Equity Crowdfunding

Translating an innovative concept into a thriving business is a complicated and unpredictable proposition. For entrepreneurs without the resources to fund a startup out-of-pocket, it’s essential to secure adequate financing – often before the nascent company has any revenues – or even a marketable product – to speak of.

Traditional banks are often reluctant to fund vulnerable startups with what they perceive as unproven ideas. And though there are numerous nontraditional startup financing options, not all are suitable in all situations.

What Is Equity Crowdfunding?

Since the 2012 passage of the JOBS Act, which loosened longstanding federal restrictions on how and from whom companies can raise money, equity crowdfunding has been a viable option for U.S.-based startups and small businesses. In 2015, the SEC relaxed regulations even further through an expansive regulatory amendment known as Regulation A+. Regulation A+ dramatically increased early-stage companies’ offering capacity and expanded the pool of eligible investors, effectively bringing equity crowdfunding opportunities to small-time retail investors.

Like traditional crowdfunding through such platforms as Kickstarter and GoFundMe, equity crowdfunding allows entrepreneurs, early-stage companies, and nontraditional investment funds (often with real estate exposure) to raise substantial amounts of money. Each contributing individual gives a relatively small amount – typically at least $1,000, but sometimes less.

The key difference is that equity crowdfunding is an investment arrangement. During an equity crowdfunding round, an entity issues equity – shares of company stock – to participating investors on a proportional basis. Less frequently, early-stage crowdfunded companies may raise money through a combination of equity and debt, or debt only. However, debt arrangements are more common for later-stage companies.

In any equity crowdfunding round, the entity’s valuation is a function of the dollar amount raised against the amount of equity offered, independent of company fundamentals. A funding round that raises $1 million in exchange for 20% of a company’s total share count values that company at $5 million.

If the company or entity grows, each investor’s stake may appreciate in value. When a successful company sells itself to another firm or launches an IPO, shareholders may realize a substantial return on their investment. On the other hand, shareholders in unsuccessful ventures stand to lose part or all of their investment.

Equity Crowdfunding Platforms

In the months and years following the passage of the JOBS Act, numerous equity crowdfunding platforms – such as Wefunder and Localstake – have arisen to complement a smattering of existing platforms (AngelList and EquityNet both preceded the JOBS Act). Though each operates on a slightly different model, all aim to connect individual and institutional investors with previously unavailable investment opportunities. Investors generally have to register, often simply with a social media account, and verify their identity, income, and assets.

Some equity crowdfunding platforms, such as PeerRealty and CircleUp, act as intermediaries between investors and companies or funds engaged in active fundraising rounds. They typically hold investors’ funds in escrow until the round ends successfully, then transfer equity to the company.

Others, such as Crowdfunder and Fundable, merely allow companies to advertise fundraising efforts to the general public. In this case, investors either make a nonbinding pledge (basically an indication of interest) or a binding, signed commitment to invest within a specified period of the funding round’s closing. Companies then contact individual investors outside the platform, accept funds via check or electronic transfer, and deliver share certificates.

Still others, such as AngelList and CircleUp, operate investment funds that own shares in multiple companies or asset classes – commercial real estate, for example – offering exposure to an entire asset portfolio with a single investment.

Equity crowdfunding platforms generally earn the bulk of their income from fees charged to listed entities, though investors in multi-company funds often have to pay annual management fees. To boost investor confidence in the available investment opportunities, some platforms also invest their own capital in listed entities.

Restrictions on Offerings

Under regulatory amendments made possible by the JOBS Act and Regulation A+, eligible entities can raise up to $50 million in any 12-month period. Regulation A+ created two distinct fundraising tiers:

• Tier 1. Tier 1 companies can raise up to $20 million in any 12-month period. Each company must provide all prospective investors with a formal offering circular filed with and reviewed by the SEC and applicable state regulators in the company’s home jurisdiction. Tier 1 offerings aren’t subject to ongoing reporting requirements or audit by independent accountants. The required offering circulars are therefore the most important and complete sources of information about Tier 1 opportunities.
• Tier 2: Tier 2 companies can raise up to $50 million in any 12-month period. As with Tier 1 offerings, formal offering circulars are required. Tier 2 offerings are subject to ongoing reporting requirements: semiannual reports, annual reports, and reports around certain “enumerated events” such as a change in control or bankruptcy. Tier 2 offerings are also subject to audit by external, independent accountants.

