being the missing piece to fill the well-known funding gap for companies which have grown beyond the capital that friends and family are able to provide, yet are too small for venture capital or private equity.
An equity crowdfunding guide wouldn’t be complete without a word on what’s required. Getting ready for an equity crowdfunding offer is time-intensive, and this often surprises founders. The platforms themselves do a lot of screening of the companies, so having a strong pitch is essential to maximise the chance of a successful round. At a minimum, you will need:
All of these cost time and/or money to put together, and these costs will have to be incurred, regardless of whether your offer succeeds or fails. The platforms will also take a cut (between 5 – 10% of proceeds raised is normal), but the fees of the platforms tend to be success-based.
There are pros and cons for rewards crowdfunding vs. equity crowdfunding. The most obvious advantage of rewards crowdfunding (such as Kickstarter) is that it is non-dilutive – the founders get to raise money without giving up any shares in their company.
But equity crowdfunding has distinct advantages of its own. For example, it is suitable for more kinds of businesses, not just ones that are consumer-focused. It is also possible to raise a lot more money with equity crowdfunding.
There are pros and cons over private investment channels such as angels and venture capital too. Equity crowdfunding will also likely give a better valuation outcome, and has strong publicity benefits, but is a much bigger marketing effort than going to large investors directly.
This equity crowdfunding guide has been a brief overview of how equity crowdfunding works. Running a successful offer is not easy, and many founders have been tripped up by the common mistakes. But equity crowdfunding is now responsible for billions of dollars in funding annually, and should be considered by any company contemplating a capital raise.
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