Every entrepreneur has felt the struggle of raising money for a business. It costs tens of thousands of dollars to launch even a modest startup, and potentially millions of dollars for a bigger or more demanding idea. Old school tactics like tapping into personal loans or shopping for an angel investor are still around, but these days, more and more entrepreneurs are tapping into the power of equity crowdfunding.
The basics of equity crowdfunding
According to Invest.net, crowdfunding is “an online method of raising capital where entrepreneurs or small business owners seek funding for future ventures from the public.” This type of campaign appeals to many investors, who each play a small part in reaching a funding goal by contributing to an idea of interest.
By now, you’re likely familiar with other types of crowdfunding. You might have even contributed to someone else’s crowdfunding campaign. But traditional forms of crowdfunding usually call for contributions in exchange for some expected payout, like a copy of a product in the future. With equity crowdfunding, contributions will be exchanged for equity in the company — in other words, every contributor in your equity crowdfunding campaign will become a partial owner of your business based on the amount they contribute.
Strengths of equity crowdfunding
There are several advantages to this model, including:
- Reach – With an equity crowdfunding campaign, you can hypothetically reach anyone in the world. If you support that campaign with marketing and advertising, You can instantly multiply your initial reach. More potential contributors increase your chances of reaching your financial goals and could increase the total amount of capital you generate.
- Financial streamlining – Equity crowdfunding also makes the investment process simple, thanks to the simplified equity crowdfunding platforms that are available to today’s entrepreneurs. While there are some legal limits and regulations you’ll have to consider, for the most part, the process is streamlined.
- Elimination of debt – One of the most common ways to fund a business before equity crowdfunding was taking out loans. But incurring debt isn’t always a good thing; equity crowdfunding allows you to bypass this necessity altogether.
- Marketability – Equity crowdfunding campaigns can also be a valuable litmus test to evaluate the strength of your idea. If nobody wants to fund your business, you might have to take another look at your business model and revise it to be stronger.
Weaknesses of equity crowdfunding
However, there are also some weaknesses, especially when you compare equity crowdfunding toward other forms of fundraising:
- Inherent limitations – The Securities and Exchange Commission (SEC) regulates equity crowdfunding and equity crowdfunding platforms, so there are some limitations in place. Thankfully, these limitations are quite forgiving; your business must be based in the United States or Canada, and you can only raise up to $50 million via equity crowdfunding in a 12-month period (though this can vary depending on which tier of fundraising you’re using).
- Fees – Most equity crowdfunding platforms charge fees for the privilege of using these platforms for your campaign. Fees vary, but most of the fees are reasonable. Still, it’s important to know that you’re not going to get all the money for free.
- Potential for failure – There’s no guarantee that your campaign is going to be a success. If your equity crowdfunding round fails, you’ll have wasted significant time and you’ll still need to raise capital – possibly through a traditional method instead.
- Legal requirements – On the surface equity crowdfunding is relatively simple, but the backend legal frameworks can get complicated. You’ll likely need to work with a lawyer to make sure everything is up to snuff.
- Risks of forfeiting equity – Some entrepreneurs are concerned about forfeiting portions of equity in their companies. When you allow equity crowdfunding contributors to become partial owners of your business, you’ll necessarily give up some degree of control. Whether or not that’s tolerable to you depends on your outlook and your business objectives.
- Demand for persuasive materials – Most people won’t contribute money to a company just because it looks interesting. They want to see a well-thought-out business model and a financial plan with significant potential for a future payoff. If you don’t have these persuasive materials, you’re going to struggle to raise the capital you need.
Is equity crowdfunding right for your startup?
Crowdfunding isn’t inherently good or inherently bad, but it’s better for some startups than it is for others. Before making any final decisions for your business, consider the following variables:
- The amount of funding you need
- Personal goals and objectives
- Business goals and objectives
- Willingness to surrender equity
- Willingness to spend time assembling and promoting the campaign
- Legal experience (and willingness to hire a lawyer)