Investor Eligibility

Before the JOBS Act was fully implemented, equity crowdfunding was limited to accredited investors. The SEC defines accredited investors as individuals who consistently earn more than $200,000 per year, couples with consistent combined income of more than $300,000 per year, and individuals whose net worth (excluding primary residence) is at least $1 million. Accredited investors are still permitted to participate in equity crowdfunding rounds with few restrictions.

Today, there are no limitations on non-accredited investors’ access to Tier 1 offerings. If you’re not an accredited investor, you can invest as much as you like in Tier 1 offerings, though you should of course do your due diligence and invest no more than you can afford to lose.

There are some limitations on non-accredited investors’ access to Tier 2 offerings. Non-accredited investors can invest no more than 10% of their net income (individually or jointly with a spouse) or 10% of their net worth (excluding primary residence) in Tier 2 offerings.

Considerations for Entrepreneurs

Easier Access to Capital

The JOBS Act and subsequent regulatory amendments removed many restrictions on advertising and eased other rules that formerly limited early-stage companies’ access to capital. Meanwhile, equity crowdfunding platforms allow startups to put themselves in front of thousands of potential investors at once, and streamline the funding process for interested investors.

The result is faster, easier, and less costly access to capital for young companies. This allows entrepreneurs to focus less on regulatory compliance and more on getting their products and services to market.

More Investors to Deal With

The flip side of easier access to early-stage capital is an increase in the number of investors involved with the firm as it tries to get off the ground. While equity crowdfunding investors typically aren’t involved in day-to-day decision-making and may not exert pressure on the company’s leaders, managing many small investors (rather than a few large stakeholders) can present logistical challenges and costs, such as the need to hire an investor relations liaison or communications staff. For Tier 2 companies, reporting and auditing requirements can be costly and burdensome as well.

Considerations for Investors

Potential for Return on Equity

For investors, the biggest benefit of equity crowdfunding is simply having skin in the game. Though most startups fail, partially or totally wiping out early investors, many go on to succeed. And a few, dubbed “unicorns” in industry parlance, achieve stunning growth and end up dominating their markets. After all, Google and Amazon were once tiny, insecure startups viewed by mainstream investors with heavy skepticism.

Traditional crowdfunding campaigns offer tangible rewards, such as a facility tour or free merchandise, for those who contribute funds. However, they don’t offer a stake in a potentially successful business.

Oculus VR demonstrates the downside of traditional crowdfunding. Back in 2012, the virtual reality startup got off the ground thanks in part to a traditional crowdfunding campaign that raised $2.4 million from thousands of contributors. Instead of shares in the company, everyone who contributed at least $25 received a branded T-shirt. Barely two years later, Facebook purchased the company for $2 billion, according to TechCrunch. While the company’s private shareholders profited handsomely from the deal, its thousands-strong Kickstarter army got nothing.

Accredited Investor Status

For many prospective equity crowdfunding investors, accreditation remains a significant obstacle to full participation. Though non-accredited investors are permitted to participate in equity crowdfunding campaigns with few limitations, many equity crowdfunding platforms remain closed to the general public.

The reasons for this vary by platform. Some platforms, such as EarlyShares and PeerRealty, impose hefty investment minimums that are simply out of reach for most non-accredited investors due to restrictions on the amount of annual income or assets they can invest. Others, such as SeedInvest, prefer to restrict access to savvy investors, using accreditation as a proxy for knowledge and experience. (SeedInvest does allow non-accredited investors to join on the expectation that it will one day allow them to participate in its offerings.) Before assuming that a particular platform is available to non-accredited investors, read its FAQ section or contact its administrators directly.

