What Is It & How Does It Work? – Forbes Advisor

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As a small business owner, attracting traditional investors to help fund your startup can be challenging. For instance, less than 1% of startups receive funding from angel investors and only .05% of startups benefit from venture capital, according to the business crowdfunding platform Fundable.

On a positive note, you may be able to leverage shares of business equity in exchange for capital through a strategy known as crowdfunding equity. Equity crowdfunding isn’t the right approach for every entrepreneur. But if you’re interested in debt-free ways to fund your business, it might be a good fit for you.

What Is Equity Crowdfunding?

Equity crowdfunding is a unique way to raise capital for your business without taking on new debt. It’s a form of fundraising that attempts to attract investors who are willing to contribute funds toward your business goals in return for a financial stake in the company.

In general, equity crowdfunding is a business funding model that involves collecting smaller sums of money from a larger number of private investors. Would-be investors may be able to get involved for as little as $100. This approach differs from trying to attract sizable investments from venture capital firms or angel investors—a business capital strategy that’s out of reach for many startups and established small businesses alike.

How Equity Crowdfunding Works

Equity crowdfunding is also called regulation crowdfunding because it is regulated by the federal government. Even though you’re not selling shares on a stock exchange, your business is still offering equity to investors in exchange for capital. As a result, the process entails more rules than you would encounter with a simple online fundraising campaign like GoFundMe or Kickstarter.

If you want to use equity crowdfunding to raise capital for your business, the following rules are critical. Otherwise, you could face some unpleasant consequences. For example, failure to follow the rules might force you to refund any investments you receive. In some cases, the US Securities and Exchange Commission (SEC) might even freeze your business’ ability to offer shares to investors for a period of time.

Below are a few of the steps you’ll need to complete in order to sell business shares through an online crowdfunding platform.

  • Work with an SEC-registered broker-dealer (aka a funding portal) to process any investment transactions
  • Accept no more than $5 million per year in crowdfunding investments
  • Follow federal income limitations on the amount you accept from individual, nonaccredited investors in a 12-month period (amounts vary based on)
  • Make any necessary financial disclosures public, based on the amount of funding your business raises

Beyond the legal concerns, you’ll also need to design a compelling campaign if you hope to energize the public and convince others to invest in your business. A good equity crowdfunding campaign should communicate key details to potential investors, including:

  • The amount of money you need to raise
  • How you plan to use the funds
  • Your target customers
  • Your profit margin
  • What makes your business different from competitors
  • Why investors should back you

Equity Crowdfunding vs. Other Types of Crowdfunding

With equity crowdfunding, you can attempt to raise funds from private investors and offer unlisted shares in your company in return. This model differs from offering shares of a company on an official stock exchange. Nonetheless, you will still need to register with the SEC to participate in this form of equity-based fundraising.

Of course, offering shares of your business to would-be investors isn’t the only form of crowdfunding that exists. There are other ways to reward and entice investors through crowdfunding platforms that don’t involve giving up any pieces of your business.

Rewards Crowdfunding

Rewards-based crowdfunding is another fundraising option that may appeal to entrepreneurs who don’t want to take on debt that needs to be repaid. This form of crowdfunding seeks contributions from financial backers and offers some type of benefit as a trade-off.

The rewards you offer to contributors can be as simple or complex as you like. For example, an author might offer copies of their book before it’s published or a massage therapist might rewards donations with gift certificates for future services.

Keep in mind that it may take some trial and error to find rewards that motivate people to support your vision. Some entrepreneurs offer different types of rewards according to the amount a supporter contributes as well.

Debt Crowdfunding

Debt crowdfunding is a cross between traditional crowdfunding and a small business loan. With this type of business financing, you’re taking out a loan from a crowd instead of a financial institution or online lender.

When you use debt crowdfunding to finance your business, you’ll have a loan agreement just as you would with a lender. You’ll repay the money you borrow, plus interest, over an agreed-upon number of months. However, you do not have to offer shares of your business to secure this type of funding.

Donor Crowdfunding

Donor crowdfunding, also called donation-based crowdfunding, is a process that involves people contributing money to a cause without expecting anything in return. For example, friends and family members might donate money to support a loved one’s dream of opening a new business. Charities and nonprofit organizations may also use this form of crowdfunding to solicit donations from supporters who believe in the cause they represent.

There are many online platforms available for donation-based crowdfunding campaigns. A few examples include GoFundMe, CrowdRise and Fundly.

Equity Crowdfunding Sites

Because the SEC regulates equity crowdfunding, you must use an SEC-registered funding platform if you wish to solicit funds from the public in exchange for equity in your company.

Despite the regulatory hurdles, there are a number of equity crowdfunding platforms available. As a small business owner, this is good news. You can review several sites to find the option that is the best fit for your situation.

Below are nine equity crowdfunding sites to consider.

Pros and Cons of Equity Crowdfunding

As with any form of business funding, there are positives and negatives to consider where equity crowdfunding is concerned.

Pros of Equity Crowdfunding

  • Equity crowdfunding offers a business funding solution if you cannot qualify for sufficient financing other due to credit issues, revenue limitations or other lender requirements needed to qualify for a business loan.
  • There’s no debt to repay.
  • By working with a larger number of investors, you might be able to raise more money.
  • As a business owner, you can structure crowdfunding campaigns so that you retain the majority of your business equity and only offer a small portion to investors.
  • You may be able to attract nontraditional investors to support your business goals.
  • You can gain visibility and build excitement before you even launch your new business.

Cons of Equity Crowdfunding

  • You give up a portion of your company’s future profits in exchange for cash now.
  • Per SEC guidelines, you must disclose your company’s financial details to potential investors, and that means almost anyone can access that information.
  • There’s a risk of public failure if your equity crowdfunding campaign isn’t successful.
  • Equity crowdfunding platforms charge fees and may keep a percentage of the funds your business raises (often 5-15%) in the form of commission.
  • Traditional investors likely won’t be interested because it can be tough to resell the shares of smaller companies without taking a financial loss.
  • Crowdfunding campaigns may be time-consuming, and there’s no guarantee you’ll generate enough funding to make the time commitment worthwhile.

Alternatives to Equity Crowdfunding

Equity crowdfunding can be a great way to raise capital for some entrepreneurs. However for some businesses, it is not the right approach, and for others, it may only be one piece of the overall funding award. If you need an alternative to equity crowdfunding, or a way to supplement the funding you raise, one of the three options below might be worth considering.

Business Loans

Small business loans are a more traditional way to generate the capital you need to start or grow your business. There are many options where small business loans are concerned as well—from affordable US Small Business Administration (SBA) loans to online business loans that may work well for new businesses and others who have trouble qualifying for traditional financing.

Business Credit Cards

Business credit cards offer a flexible way to borrow money for your startup or existing business. If you have good personal credit, there are numerous business credit card options that may be easier to qualify for even if your business is new.

Investors

If you have a promising startup business, you may be able to attract funding from venture capital firms or angel investors. While trying to work with accredited investors isn’t the right move for every new business, if you’re successful you might be able to get enough funding to take your startup to the next level.

Find the Best Small Business Loans of 2022

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