Equity crowdfunding is a form of crowdfunding that helps you find people who are willing to fund your startup in return for a financial stake in the company. While this type of fundraising can help you raise capital without going through the traditional channels (like finding venture capital or taking on debt), it’s not the right solution for every startup.
Here’s what you need to know about equity crowdfunding, including how it works, potential platforms to consider, and the pros and cons of this funding approach.
Key Points
• Equity crowdfunding allows startups to raise funds by offering ownership stakes to a large number of investors through online platforms, democratizing access to investment opportunities.
• Unlike traditional funding, equity crowdfunding attracts a wide variety of investors, from individual contributors to professional backers, enabling startups to secure diverse sources of capital.
• Startups gain not only funding but also brand advocates as investors often become loyal customers or ambassadors, boosting the company’s visibility and credibility.
• Startups dilute their ownership by sharing equity, and they must manage ongoing communication and reporting obligations to numerous shareholders.
• Alternatives to equity crowdfunding for startups include small business loans, business lines of credit, merchant cash advances, and equipment financing.
What Is Equity Crowdfunding?
Equity crowdfunding is when a private company allows individual investors (both accredited and unaccredited) to purchase equity in their company through a crowdfunding site. Should the company do well, the investor would make a profit. However, if it were to fail and go out of business, the investor would lose all of their investment.
Equity crowdfunding differs from other forms of small business crowdfunding because with it you are actually selling a percentage of your business. With rewards-based crowdfunding, you don’t give up any equity, but instead offer rewards for capital received. With loan crowdfunding, you borrow from the “crowd” instead of a traditional lender. You must repay the debt plus interest.
Equity crowdfunding is also called regulation crowdfunding because it is regulated by the U.S. Security and Exchange Commission (SEC). Because the SEC governs equity crowdfunding, you must use an SEC-registered funding platform if you want to solicit funds from the public in exchange for equity in your company.
Types of Equity Crowdfunding
There are two types of equity crowdfunding: accredited crowdfunding and open-access regulated crowdfunding.
Accredited Crowdfunding
Accredited crowdfunding is when a company raises money from accredited investors. To be an accredited investor, you must have a net worth exceeding $1 million, make at least $200,000 a year ($300,000 if filing jointly), or hold (in goodeifgjgggcdcgtenedguijkffiddtgiebgndcglkenjkt standing) a Series 7, 65, or 82 license.
Open-Access Regulated Crowdfunding
Open-access crowdfunding allows anyone to invest in a company in exchange for equity. Both accredited and nonaccredited investors alike may invest in a company running a campaign through an open-access regulated crowdfunding site.
Recommended: The Reward-Based Crowdfunding Guide
What Type of Business Can Use Equity Crowdfunding?
Any type of business can take advantage of equity crowdfunding — it isn’t limited to new startups or certain types of businesses. Whether you have a product you need help funding or you’re a veteran restaurant owner, you can create an equity crowdfunding campaign. Businesses of all kinds have found success with equity crowdfunding.
Who Can Invest In Your Business?
Before the advent of crowdfunding, only accredited investors could participate in early-stage, speculative ventures that had the potential for high reward but came with high risk. That’s not the case with equity crowdfunding. While some sites limit investors to only accredited investors, others allow anyone to take part. Individuals can often make an investment of just $100 in a promising startup.
Where Can You Find Potential Investors?
Online platforms are often the best choice for finding potential investors. Here are ten options to consider:
• Fundable
• Mainvest
• MicroVentures
• Netcapital
• Republic
• StartEngine
• Wefunder
• CircleUp
• EquityNet
• NextSeed
Recommended: Angel Investors: What They Are and How to Find Them
What Are the Pros and Cons?
All major financial decisions require you to weigh the pros and cons, and equity crowdfunding is no different. Here are some things to consider before jumping in.
| Pros of Equity Crowdfunding | Cons of Equity Crowdfunding |
|---|---|
| Provides a funding option for startups that can’t qualify for traditional financing | Must disclose company financials to public |
| Access to a large number of investors | Risk of public failure |
| Can retain majority of ownership in your business | Takes time to create a campaign and promote it |
| Could get publicity from investors who believe in your business | Must give up some of your future profits |
Pros of Equity Crowdfunding
Equity crowdfunding can provide a funding avenue for a startup that can’t qualify for small business financing due to revenue and credit requirements set by lenders. Also, with equity crowdfunding, there’s no debt to repay.
In addition, these platforms give you access to a large number of potential investors (including nontraditional investors). And, you can typically structure the crowdfunding campaign so that you retain the majority of ownership in your business, and only offer a small portion to investors.
Another perk of equity crowdfunding is that it allows you to gain visibility and build excitement before you even launch your new business. Many successful crowdfunding campaigns end up getting promoted by the investors themselves, creating a snowball effect of buzz and interest.
Recommended: How to Be Your Own Boss
Cons of Equity Crowdfunding
Unlike using a small business loan to raise capital for your company, equity crowdfunding requires giving up a portion of your company’s future profits, which could potentially be more costly than debt financing in the long run.
Also keep in mind that per SEC guidelines, you must disclose your company’s financial details to potential investors. As a result, virtually anyone will be able to access this information.
Crowdfunding campaigns can also be time-consuming, and there’s no guarantee you’ll generate enough funding to make the time commitment worthwhile. Not every company that takes this crowdfunding route is successful.
Alternative Funding Options for Startups
Equity crowdfunding is one, but not your only, option for startup business funding. There are many different types of small business loans (including equipment financing, merchant cash advances, and business lines of credit) that you may be able to take advantage of to grow your business. While banks tend to require at least two years of business history and a certain minimum amount of annual revenue, online lenders generally have more flexible qualification criteria and will often work with newer businesses. They are also faster to fund. However, rates tend to be higher.
With debt financing, you need to repay the funds you receive, plus interest. However, you won’t have to give up any ownership in (or control over) your business or share future profits. Once you repay the funds, your relationship with the lender ends.
The Takeaway
Equity crowdfunding empowers startups to raise capital while building a community of loyal investors, but it requires careful planning and compliance with regulations. For businesses seeking more traditional funding, small business loans can provide an alternative, offering structured repayment terms and preserving equity while supporting growth and operations.
If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.
FAQ
What is equity crowdfunding and how does it work?
Equity crowdfunding is a fundraising method where startups raise capital from multiple investors via online platforms by offering equity stakes in the business. Investors contribute funds in exchange for ownership shares, benefiting from potential future growth.
What are the benefits of equity crowdfunding for startups?
Equity crowdfunding provides access to diverse funding sources, increases public visibility, and often creates a community of loyal investors who can act as brand advocates.
What are the risks of equity crowdfunding for startups?
Risks of equity crowdfunding include ownership dilution, regulatory compliance requirements, and managing communication with numerous investors. Additionally, startups face the challenge of meeting fundraising targets within platform-specific deadlines.
Photo credit: iStock/jacoblund
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