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I came across the data reported by Fundly that Equity Crowdfunding market has grown to $2.5 billion in 2020.
“There was a time only wealthy individuals, angel investors or venture capitalists could invest in startups”
As an entrepreneur I started doing a deep dive to get some knowledge and here are my notes.
Equity crowdfunding democratized funding so that ordinary people can invest in an unlisted company in exchange for shares. And just like any other shareholding it allows profits when the company does well and if the company fails, the investors can lose some or all of their investment.
The general crowdfunding paved the way to equity-based crowdfunding. Certain platforms came first and then the regulatory agencies came in to legitimize such transactions along with the restrictions to safeguard the investors.
Each country have their own regulations or the lack of it, I came across this article Equity Crowdfunding Regulations by Countries which lists some of them.
What are the rules for Equity crowdfunding?
For our discussion, let’s have a look at the US Security Exchange Council (SEC), as it gives a clear picture of what can be or can’t be done in the US. They call it “Regulation Crowdfunding” and here are the rules they established in 2015:
- require all transactions under Regulation Crowdfunding to take place online through an SEC-registered intermediary, either a broker-dealer or a funding portal
- permit a company to raise a maximum aggregate amount of $1,070,000 through crowdfunding offerings in a 12-month period
- limit the amount individual investors can invest across all crowdfunding offerings in a 12-month period and
- require disclosure of information in filings with the Commission and to investors and the intermediary facilitating the offering
Securities purchased in a crowdfunding transaction generally cannot be resold for one year.
Who can make equity based crowdfunding investments?
Anyone can invest in a securities-based crowdfunding offering but there are limits to how much one can invest during any 12-month period and it depends on your net worth and annual income.
If your annual income or net worth is less than $107,000, then you can invest up to the greater of either $2,200 or 5% of the lesser of your annual income or net worth in a per year basis. If you are worth more than you can invest up to 10%.
You can calculate your net worth by adding up all your assets and subtracting all your liabilities. The resulting sum is your net worth. You can also do investments jointly with your spouse’s income or assets.
In my opinion you will need a financial consultant to assess your net worth as it is complicated. There are more rules such as you primary residence is not included in the net worth and mortgages on your home does not count as liability.
They also dictate that “You can only invest in a crowdfunding offering through the online platform, such as a website or a mobile app, of a broker-dealer or a funding portal”. There is no provision for companies to sell crowdfunding investments directly and they must use a broker-dealer or funding portal.
You can read more on US SEC rules here, and here .
What are the risks as an investor?
Companies or ventures are in early stage thus making investments a very high risk. You should do your research thoroughly before making any decisions. Try to understand the benefits and risks involved, following are some to consider:
- Early stage investments are purely speculative. There is no or minimum track record and are dependent on the product and service they promise to build.
- Regulations limit your ability to resell your investment for the first year. You may as well end up holding the investment for indefinite time-period.
- Unlike stock exchange you may have to find an interested buyer when you want to resell your investment.
- Valuation of startups are arbitrary unline publicly traded companies. There is a risk to overpay for the equity you are purchasing.
- You will generally get only limited disclosure from any early-stage company.
- You are not just investing on the company but also on the people running them. Can they execute on their promise?
Beyond the risks mentioned above there is a lack of professional guidance in this new type of investment opportunity. You can imagine even armed with expertise and professional capacity the angel investment and venture capital firms lose money in 7 out of 10 companies they invest in. In fact there is a lot of scope for fraud as well.
What is the function of equity crowdfunding platforms?
In exception to other types of crowdfunding platforms they have to be a registered broker with the SEC and follow all the guidelines to protect the investors. They provide educational materials to help investors understand the process and risks involved when making a crowdfunding investment.
If we look at the top three platforms — Wefunder, StartEngine, and Republic, they alone account for over 80% of 2020 equity based crowdfunding in terms of the amount of capital raised. Though there are smaller niche players as well focusing on specific type of companies, you can check the complete list — FINRA-approved funding portals. If you are looking for highly vetted deals, give a try to Seedinvest.
Please note that these platforms have different structures in terms of charging fees to investors and some like Republic do not charge at all. Currently, most platforms do not provide any secondary market to sell the shares you may have except Netcapital.
What does investors look for in a platform?
- The types of companies and deals they offer
- Quality and Quantity of the deals on offer
- Do they focus on Early-stage vs. Later-stage startups
- How much to they charge as Investor fees
- Their practices on due diligence of the deals
- The types of securities available (Common Stock vs. SAFEs)
- Do they have secondary market
How to select a platform as a founder?
- Types of campaigns supported
- Total number of active investors
- Kind of deals the investors back (Large vs Small)
- Total amount of capital raised
- Average capital raised per campaign
- Platform fees and discounts
- Types of securities offered (e.g. SAFE, Equity, etc.)
- Cap-table structure (i.e. single cap table line-item vs. many)
What are the key elements to start a crowdfunding campaign?
- An incorporated company
- Branding materials (Logos, Landing Pages, Videos, Social Media)
- Company profile (Overview, Partners, Customers, Press)
- Compelling showcase (Product or Service)
- Traction till date
- Customer reviews
- The team and the advisors
- All current funding
- Investment profile and management
Even with the crowdfunding the reality is that 80% of the capital comes from accredited investors, while only 20% of the capital comes from the larger number of non-accredited investors. For founders they key is to look for the right type of investor for their campaign. One should also note that the current limit of fund raising is capped at $1.07M by the SEC.
To be successful with equity based crowdfunding both the investor and the founder should know each others game. If you want to understand and explore the space further, you may find a lot of information out there I recommend to start with Top 10 Equity Crowdfunding Sites — 2020 from Crowd Wise.
