Equity Crowdfunding
Sound investment or crazy bet?
Hey 👋
When a company says it’s crowdfunding, the immediate question that crosses my mind is: why are you in this position and should I be worried about the health of your business?
But it strikes me how unfair that viewpoint is.
I never draw the same conclusion when a friend or colleague tells me they’re thinking about raising funds, via VCs or Angel investors, for their start-up.
And so this week, I want to take you into the world of equity crowdfunding and the merits of it as an investment opportunity.
I’ll be covering:
- What is Equity Crowdfunding? 🤷🏼♀️
- How can you make money from crowdfunding investments? 💵
- How to get started in equity crowdfunding?
- How much money would you be worth if you invested in Uber or Revolut at their early funding stages? 😳
- Notable companies that undertook equity crowdfunding 📝
- The downsides and upsides to equity crowdfunding
- Tools, resources and further reading 📚
What is Equity Crowdfunding? 🤷🏼♀
You’ve probably heard the term “crowdfunding” before, likely in the context of a Kickstarter campaign or a GoFundMe page.
At the most general level, crowdfunding refers to a financing model in which small sums of money are collected from a large pool of people (the crowd).
Equity crowdfunding uses this same model, but instead of offering products or perks, funders receive a percentage of ownership, a financial stake in the company, or the right to future revenues or crypto-assets with an aim to earn a return.
To avoid any confusion, the other two other types of crowdfunding are:
Reward-based crowdfunding 🛍️
This is when you contribute money and get a reward or product in return. This is mostly used for creative campaigns, and there are often different levels of rewards, or perks, that correspond to pledge amounts. Think Kickstarter and Indiegogo.
Donation-based crowdfunding 🤲🏼
This is when a funder contributes to a campaign without expecting any perks or value in return. This is mostly used to fund charitable causes, like funding to build a school in an underdeveloped region, or personal expenses, like helping pay a friend’s medical bills. Think GoFundMe, YouCaring and CrowdRise.
Legal stuff…
It’s worth pointing out crowdfunding is legal and since 2016 non-accredited investors in the US can invest in private small businesses and start-ups.
Prior to 2016, investing in a private company was illegal unless you were an ‘accredited investor’ i.e. you were very wealthy.
If you’re a non-accredited investor, there’s some rules about how much you can invest, which is all based on net worth.
This calculator will give you a sense of how much you’d be able to invest in Reg CF (Regulated Crowdfunding) deals over a 12-month period.
How can you get started in equity crowdfunding? 🗒️
🕵️ Find a business (that’s running a crowdfunding campaign) that you want to invest in!
Equity crowdfunding takes place through online platforms - websites that bring companies and investors together. Although the companies seeking crowdfunded capital are not subject to government oversight, the equity crowdfunding platforms are.
An equity crowdfunding platform must either be operated by a licensed broker-dealer or registered with the SEC as a "funding portal". A platform must also become a member of the Financial Industry Regulatory Authority (FINRA), which regulates brokerage firms.
Most of the platforms are all fairly easy to use and generally work in the same way. As an investor you log on to the platform's funding portal site and verify relevant financial information, such as income and assets.
Then you can see all the offers from companies seeking capital: information about the companies, their plans and details of the deal, such as the company's price per share.
🗒️ Due diligence
Once you’ve created a shortlist of potential companies you’d like to invest in, you’ll need to then carry out some investigation to make sure you’re comfortable with everything.
Considerations:
- Review the business plan: thoroughly examine the business plan and financial projections provided by the company seeking funding. Look for clear and realistic goals, a viable market strategy, and a well-thought-out path to profitability.
- Understand the industry: familiarize yourself with the industry in which the startup operates. Understand the current market trends, potential challenges, and the competitive landscape. Investing in an industry you understand will help you make more informed decisions.
- Assess the management team: The management team is a critical factor in the success of any startup. Research the backgrounds and experience of the founders and key team members. Look for a team with relevant expertise, a track record of success, and a clear commitment to the venture. For what it’s worth, this is my number 1 out of all due diligence.
- Review financial statements: Request access to the company's financial statements and analyze them carefully. Pay attention to revenue growth, expenses, profitability, and cash flow. If you are not financially savvy, consider seeking advice from a financial advisor.
- Evaluate valuation: Assess the valuation of the company seeking funding. Compare it to industry peers and similar startups to determine if it's reasonable and realistic. Overvalued companies may present higher risks for investors.
- Check for legal and regulatory compliance: ensure that the company is compliant with all relevant regulations and has filed the necessary legal documents. Equity crowdfunding is subject to specific rules, and non-compliance could lead to problems down the road.