Liquidity

Equity crowdfunding involves buying shares in privately held firms. Unlike shares in publicly traded companies, these shares for the most part can’t be sold on public exchanges – though some Tier 2 companies do opt for public listings after a fashion. And though some crowdfunded entities make regular income distributions, the vast majority don’t. Even if the company you’ve invested in survives and thrives, you’re likely to wait years to see a return on your equity crowdfunding investment. Typically, this happens only when the company is bought out privately or launches an IPO.

Some equity crowdfunding platforms, such as PeerRealty, operate exchanges that allow their investors to buy and sell shares on the secondary market. However, such exchanges are typically platform-specific and may only be open to accredited investors. Given the comparatively small number of individual shareholders in any given equity crowdfunding vehicle, the liquidity of any secondary market is likely to be limited anyway. If you don’t have a long investment time horizon or want assurances of liquidity, equity crowdfunding isn’t an ideal investment.

Equity Crowdfunding Sites for U.S. Investors & Companies

These online equity crowdfunding platforms are available to U.S.-based investors and companies. While all platforms accept accredited investors, only some accept non-accredited investors. Many aren’t clear on this point, and a particular platform’s investor requirements may change at any time. Prospective investors should contact their platform of choice to determine current policy.

In all cases, investors need to provide their identity, income, and asset verification to register with the platform and participate in listed companies’ funding rounds. Unless otherwise noted, platforms don’t charge fees to register or maintain membership as an investor.

1. AngelList

Founded in 2010, AngelList is one of the oldest and most established equity crowdfunding platforms. It was originally conceived to broker connections between cash-strapped technology entrepreneurs and angel investors – high-net-worth, tech-savvy funders, many of whom earned their fortunes by selling out of their own successful startups.

AngelList remains true to its roots today. There are three main ways to invest in companies and funds on this platform:

1. Deal-by-Deal Investments. Registered investors can partner with investor syndicates led by notable lead investors – usually venture capitalists with extensive Silicon Valley experience. Syndicates generally exist to invest in specific companies. They can have dozens or hundreds of investors who pool their resources to make low-six-figure investments. (The average check size is $200,000 to $350,000 per deal.) The minimum individual investment is $1,000. Be aware that single deals are by definition not diversified, so if you’re looking to build a customized angel portfolio, you’ll need to invest in a dozen or more individual deals across multiple market segments. Also, you need to do your own due diligence – it’s not wise to take the lead investor’s word on the deal’s suitability, even if their reputation precedes them.
2. AngelList Access Fund. The AngelList Access Fund offers access to dozens or hundreds of individual deals. All are vetted by AngelList, cutting down on your due diligence responsibilities (though you should still vet all component companies yourself). The minimum investment is $100,000, so this isn’t for everyday investors.
3. Professional Investors. This service is limited to high net worth individual and institutional investors (including family offices) that can afford to invest at least $500,000 at once. Professional investors get their own AngelList representative, plus rare access to company founders and executives.

Separately, AngelList operates a high-end job board that connects developers, engineers, marketers, medical professionals, and other talented job-seekers with early-stage companies looking for help. You don’t need to register as an investor to use AngelList’s job board.

2. CircleUp

CircleUp connects investors with consumer-facing startups, mostly in the technology, fitness, and food and beverage sectors. Most companies have at least $1 million in revenue, and all “have a tangible product or retail outlet that you can touch, taste, use, or visit.” CircleUp’s machine learning engine, Helio, evaluates more than 1 million companies on billions of individual data points to pick the most promising startups from the pack.

CircleUp features company profiles with information about each company’s products, business model, leadership, retail partners, revenue, and more. Through CircleUp’s DealFlow feature, platform-registered investors can see which companies are actively raising funds, view complete investment prospectuses, and even request product samples, if offered. An investment isn’t final until the company hits its investment target, which is usually in the six- or low seven-figure range.

There are two ways to invest with CircleUp:

1. Direct Company Investments. If a company is actively fundraising, investors can purchase shares directly through the platform.
2. Circles. Circles are index funds that purchase shares in multiple companies – often dozens – at once. CircleUp selects a highly qualified CircleUp member, typically a qualified investment professional with years of industry experience, to oversee each Circle. Circles can cover specific sectors, such as health food, or include a broader mix of companies favored by the lead investor.

