The numbers don’t lie. Equity crowdfunding remains one of the most popular ways to raise money.
In 2020, even amid the height of the coronavirus pandemic, $239.4 million was raised via equity crowdfunding in the United States – a 77% jump from 2019. While campaigns raised about $74 million in 2018.
Many see equity crowdfunding – where people invest in an early-stage company in exchange for shares – as a model that helps democratize the investment process by empowering more people to get involved.
While equity crowdfunding continues to gain a reputation as a viable way to raise capital, many still have questions about the concept. Here’s a breakdown of common questions along with the answers you need.
What Is Equity Crowdfunding?
Equity crowdfunding is a ‘security-based’ fundraising model, and common stock remains the most popular crowdfunded security.
Equity crowdfunding has grown in popularity as it allows investors to secure a financial stake in a company with smaller amounts of money. Historically, the model was regarded as a last-resort strategy as the business world would often presume a company or idea was not viable enough to attract institutional dollars.
However, many today see equity crowdfunding as a savvy marketing strategy, since it provides opportunities to “pre-sell” an idea, concept, or business.
Is Crowdfunding Legal In The US?
In the United States, equity crowdfunding is legal and regulated by the Securities and Exchange Commission (SEC), since investors receive a financial return.
The Jumpstart Our Business Startups (JOBS) Act birthed the equity crowdfunding industry in the United States. First enacted in April 2012, the legislation initially only permitted investment by accredited investors.
In June 2015, the addition of Title IV opened up opportunities for large companies to crowdsource from ‘ordinary people’ (non-accredited investors).
About a year later, Title III of the JOBS Act came into force, permitting early-stage startups to solicit up to $1 million from non-accredited or accredited investors within a year. 2021 saw this limit raised to $5 million, opening up opportunities for companies needing to raise more funds.
Companies looking to equity crowdfund must follow strict SEC standards. For example, all transactions must occur within an SEC-approved online broker-dealer or funding platform. The regulator also mandates various reporting and record-keeping requirements for companies. Now that RedCrow is a part of Alira Health, they have begun building ‘Reg CF’ platform to open the door to their companies to take advantage of the opportunity to raise capital based on Title III.
What are the risks associated with equity crowdfunding?
Despite its growing popularity, equity crowdfunding does come with a degree of risk that investors need to be aware of.
Any investment will be naturally illiquid as shares are not able to be easily sold on secondary markets. Investors will likely need to hold until the company exits or floats on an exchange.
Reaching these milestones could take years. Investors may need to be patient before they make a return on their investment. Many startups are also unable to pay dividends to investors.
Dilution is another issue. Companies that raise more capital will issue new shares to new investors, which means the percentage a shareholder has in a company will decrease.
Are equity crowdfunding websites regulated?
Legitimate equity crowdfunding platforms are properly registered as a broker or funding portal with the SEC. They must also become a member of the Financial Industry Regulatory Authority (FINRA).
On its website, FINRA publishes a list of SEC-registered and FINRA member crowdfunding intermediaries and broker-dealer firms. Prospective investors can visit these pages to search for legitimate crowdfunding intermediaries.
What are the benefits and drawbacks of equity crowdfunding?
One of the key advantages of equity crowdfunding is the ability for an entrepreneur or company to raise capital from investors who believe in their mission and vision.l
Opening up opportunities for small-scale investors lets those interested in a company get involved, while still ensuring the leaders can maintain a large ownership percentage. Overall, equity crowdfunding is a strong economic driver in the United States as it enables business owners to bring ideas and concepts to fruition.
Drawbacks include the potential for investors to need to wait for long periods of time to see a return on investment and the ever-present risk of fraud and manipulation.