A Guest Post by Nathan Rose, Assemble Advisory
You may have heard of “equity crowdfunding” in passing, but not really understood exactly what was meant. There are many different types of crowdfunding, and it understandable that there’s a lot of confusion between the different forms.
In this equity crowdfunding guide, I’ll tell you what equity crowdfunding is, and why it matters to companies wanting to raise capital.
What is equity crowdfunding?
Think of equity crowdfunding as being a hybrid between Kickstarter and angel/VC funding.
Kickstarter and other such platforms offer up creative projects, causes to donate to, and pre-orders for new products. Conversely, with equity crowdfunding, pledgers become owners, not donors. Shares in the company are on offer.
Investors can even use equity crowdfunding to form a portfolio of early-stage investments – hitherto impossible for all but the very wealthy. If an investor puts money into an equity crowdfunded company and it goes on to be the next big thing, they stand to profit. This is a game-changer.
Some terminology will help understand the rest of this equity crowdfunding guide.
- Platforms– run the crowdfunding websites and select the companies to publish for investors to see. Different platforms have different specialities, and it is worth understanding these in detail.
- Companies– the companies seeking investment money, giving up a share of equity in return.
- Investors– the public. They can visit the platforms online, see the companies open seeking funding, and choose to invest if they like what they see.
Because equity crowdfunding is an offer of securities, the law needs to change in each individual country in order to make it legal. Before then, only the wealthy could access early stage companies without a prospectus being filed, and only so long as they passed a “sophisticated / high net worth” investor test. More lately governments have altered their position and allowed ordinary investors the opportunity to access a new asset class.
Equity crowdfunding has recognised that preparing a prospectus is too costly for early stage companies – and practically speaking, nobody reads those long, legalistic documents anyway. Therefore, through equity crowdfunding, ventures can raise capital with a lower level of disclosure.
Which companies can use it?
The decision to raise equity capital (of any kind) is one that shouldn’t be taken lightly, and many companies simply aren’t suited. It will work best for raising growth capital, typically over $200,000+, and giving up roughly 10 – 40% equity. It’s very rare to be used as a vehicle for existing owners to cash-out. Pre-revenue businesses are sometimes possible (but are harder). Revenue-generating and already-profitable businesses are more suited.
Although people associate “equity crowdfunding” with early-stage companies, it’s not necessarily limited to this (at least not everywhere). The lines of what constitutes equity crowdfunding have become blurred since the term was originally coined.
The World Bank thinks equity crowdfunding could be as being the missing piece to fill the well-known funding gap for companies which have grown beyond the capital that friends and family are able to provide, yet are too small for venture capital or private equity.
What will you need to launch?
An equity crowdfunding guide wouldn’t be complete without a word on what’s required. Getting ready for an equity crowdfunding offer is time-intensive, and this often surprises founders. The platforms themselves do a lot of screening of the companies, so having a strong pitch is essential to maximise the chance of a successful round. At a minimum, you will need:
- An information memorandumthat details your market size, key competitors, risks etc
- A financial modelthat details your projected business performance
- A detailed breakdown of how you plan to spend the fundsyou raise
- A justifiable valuation, with pre-money and post-money value clearly defined
- A videothat hooks potential investors into wanting to know more
- A promotionstrategy, which can be done yourself or through a public relations agency
- Legal reviewof your shareholder agreements and company constitution
All of these cost time and/or money to put together, and these costs will have to be incurred, regardless of whether your offer succeeds or fails. The platforms will also take a cut (between 5 – 10% of proceeds raised is normal), but the fees of the platforms tend to be success-based.
Why choose equity crowdfunding instead of Kickstarter?
There are pros and cons for rewards vs. equity crowdfunding. The most obvious advantage of rewards-style Kickstarter crowdfunding is that it is non-dilutive – the founders get to raise money without giving up any shares in their company. But equity crowdfunding has distinct advantages of its own:
- Suitable for more kinds of businesses, not just ones that are consumer-focused
- It’s possible to raise a lot more money with equity crowdfunding
- Your company can have a valuation validated through a public offer, which may form a valuable anchor point for the valuation of your company for future fund-raising efforts
- The rigor of the process will make you think carefully about which growth channels make the most sense, and having these challenged by investors will strengthen your company’s direction
What about the advantages over angel investment?
When weighing up traditional angel investors vs. equity crowdfunding, you should realise it’s not an “either-or” decision. Angel investors and equity crowdfunding can work well together. Equity crowdfunding benefits from being anchored by a “lead investor”, allowing founders to get the benefits of both angel investor “smart money” and the advantages of equity crowdfunding, which include:
- Likely a better outcome on valuation
- Broad shareholder base gives a large number of passionate advocates
- Strong publicity benefits, due to current interest in equity crowdfunding
- The platforms often have standardised investment terms that companies will sign up to, combating unfavourable clauses that may be inserted by financial investors as a pre-condition of investing
This equity crowdfunding guide has been a brief overview of how equity crowdfunding works. Running a successful offer is not easy, and many founders have been tripped up by the common mistakes. But equity crowdfunding is now responsible for billions of dollars in funding annually, and should be considered by any company contemplating a capital raise.
|Nathan Rose is the founder of Assemble Advisory, an agency for companies wishing to pursue equity crowdfunding campaigns, and the author of the upcoming book Equity Crowdfunding: The Complete Guide For Startups and Growing Companies.|
Also published on Medium.