In both cases, listed companies set the minimum investment amount – typically $1,000, but occasionally as low as $250 or $500.

3. Fundable

Fundable offers rewards-based crowdfunding, a la Kickstarter, as well as equity crowdfunding. For companies interested in equity crowdfunding, Fundable provides hands-on help with onsite profile building, pitch construction, and even business plan development. Now operating under the aegis of TheStartups.co, whose portfolio businesses include virtual assistant platform Zirtual, its wheelhouse is software, hardware, and consumer products startups.

Fundable’s basic company profiles are available to everyone. Registered users can request a prospectus and make nonbinding funding pledges through the Fundable platform. However, Fundable isn’t set up to broker direct investments. You need to contact potential investment targets directly, and all money and shares actually change hands outside the platform. Unless otherwise noted, the minimum investment amount is $1,000.

4. Crowdfunder

Though it doesn’t formally restrict admission, Crowdfunder‘s listed companies and funds skew heavily toward innovative consumer products, consumables, and social/nontraditional niches (such as green energy startups and African real estate funds).

Company and fund profiles are incredibly detailed, with sales metrics, case studies, business plans, third-party analyses, and leadership profiles visible to the public. Unlike many equity crowdfunding platforms, Crowdfunder makes these profiles visible to the general public, including unregistered users. Registered users can request a full prospectus and audited financial disclosures as well.

As with Fundable, investors make nonbinding funding pledges (“reservations”) through the Crowdfunder platform, but the actual funding transaction takes place off-site. Transactions don’t typically close until listed companies reach their investment target. Crowdfunder doesn’t explicitly set out an investment minimum, but it’s rare to find offerings with minimums lower than $1,000.

5. EquityNet

Founded in 2005, EquityNet bills itself as the “original equity crowdfunding site” and claims to hold the only patent for the concept. Its listed entity mix is similar to Crowdfunder, with emphasis on consumer products and social enterprises. EquityNet also appears to attract single-asset projects, such as assisted-living facilities and medical clinics, as opposed to product-based startups or multi-asset funds. High-tech B2B concepts – enterprise-grade SaaS security solutions, next-generation lithium-ion batteries, “smart” glass coatings – proliferate here too.

Like Crowdfunder, EquityNet features detailed entity profiles visible to the general public, but requires registration to view full prospectuses and audited financial disclosures. Registered users message listed entities directly through the EquityNet platform to arrange a nonbinding funding pledge or binding commitment. In all cases, funding transactions take place off-site.

EquityNet doesn’t have an explicit investment minimum, but it’s rare to find minimums lower than $1,000. Higher minimums are commonplace. In a recent survey of the site, the average ranged from $5,000 to $25,000. Convertible debt offerings, or debt issues that can be exchanged for equity at some point in the future, are common as well.

6. Wefunder

Wefunder‘s co-founders were heavily involved in the debate over the JOBS Act and claim some credit for the crowdfunding-friendly measures that made it into the final legislation. Whereas most competitors require investors to put up at least $1,000 per company or fund, Wefunder offerings’ minimum investment thresholds can be as low as $100 – though many offerings require at least $500 or $1,000. Listed offerings range from funds invested in 10 to 15 early-stage companies to individual startups in the biotech, green energy, insurance, logistics, retail, and packaged food segments.

Wefunder’s comprehensive listings include detailed sales metrics (often including easy-to-parse graphs and charts), summarized business plans, interviews with leadership, and a “Why We Like This Company” section written by Wefunder staffers. Thanks to an integrated question-and-answer system, registered users can communicate directly with company founders or executives, too. All funding transactions (including in multi-company funds) occur off-site as of mid-2015, but Wefunder has indicated that this will change in the future.

7. Localstake

Localstake connects investors with revenue-generating small businesses. Listed companies tend to be involved in consumer-facing enterprises, such as brewing, food production, and apparel manufacturing. Minimum investment thresholds typically range from $250 to $500.

