Equity crowdfunding comes about when private companies raise public capital through securities sales. These may include shares, convertible notes, revenue shares, debts, and tokens. Today, equity crowdfunding is an important part of global financial markets, as it provides a more cost-effective strategy for SMEs to raise capital versus traditional IPOs.
Curiously, equity crowdfunding is a fairly new method for investment. President Obama allowed equity crowdfunding back in 2011 when he signed the JOBS Act, but the practice became famous not until five years later on. One reason it took so long for equity crowdfunding to gain traction is that key regulations had to come into effect until May 2016.
How Does Equity Crowdfunding Work?
Equity crowdfunding operates very similarly to Kickstarter, the popular crowdfunding website. Investors are basically looking for private firms which meet their criteria. Once an appropriate investment is found, an investor visits a website on the funding portal that gives access to the opportunity and its details. Here investors are able to discover the company’s numerous investment prospects in equity crowdfunding.
Key Differences from Kickstarter
Unlike Kickstarter, investors are not getting early access for their contributions to a product or service. Instead, investors seek to make a profit for their participation in equity crowdfunding campaigns. Investors mostly get shares, rights, and other benefits for their investment.
Different to Stocks
It’s important to understand that equity crowdfunding provides different incentives for entrepreneurs compared to trading stock market shares. For starters, private companies are equity investing, and in most cases startups. In the past, IPOs were the only manner in which a firm might participate in crowdfunding. For many entrepreneurs, the activity restricted market access for SMEs.
Many organizations simply lacked the resources to meet the immense financial and legal requirements required to host an IPO. In addition, only the biggest corporations were able to raise the funds required to successfully launch an IPO. Studies therefore show that IPOs tend to see a decrease in use as more affordable alternatives are available now.
Those activities have also left investors out of the loop. Most IPO’s are available to approved investors only. Accredited investors spend at least $200,000 a year, or may display assets in excess of $1 million. An important thing to note is that your assets must exclude your house. As you might expect, this program has kept the average investors away from the most profitable investments.
Now everybody has access to these lucrative resources, thanks to the growth of equity crowdfunding platforms. Until the increase of crowdfunding sites on the internet, investors were mainly VC and angel investors. They were the only citizens who had the resources to make both a big investment and wait for the necessary lock-up period before collecting returns.
No Lockup Time
Notably, investors who invested in private equity crowdfunding before the enforcing of regulations until 2016 had to wait for a specified lockup time, similar to IPOs, to access their funds. Investors have been unable to sell or cash out their investment during this period. This lockup left investors vulnerable to substantial losses. Fortunately, the new regulations opened the door to these financial instruments’ secondary trading via Alternative Trading Systems (ATS). Through this way, ATS is supplying the market with much needed liquidity.
Advantages of Equity Crowdfunding
Aside from the obvious financial benefits crowdfunding equity brings to the table, there are plenty of other explanations why a company should follow that strategy. Companies get good brand interest from investors, for one. Every investor in your firm acts as a brand ambassador to your company. Since these investors need you to succeed to make a profit, they also spread the word about your company and products with diligence.
Management aspects also exist which make equity crowdfunding a more desirable choice to consider. For one thing, an entrepreneur raising money through equity crowdfunding has full control of the bid. The entrepreneur can choose the value, how much capital to raise, what to sell and at what price. They may also define a minimum target of funding to ensure that the organization receives adequate funds to carry out its plans. By contrast, a firm that is engaged in an IPO is bound by the terms of its lender.
Keep it Reasonable
With all that flexibility, of course, new responsibilities also come in. In the equity crowdfunding room, only companies that can generate a fair valuation and terms see success. With minimal risk, investors are searching for great opportunities.
Crowdfunding Rules and Regulations
There are some key criteria that a company must fulfill first before launching a crowdfunding campaign for equity (Read our Equity review here). Firstly, the company must be privately owned and not listed globally on any stock exchange. Second, all investors must show their identity and be over 18. In addition, many crowdfunding campaigns for equity include limitations on how much capital an individual can invest based on their income and net worth.
Every area currently has its own legislation on equity crowdfunding in place. There are two main forms of equity crowdfunding campaigns in the United States – Regulation Crowdfunding and Regulation A+. Both provide a more secure and cost-effective option for SMEs than hosting an IPO.
Crowdfunding laws require businesses to collect up to $1.07M annually. Currently, after filing a Form C with the SEC, certain companies will start raising capital for free. Importantly, if the company wants to raise more than $107,000, an independent CPA would need to check the financials of the corporation for the previous two fiscal years.
Companies under Regulation A+ will collect up to $50 million annually. Companies wanting to follow this path will first undergo a financial audit within the last two fiscal years. Additionally, to establish a Form 1-A, they must employ a securities attorney. This form must be submitted for approval to the SEC. Unfortunately it can take some time to complete the certification. It takes at least 3–5 months on average.
Importantly, during this time period, businesses are unable to raise money, but they are able to collect information from investors to better measure the levels of anticipation from investors. This practice is called “testing the waters,” and is a powerful tool that allows businesses to gain valuable customer input before their crowdfunding campaign is officially launched.
