If all you know of crowdfunding for startups is the world of Kickstarter, you’re missing out on a booming opportunity to raise money online. Equity crowdfunding (aka crowdinvesting) is not right for every startup, but for some entrepreneurs, it can be a terrific way to raise capital and get great investor expertise for your small business.
How is equity crowdfunding different from Kickstarter-style, rewards-based crowdfunding? One important difference: Rewards-based crowdfunding is usually for a specific product or project, but equity crowdfunding can be used for anything you define—working capital, research, marketing, hiring, and more. The other big difference: Instead of handout out product to reward your backers, equity investors usually receive a small ownership stake in your business in exchange for their money.
Raising equity online from a large pool of investors has legal requirements that some startups won’t be able to meet. Company leaders can’t have ever been convicted of a felony, for one; equity crowdfunding is more time-consuming, as well, because there is a lot of legal paperwork to complete.
But for startups with the right stuff, equity crowdfunding can be well worth it, as your business can raise large amounts of capital this way. It used to be that only super-wealthy “accredited investors” could invest in startups, but new rules contained in the 2012 JOBS Act opened equity investing to all. These provisions took effect in 2016.
Startups have been quick to capitalize on the opportunity. Statista forecasts the amount raised through crowdinvesting from $11.1 billion in 2018 to $31 billion by 2022. The number of equity crowdfunding platforms continues to grow, too. For instance, prominent rewards player Indiegogo got into equity crowdfunding in 2016, by partnering in the equity site First Democracy VC.
In the U.S., there are several different rules under which you can do equity crowdfunding online:
- Regulation Crowdfunding allows you to raise up to $1 million from unaccredited investors.
- Regulation A+ lets your startup conduct a small initial public offering (IPO) online, and raise up to $50 million from unaccredited investors.
- Regulation D is basically old-fashioned venture-capital fundraising brought online—you can raise unlimited funds, but only from accredited investors.
As you can see, there’s a lot of flexibility here. The same goes for the form of investment your equity raise will use. Options include issuing common or preferred stock, convertible debt, or using a SAFE (Simple Agreement for Future Equity). The latter grants investors the right to buy company stock in your startup’s next round of fundraising.
Finally, if you don’t want to give up any ownership in your startup and your business is making sales, you can make a revenue-share deal. In this scheme, equity investors are paid back (plus hefty interest) out of your monthly sales.
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Now that you know how equity crowdfunding works, it’s time to answer the big question: Is equity crowdfunding right for your startup?
The following questions are ones equity investors will ask about your startup. See if your answers indicate your small business is ready for equity crowdfunding:
1. Is your startup at the right stage? Most equity investors are looking for proof of concept. Your startup should have at least one product or service that’s already on the market and getting a positive reception. If your company is pre-revenue, consider whether you’d have better odds once you’re more established.
2. Have you raised money before? Online platforms look for past fundraising experience. “Usually, we’re not the first money in,” says Bill Clark, founder of the equity platform MicroVentures (Indiegogo’s partner in First Democracy VC). “You should have raised money in some aspect before.”
That prior fundraising might only be a small friends-and-family round, or seed money from an angel investor. Equity platforms tend to be picky about whom they green-light; Clark says he only accepts about 1% of applicants. Prior fundraising success is a key metric that gets you in the door.
3. Could you recruit a lead investor? You’ll stand a better chance of impressing an equity platform and getting featured if you bring a lead investor with you. Some platforms—Crowdfunder is one—flat-out won’t accept your application without a lead investor on board. It’s a myth that you will be able to find all your investors simply by being listed on an equity crowdfunding platform.
4. Does your team have a track record? While it isn’t essential, equity investors do like to see proof the team is strong. Solid team credits could include working in key positions at a top industry player (think Google or Apple in tech), or of leading other successful startups—ideally, ones that were successfully sold or went public. Many startups recruit top-drawer talent if they are planning to raise equity, so if your team is weak in this area, consider whether you might make a key hire.
5. Is what you offer unique? If there’s one thing equity investors love, it’s groundbreaking products and concepts. “Please, not yet another Groupon clone, or another type of drone,” says MicroVentures’ Clark.
6. Can you wait for the money? Equity crowdfunding isn’t an instant process you can use to solve this week’s cash-flow crisis. For instance, beauty startup Sweat Cosmetics devoted roughly six months to preparing and running its equity round on MicroVentures, which raised $255,000 in April 2018, says co-founder Leslie Osborne. Sweat had previously done a small seed round of fundraising in 2015.
It may seem counterintuitive, but most equity fundraising is for money the company could survive without. Any whiff of desperation may send investors running. Remember, one of the big reasons to do equity fundraising is for the investor expertise, not just the money. This isn’t like running a Kickstarter to get enough money to manufacture your widget.
7. Do you have an exit? Equity investors are looking down the road to the day they can cash out and reap a return on their investment in your startup. They’re expecting at some point you’ll either raise more money, sell the company, or do an IPO. If you want to retain full ownership and don’t want to sell all or part of the company in future, equity crowdfunding isn’t a good fit.
“You have to have exit potential,” says Sherwood Neiss of Crowdfund Capital Advisors, who’s a coauthor of the JOBS Act and coauthor of Crowdfund Investing for Dummies. “Nobody’s buying a dry cleaner or something like that, where you’ll never go public.”
If those questions showed your startup is at the right point to succeed in equity crowdfunding—congratulations! If not, use these tips to build a road map to prepare your small business to appeal to equity investors.
It’s worth the effort, as a successful equity campaign can be a great way to raise your profile, get funding, and build relationships with investors who can help your business grow.
Post by: Carol Tice
Carol Tice is a Seattle-based business writer for Forbes, Entrepreneur, and many others. She writes the award-winning Make a Living Writing blog and for corporate clients including Costco, American Express, and Delta Airlines. Her new e-book for Oberlo is Crowdfunding for Entrepreneurs.