Localstake offers four investment options:

• Revenue Share Loans. Revenue share loans have open-ended maturities and return fixed amounts to each investor – typically an amount equal to 1.5 times principal. For instance, a representative loan offered to an individual investor might have a $1,000 principal, a total repayment amount of $1,500, and a five-year maturity – equating to a 10% annual return on investment. The offering entity makes monthly payments on each investor’s loan, based on loan principal and the company’s revenues that month. Repayments continue until the rate of return has been reached.
• Convertible Debt. Convertible debt offerings function as traditional loans until the offering entity’s next fundraising round, at which point they convert to equity at the then-current valuation.
• Preferred Equity. Investors own shares in the company, either directly or through an intermediary, and may receive regular dividend payments after a set period of time.
• Traditional Loans. Investors receive principal and interest payments according to a set schedule. Time horizons vary by company.

8. SeedInvest

SeedInvest is a more buttoned-up platform that specializes in “highly vetted investment opportunities.” The platform claims to accept just 1% of applicant companies. Though its company profiles are mostly invisible to the general public, registered investors have access to a wealth of descriptive and financial detail about each listed entity, plus direct access to founders or executives.

The majority of listed companies are individual technology startups, though there are some options from other sectors, as well as a handful of multi-company funds. SeedInvest has an escrow system that allows folks to invest in companies directly through the platform, though some funding transactions may occur outside the platform (at the discretion of each participating company).

SeedInvest was once open only to accredited investors. Certain offerings (known as Reg D offerings) remain exclusive to accredited users. Non-accredited investors can invest as little as $500 in Tier 1 and Tier 2 companies.

9. EarlyShares

EarlyShares is dedicated exclusively to commercial real estate crowdfunding opportunities, including multi-asset funds and discrete properties. For instance, you can invest in a retail complex in Las Vegas or an office building in Raleigh.

Due to the high value of the assets involved, most opportunities require minimum investments of anywhere from $5,000 to $25,000. Depending on the listed entity’s preference, investors either make binding commitments or nonbinding pledges. In either case, the transaction occurs off-platform. Traditional debt and equity investments are available.

10. PeerRealty

PeerRealty also focuses exclusively on real estate, mostly commercial and multi-family residential. Most opportunities are specific projects, such as already-completed apartment buildings and planned or under-construction office buildings. Multi-property portfolios are available as well. Note that investing in planned or under-construction projects may present additional risks.

Most PeerRealty opportunities require minimum investments of $5,000, and occasionally higher. Funding transactions typically take place through the platform’s escrow system.

PeerRealty is one of the only equity crowdfunding platforms that operates a secondary exchange where current investors can sell their shares to other PeerRealty investors. This provides investors with some liquidity, though PeerRealty doesn’t guarantee an active market for shares in any particular project or property portfolio.

Final Word

Oculus VR isn’t the only wild crowdfunding success. According to Crowdfund Insider, home automation company SmartThings raised $1.2 million in startup capital via Kickstarter. With a killer idea and strong leadership, it grew rapidly. Barely 24 months after its first Kickstarter campaign, the firm sold itself to Samsung for $200 million. Like Oculus’s Kickstarter contributors, SmartThings’ crowdfunders didn’t see a dime of that windfall.

However, for every SmartThings-sized success, there are 100 crowdfunded ideas that don’t go anywhere. Statistically speaking, even if you invest exclusively in multi-company funds overseen by experienced venture capitalists, you’re highly unlikely to ever gain exposure to a company that commands a multi-million or -billion dollar valuation within two years of its official launch. The best you can hope for is to find yourself with stakes in viable companies with solid growth potential.

In other words, equity crowdfunding is a great way for entrepreneurs and small business owners to raise money. For investors, it offers the opportunity to support exciting concepts. However, equity crowdfunding is riskier than investing in established, publicly traded firms with marketable products, experienced leadership, and a history of profitability. Don’t invest any money you can’t afford to lose.

Have you ever used equity crowdfunding to raise money for your business idea or fund a new startup? Share you comments below.

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This article is written by The Trusted Automation Advisory team, provides advisory services for leaders worldwide. If you have any questions, you can contact us via email at inquire@thetrustedautomation.com, from their website at https://thetrustedautomation.com, or phone at (949) 333-7200.

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