Equity Crowdfunding

Helping small investors get into the entrepreneurial game

Most entrepreneurs need investors, and investing in startup businesses is, when you think of it, kind of an entrepreneurial activity.

By definition, investing in new businesses is risky, and not everyone has a ton of money to put into high-risk ventures. However, a five-year-old fundraising option for new business owners also offers an opportunity for small investors to get into the entrepreneurial game.

Called “equity crowdfunding,” this option allows individuals to put up amounts as low as a few hundred dollars to purchase shares in business startups. These shares are not truly public offerings as found in the stock markets; instead they are available through licensed, regulated brokers. These brokers operate websites — portals in the language of the trade — that are similar to typical crowdfunding sites.

The difference is that instead of making a donation to support a product, person or cause as is typical of standard crowdfunding sites — and getting non-monetary rewards for your support — you are actually purchasing an interest in the business itself.
There are multiple equity crowdfunding portals, each offering the opportunity to invest in a variety of startups. While there are clear differences among them, virtually all the portals provide a good deal of information about each of their featured new ventures, including financials, business plan, investment details, etc.

Each offering also includes a capital goal for the business, and the owner only receives the funds if that goal is achieved. When you choose to invest in a specific venture, you must provide the funds immediately, but they are held in escrow until the financial goal is reached.

There are quite a few regulations related to equity crowdfunding, including caps on how much you can invest and restrictions on selling your ownership shares. These have been put in place by the SEC (Securities and Exchange Commission, not Southeastern Conference) in recognition of the fact that startup investing is indeed risky business.

So if you pick a winner, how do you get a return on your investment? One way is through dividends: If the company you choose is successful, it can return some of its profits to its investors on a percentage basis, just like traditional shareholders receive returns. Or if the company is sold, you can expect to receive a proportional share of the proceeds of the sale. Finally, if the company decides to go public through the regular stock exchanges, the value of your shares should increase (and possibly become more liquid in the process).

Before you let the frustrated entrepreneur in you run wild, keep in mind that a large percentage of new businesses never get off the ground, while only a small percentage are successful on a significant scale. Also, while the equity crowdfunding portals do provide a lot of information on the companies they offer, you have much less knowledge about individual(s) behind these ventures. This might suggest that doing some additional research on their previous business history, if available, could be helpful in your decision-making.
On a related note, although most equity crowdfunding investors are going to make their investing decisions based on their evaluation of which ventures are most likely to succeed, there are other factors you might want to consider. For example, you might want to support businesses in our region, or those whose products or services seem likely to produce social benefits.

As with any other type of investing, get as much information as you possibly can and be mindful of the risks. That said, if you don’t have the time to build a better mousetrap yourself, equity crowdfunding at least offers you to chance to join with someone who has.

The Basics

Breaking it Down

For as little as a few hundred dollars, investors can use equity crowdfunding to purchase shares in startups through a broker. As with typical crowdfunding, each startup has a capital goal and the owner only receives the funds if that goal is achieved. If the fundraising goal is achieved, an investor’s money is pulled out of escrow and given to the startup in exchange for an interest in the business.
Examples include websites like AngelList, Fundable and Crowdfunder.

Keith Twitchell  spent 16 years running his own business before becoming president of the Committee for a Better New Orleans. He has observed, supported and participated in entrepreneurial ventures at the street, neighborhood, nonprofit, micro- and macro-business levels.

Categories: Finance, The Magazine