Equity crowdfunding, which can also be called investment crowdfunding, business crowdfunding, real estate crowdfunding, crowd investing, or crowdlending is a way for startups and early-stage or early-growth companies to raise capital.
Companies list their private securities (shares, convertible notes, debt, revenue share, etc.) for sale on an equity crowdfunding portal online where investors are given the opportunity to buy those private securities (not listed on a stock exchange) for a piece of equity in the company that is reflective of their investment.
These companies, also known as “Issuers” of the private securities, are afforded the opportunity to raise capital through the crowd, or investor community.
Equity crowdfunding vs. other crowdfunding
Equity crowdfunding has several differences from other types of crowdfunding methods such as donation crowdfunding or rewards-based crowdfunding. Companies like Kickstarter or GoFundMe, allow entrepreneurs to raise money by pre-selling their product at a discount or through offering tiered rewards and perks to attract potential customers. However, once people have donated funds or pre-bought a product, that is the end of the road for both parties.
With equity crowdfunding portals, such as TycoonInvest, the entrepreneur or company sells equity in their company, which could be anything from a product company, to a service business, to a real estate company, or anything in between. Instead of buying a product, investors buy shares in the company, which allows them to take part in any future upside potential. On the flip side, if the company does not do well, the investors can potentially lose their investment.
Equity crowdfunding vs. venture capital or private equity
Well, now that you know what equity crowdfunding is, how is it different from venture capital, private equity, or angel investors?
It is possible for these venture capital & private equity firms, or even angel investors to invest in companies on equity crowdfunding portals. If they invest in your company on an equity crowdfunding platform, they have an interest in you, however small, and they will be tracking your progress.
Equity Crowdfunding for Real Estate
Also known as real estate crowdfunding, this type of crowdfunding allows investors to buy shares in a company that holds property. The company can hold a single property, or a portfolio of properties, of any type. As a shareholder in the private securities of the real estate holding company, the investor can earn a portion of the profits generated from the real estate investment. For instance, revenue generated from the building’s rental income or proceeds from the sale of property would be paid to the investors.
Prior to the JOBS Act, real estate investors were mainly able to invest in real estate by buying a physical property or investing in REITs (real estate investment trusts). Crowdfunding has opened the door to a new way of investing in real estate.
Now, investors are able to invest in real estate crowdfunding with a very low minimum investment, even as low as $200.
Another benefit to real estate crowdfunding is that it can help investors reduce the risk that is associated with an all-equity portfolio by diversifying their holdings into this type of real estate investing.
Raising debt on investment crowdfunding portal vs. a bank loan
Banks typically require some form of collateral and/or personal guarantee in order to extend credit on a business loan. Startups or early-growth companies may have difficulty putting up collateral for a loan, which could lead them to seek alternative sources of funding.
If you are a current business owner, and you need to grow your company quickly or you are looking for an acquisition, you would again need to put up collateral for a bank loan and/or use assets or receivables to get the funding you need.
You are also subject to the underwriting of the bank you are dealing with, and if they say “no”, then that’s it. No loan.
If you raise debt through equity/investment crowdfunding, then you can set your own terms for the debt offering, and potentially raise debt from a crowd of investors who all share the risk. They may receive interest payments based on the terms of the note, and you potentially get the capital you need to continue growing your company.
Benefits of equity crowdfunding for private companies
A potentially large pool of investors
A large pool of investors may provide many benefits. Marketing efforts could help companies promote their businesses to a larger number of potential investors, as compared to some other forms of capital raising methods.
Collateral or connections not required
Depending on the type of business you have, collateral is not a requirement to raise capital through equity crowdfunding. This opens the door to an opportunity that may not have been available to you before.
Different solutions provided through equity crowdfunding
Business crowdfunding or equity crowdfunding may provide a solution for underserved startups and growing companies. Here are the potential solutions:
- Funding for startups with limited assets or collateral.
- Funding for pre-revenue startups.
- Funding for existing companies that want to grow quickly.
- Ability to use proceeds to acquire another business or company.
- Ability to use equity proceeds for marketing and operational costs.
- Ability to use equity crowdfunding for real estate projects.
- Can close the gap from proving your business concept to getting VC or private equity money or even seek an IPO.
- Funding for underserved markets, such as female or minority-owned businesses.
- Acquiring a community of investors who wish to see you succeed, as well as a new customer base.
Risks associated with equity crowdfunding
Any investor that is willing to participate in equity crowdfunding should be aware of the risks involved. Here are some of the risks below:
High risk of failure
Startups are extremely risky ventures, and there is a high likelihood that the company will fail.
Potential investors should be aware that securities purchased on equity crowdfunding portals are highly illiquid. This means that exit options are extremely limited. Similar venture capital or private equity investors, you may have to wait years for your investment to pay off, if at all.
Equity Crowdfunding and the JOBS Act
In 2012, the Jumpstart Our Business Startups Act (JOBS) was passed to make it easier for small businesses to raise capital, and thus, spur economic growth through job creation. Title III of the JOBS Act deals specifically with crowdfunding. In 2015, the U.S. Securities and Exchange Commission (SEC) adopted regulation crowdfunding to implement the requirements of Title III. And in 2016, the rules began allowing eligible companies to begin raising capital through regulation crowdfunding.
The law allows the participation of both accredited and non-accredited investors in equity crowdfunding. Also, the act establishes limitations on the amount of funds that can be raised by companies, as well as on the amount that can be invested by each investor.
Regulation of Equity Crowdfunding Portals
Equity crowdfunding portals must be SEC-registered and approved members of FINRA in order to operate.
For more information regarding crowdfunding for investors, read the SEC Investor Bulletin.