- Investigate use of funds: understand how the company plans to use the funds raised through crowdfunding. Ensure that the allocation of funds aligns with the business plan and supports the company's growth objectives.
- Understand investor rights: familiarize yourself with the rights and privileges associated with the equity shares you'll be purchasing. Know what level of influence or control you will have over the company as a shareholder.
- Risk assessment: Assess the potential risks associated with the investment. I’d suggest outlining all the risks and reflect on can the company succeed despite theses risks. And of course, whether your risk tolerance will accept or not.
Some of the top crowdfunding platforms include:
Billed as the largest equity crowdfunding platform based on investment volume from Regulation Crowdfunding (Reg CF) offerings since 2016, Wefunder allows anyone to angel invest in startups.
Minimum Investment: $100
Fees: Wefunder charges investors a transaction fee of 2%, with a minimum of $8 and a max of $100. For credit cards, Apple Pay, or Google Pay, Wefunder charges a 5% fee, with a minimum of $8 and no maximum. Fees are one-time and are not reoccurring.
Non-Accredited Investors? ✅
Target Return: Varied (typically 10% – 20%)
Country Available: Worldwide
Term of Investment: Varied (typically 3 – 7 years)
According to their LinkedIn, StartEngine has helped more than 750+ companies raise over $700 million raised between Reg. CF and Reg. A+ combined through StartEngine’s funding portal and broker dealer, from a community of over 1,000,000 prospective investors.
Minimum Investment: $100
Fees: So the way Start Engine works is that they don’t typically charge the investor any fees, as they make their money through the issuer i.e. the company raising the funds. But they do give the issuer the option of offsetting the fees by charging the customer, though this seems the exception rather than the rule.
Non-Accredited Investors? ✅
Target Return: Varied (typically 10% – 20%)
Country Available: Worldwide
Term of Investment: Varied (typically 3 – 7 years)
Republic is definitely geared to the everyday investor and you can invest from as little as $50. In terms of the offering on their site, it’s vast, everything from health and wellness to fintech – including cryptocurrency startups.
Minimum Investment: $50
Fees: 0% (Republic take the same approach to Start Engine)
Non-Accredited Investors? ✅
Target Return: Varied (typically 10% – 20%)
Country Available: Worldwide
Term of Investment: Varied (typically 3 – 7 years)
Mainvest differs to the others I’ve mentioned in that their core focus is on small and medium sized businesses and they also have a different repayment structure.
Also, before being listed publicly on Mainvest, a business must raise at least $10,000 from 10 people they know personally.
Personally I really like this approach as it shows a level of convinction and they already have skin in the game.
Minimum Investment: $100
Fees: 0%
Non-Accredited Investors? ✅
Target Return: Varied (typically 8% – 12%)
Country Available: Worldwide
Term of Investment: Varied (typically 1 – 5 years)
From my research, Seed Invest gets some top reviews. They accept just 1% of the startups that apply, yet still manage to offer a very broad selection of investment offerings spanning industries and company stage, most open to any investor.
Minimum Investment: $500 (although from searching many companies have a $1k min investing threshold).
Fees: Investors pay a 2% transaction fee on SeedInvest that's capped at $300. This fee is returned if you invest in a company that doesn't end up completing its raise.
Non-Accredited Investors? ✅
Target Return: Varied
Country Available: Worldwide
Term of Investment: Varied (typically 3 – 7 years)
Note: In the resources section at the end, I link to some super helpful deep reviews of each platform.
How much money would you have made if you invested in Uber or Revolut at their early funding stages? 😳
When Uber originally started fundraising, it was pre 2016 and therefore it was not possible for non-accredited investors to invest.
But for argument’s sake, let’s say the next Uber is currently crowdfunding, how wealthy could it make you?
Well, let’s look at the numbers for some of the earliest investors in Uber….
Not too shabby, right?
And how about UK Fintech, Revolut?
If you were one of the 433 investors that had invested the maximum £5k allocation of Revolut shares when they raised funds on Crowdcube then you really are sitting on a goldmine, given most recent valuations put the company close to $20 billion.
I do recognise I am highlighting $ beasts in the crowdfunding space and these figures are the exception rather than the rule.
What it hopefully does demonstrate is that when you choose a good horse that can go the distance, then equity crowdfunding can be incredibly lucrative.
Picking the horse being the challenge, of course.
