This is an update to an article originally published by Naomi Garlick in 2015.
Equity crowdfunding started as an exciting development for opening access to invest in high growth startup companies with the potential for large returns. With the large returns come equal high risks. Risks are shared between the investors as well as the entrepreneurs. Small businesses now have an additional source of capital through the creation of online portals, but challenges arise with selecting the right one. Investors continue to face the same risk of any venture investment with the high chance of total failure and losing everything. Services have been created to address each of these which we review in detail.
Individuals can raise money through crowdfunding within several categories, the two most popular are donation and rewards based crowdfunding. Equity-based crowdfunding is lesser known but poses the greatest potential return to the investor. Donation and rewards based funding facilitate money movement from anyone, no matter who they are or how much money they make. However with equity-based crowdfunding, only accredited investors are allowed to invest in most equity offerings. Accredited investors are wealthy, or high net-worth, individuals who the Securities and Exchange Commission (SEC) deem capable to invest.
Equity Funding Portal Growth
Today anyone is able to invest a percentage of their income in exchange for a stake in the company. Equity Crowdfunding provides an opportunity for startups to raise capital while gaining insightful advisors. The portals help facilitate the startup's equity offerings to broader groups of investors. The Jumpstart Our Business (JOBS) Act, Title III was built to "bring Wall Street to Main Street" by allowing individuals to invest in private companies in exchange for equity. The law was believed to democratize the capital markets by creating a populist investing pool, but limitations in the US resulted in this dream falling short compared to other countries.
Since the JOBS Act have been passed allowing for general solicitation of qualified offerings, Equity Crowdfunding has experienced growth, but not to the extent some believed, including myself. When compared with rewards-based or donation-based, equity-based Crowdfunding raises the most funds per project.
President Barack Obama signed the JOBS Act into law in April 2012, and in 2016 title III was implemented. It has driven $260.9 million in funding in the Americas to help get startup companies off the ground by end of 2017. This is based on data from the University of Cambridge’s Center for Alternate Finance. According to research from PitchBook, in 2018 US Venture Capital reached $130.9 billion, and 2017 was $84 billion. That results in the Americas equity crowdfunding only totaling 0.3 percent of the overall venture funding space.
The most obvious reward of using equity funding portals would be the greater access to capital it provides entrepreneurs and greater access to investors. AOL co-founder Steve Case recently sat down with Fox News and shared some of his thoughts on the future for entrepreneurs and the equity crowdfunding phenomenon. Case told Fox News that "we're beginning to see the benefits of crowdfunding as a means of leveling the playing field, so anybody with any idea, irrespective of where they are, have more of a shot. The seed capital to get started will increasingly come from these crowdfunding platforms, and then as entrepreneurs achieve some momentum, they can more readily connect with institutional investors to get expansion capital."
Risks regarding Equity Crowdfunding platforms will always exist. Many Equity Crowdfunding platforms themselves perform their own due diligence officiating those that list on their sites. Entrepreneurs can list their equity offering on the platform and, in exchange, the platform receives compensation either in up front fees or fees structured to the deal itself. When posting an equity offering, the entrepreneur must determine that both the platform and the investors are legitimate. Likewise when investing in an equity offering, the accredited investor must determine that both the startup company and the platform are legitimate.
Online investment platforms have regulatory obligations to perform due diligence on the companies they allow to raise money. This process to review the firms requesting access to capital can shield the portals from potential liabilities.
Risk Reduction Offerings
We at Fund Wisdom review platforms prior to adding them on our database while also partnering with a number of services to address these risks.
CrowdCheck is a due diligence and disclosure company for online offerings providing transparency and investor protection to platforms, investors and entrepreneurs. Sara Hanks, Founder and CEO of the firm recently shared with us, "We help to make sure the investor has the tools to make an informed investment decision. We thus protect the issuer, the investor and the intermediary."
At Fund Wisdom we review platforms prior to working with them. We have chosen not to work with a few platforms due to their standards of vetting. We have chosen to not include Angel Investment Network, a UK-based platform that states they have "the largest database of investors worldwide" with "3,500 angel investors from the US and the remaining amount are spread across 22 other countries." This is due to the quality of offerings and compensation structure. Entrepreneurs report that upon creating a company profile they receive an email notification from AIN that a number of investors were interested in their equity offering. However, in order to be further connected with these investors, the entrepreneur must pay $99 to the platform, known as a "pay-to-pitch" policy.
Entrepreneurs must either rely upon services or perform their own due diligence on both the investing portals and individual investors before signing any legal agreements. Bill Southworth, CEO of the renewable energy startup company Elecyr, used EquityNet for one of his earliest funding rounds. He has reported that one of the investors had gone so far as to steal the identity of a genuine angel investor. Once Southworth made this discovery he immediately took down his listing on EquityNet. The Funded the "Yelp of Venture Capital" was created to allow portfolio companies to rate their investors.
Since online financing platforms provide limited information about the people involved in an investment deal, government agencies like the SEC, and FINRA, along with other service providers are working to eliminate these risks from the Crowdfunding world by providing transparency and security to both investors and entrepreneurs.
Online investing via Equity Crowdfunding is an exciting opportunity for both businesses and investors. While investors and entrepreneurs need to be aware of the risks involved in this new market, this form of financing creates the potential for huge rewards. It has and will continue to create opportunities for individuals to participate in a team of passionate and hardworking entrepreneurs. Equity Crowdfunding spurs economic expansion and job creation.
If you have any service providers or stories to share we are interested to hear. Please feel free to share in the comments below or contact us.