What is Crowdfunding in Real Estate?
Importantly, sites for equity crowdfunding have given way to a new way of investing in commercial real estate- crowdfunding immovables. Real estate crowdfunding requires a group of investors each contributing money to a particular real estate contract. Importantly, this approach lowers the investor entry bar and provides exposure to global capital for real estate owners. As such, in recent years the practice has exploded in popularity, particularly after the introduction of blockchain technology.
How Real Estate Crowdfunding Works
A developer or experienced real estate professional identifies an investment opportunity in most crowdfunding transactions. This professional may decide they don’t want to finance the whole project. This decision may be due to a shortage of funds or a willingness to use funding from other people to complete the project. The pro will then open up the market for investors, whichever the reason.
Any crowdfunded real estate project has three main players. All real estate projects that crowdfund start with the sponsor. The sponsor is the person or company determining, preparing, and managing the investment. Their duties may include purchasing the asset, planning the necessary work, coordinating the financing and managing the property’s eventual sale. Sponsors need a certain proportion of any money they earn for their labors.
The platform is the second core component of any real estate crowdfunding transaction. Think of investors and sponsors of such platforms as the middleman. The primary aim is to bring together investors and sponsors. As such, they do have a duty to raise funds from investors. A host of other duties come along with this mission, such as checking criteria, ensuring investors meet investment requirements, advertising deals to potential investors and coping with regulatory issues.
The investor is the puzzle end piece. An investor trades their funds from the benefit generated by the property for some sort of income distributions. They’ll also earn a proportional bonus from every potential successful land sale. Some voting rights are in some cases a part of the contract. Those rights may include, for example, whether or not to accept a property bid.
Benefits of Crowdfunded Real Estate
There are some significant benefits gained by crowdfunding campaigns for immovable property. For one, the potential for improved returns is much higher as compared with other big asset groups. Investors also gain access to assets which they may otherwise find unavailable. In that way, real estate crowdfunding is a smart way to diversify your portfolio.
It is important to note that equity crowdfunded real estate platforms usually focus on a particular property. This is against trusts in real estate investment trusts (REITs), which can require billions in properties. As a result, crowdfunded real estate investors will reap the advantages of investing in a single property without the financial risk of actually being a landlord. Ultimately, those investors are getting the best of both worlds. They earn both a profit and a fixed lump-sum return without excessive risk exposure.
Top Crowdfunding Websites
Now that you have a strong understanding of what equity crowdfunding is and how it helps the market as a whole, you are able to explore some of the top sites that offer such services. Importantly, many of these businesses are now using blockchain technology to minimize the total cost of handling and executing their equity crowdfunding concepts.
SeedInvest was founded in 2012 and began its work in 2013. The site is unique in that it has more strict policy of acceptance. Only handpicked start-ups are being allowed exposure to this important resource in the upcoming future tech industries. A company needs to deal directly with blockchain, virtual reality, 3d printing, artificial intelligence, robotics, or space technologies. Importantly, the pickiness of SeedInvest has paid off as the company has so far managed to raise funds for more than 150 businesses.
In 2009, the crowdfunding company Microventures based in Austin came onto the market. As part of its target market, the organization focuses exclusively on the late-stage firms. Late Stage companies are businesses which are expected to go public over the next few years. These businesses are usually well-known players in the sector as well. For example, you can invest via Microventures in SpaceX, Lyft, Pinterest and Robinhood. Importantly, the firm only allows qualified investors to enter as each investment ranges from the range of $5000 to $50000.
WeFunder came onto the market in 2011. This company based in San Francisco emerged from the accelerator system Y Combinator. Importantly, the Y Combinator was instrumental in funding some of the most promising projects to date. Such ventures include companies like Coinbase and Airbnb. Also since WeFunder is one of the oldest platforms on the market, the organization has collaborated with the Obama administration in writing the JOBS Act.
On 22 May 2012, Fundable entered the market as an investment opportunity focused on incentives. Investors could promise exchange of pre-order and thus pledge funds. In 2012 the company turned to a true crowdfunding approach for equity. Notably, at this time, Fundable’s equity crowdfunding services are open only to approved investors.
StartEngine entered the market in 2014 with the goal of giving entrepreneurs more flexibility in the sphere. Unlike most of the competition, StartEngine is more conservative about what kind of companies and investors will use its services. Investors also need to take a little more due diligence when investing on the platform. Importantly, StartEngine was exhibiting its capabilities in 2018 after successfully raising $10M via a self-hosted STO.
Equity Crowdfunding – The Future is Now
Equity crowdfunding is today an essential tool that startups use to access capital markets. Consequently, due to its lower costs and more effective business model, you would expect to see this form of crowdfunding-acceptance. Fortunately, the blockchain technology continues to streamline the entire process of equity crowdfunding. If the trends continue, equity crowdfunding will surpass the stock market in the coming decades as the leading crowdfunding strategy.