🚨 Equity crowdfunding risks🚨
Before you might rush off to invest in what you think may be the next ‘hot thing’ take a pause, and reflect on some of the risks:
Start-ups fail, all the time:
Firstly, most companies fail. That’s a somewhat cliche thing to say, I realise, but it’s arguably the most important point to be aware of ahead of investing in equity crowdfunding.
The performance of startups tends to follow a power law curve. The idea is that a handful of startups will generate almost all the profits each year.
Accessing the most promising start-ups is a challenge:
Sadly, you can't just invest in any startup you want. You have to secure access to a startup's funding round. This is the job of equity crowdfunding platforms.
Their role is to convince the best founders, who often have alternative funding options, to list on their platform. The better the business, the more competitive it is to secure access, as you are competing against angel investors and venture capitalists who are trying to maximise their share of the round.
Dilution of ownership:
Unlike venture capitalists and early angel investors, equity crowdfunding investors very rarely have pro-rata rights to maintain their percentage in companies as they scale.
As a result, future investors will dilute equity crowdfunding investors, further impacting their returns.
Let’s bring this to life using an example…
Imagine there's a startup called "Grubby" that offers an awesome product. They are seeking funding to grow their business and decide to raise money through an equity crowdfunding campaign. During the campaign, they offer 1,000 shares of the company at $10 per share, valuing the company at $10,000.
You decide to invest $100 and purchases 10 shares of Grubby at $10 each, which represents 1% ownership of the company (10 shares / 1,000 total shares).
A few months later, Grubby's business shows great promise and attracts the attention of venture capitalists (VCs). The VCs offer to invest $10,000 in Grubby in exchange for 1,000 additional shares, which means the company is now valued at $20,000 ($10,000 original valuation + $10,000 from the VCs).
Grubby accepts the VC investment, issuing the additional 1,000 shares to the VCs. Now, the total number of shares in the company has doubled to 2,000 shares. Your original 10 shares are now only 0.5% of the company (10 shares / 2,000 total shares).
This means that your ownership percentage has been diluted from 1% to 0.5%.
The dilution occurred because new shares were issued, reducing the proportion of ownership each existing shareholder holds in the company.
In more complex scenarios, dilution can occur due to subsequent funding rounds, stock option grants to employees, or other events that increase the total number of shares outstanding. As a result, an investor's ownership percentage can decrease unless they invest more money to maintain their ownership stake.
Years to materialize
Every investor expects some future return. However, returns on equity crowdfunded ventures may take many years to materialize, if at all.
If you decide to invest, you should absolutely view it as a long-term investment.
Highly illiquid investment
Any equity crowdfunding investment you make will be highly illiquid as there's no secondary market where you can easily sell on your shares. This means you will most likely have to hold on to your shares until the company you invested in exits or floats on an exchange.
Potential Upsides ☀️
I appreciate I listed a lot of risks, and being blunt there’s probably only one key upside worth discussing:
The (potential) size of returns
Since the risks are high, the potential for huge returns on equity crowdfunding is high, too.
In short, if you think you’re capable of spotting the next Uber or Revolut and you’re willing to invest time and effort into investigating which companies are crowdfunding and their long-term potential, then this could be an interesting avenue to look into.
And from my research, I’m sensing that the stigma associated to equity crowdfunding i.e. that they’re VC and top angel investor rejects is fading, meaning we will see more great companies using equity crowdfunding as an investment mechanic.
Recent crowdfunded companies
- Mercury: In August 2022, Mercury, the banking for startups platform, raised $4,914,037 from 2,453 investors.
- Replit: In May 2022, Replit, the collaborative coding platform, raised $5,240,140 from 2,589 investors.
- Substack: In March 2023, Substack, the publishing platform for subscription newsletters, raised $7,990,918 from 6,921 investors.
- Meow Wolf: In August 2017, Meow Wolf, the Disneyland-psychedelic-like funhouse, raised $1,322,006 from 621 investors.
- Modern Times: In May 2019, Modern Times, a famous brewery with multiple tap rooms throughout the United States, raised $1,224,431 from 1,189 investors.
Tools, resources and further reading 📚
- Equity crowdfunding platform reviews - not all the major platforms are covered but those that are are covered in great depth in this piece from Boring Business Nerd.
- Crowdfunding success stories - a view of some great success stories, for investors and companies.
- Equity dilution calculator - a simple calculator letting you see how your overall ownership could change if further shares get issued
And that’s a wrap on equity crowdfunding - hope you this insightful! I
Jason
DISCLAIMER: None of this is financial advice. Finbrain is strictly for educational purposes.