What is equity crowdfunding?
Equity crowdfunding gives you access to small investors en masse. Plus, it lets you do startup fundraising without ever setting foot in a venture capitalist’s office.
But equity crowdfunding isn’t right for everyone. And the landscape is constantly evolving—it can be hard to keep up with trends. So here’s your equity crowdfunding primer: What it is, how it works, a little history, and the pros and cons.
You’re probably familiar with crowdfunding, minus the equity.
Example: An artist wants to release an album, so they post it on a crowdfunding platform, collect money from fans, and use it to produce the album. In exchange, fans get copies of the album, t-shirts, stickers, or other products, depending on how much they contributed.
In equity crowdfunding, the crowd gives you money in exchange for securities. How is this different from going public?
For starters, you don’t need to file an IPO, thanks to SEC exemptions (discussed below). At the same time, you have to abide by restrictions set by the SEC, which affect how you advertise your funding round, as well as who can invest—and how.
Equity crowdfunding and the JOBS Act
After the market crash of 1929, the SEC was formed, in part to protect investors. The SEC put limits on how privately held companies could advertise or publicize stock offerings.
Essentially, if you were part of a private company and you wanted to sell stock to investors, you would need to get to know each of them individually, and approach them one-on-one.
Especially after the 2008 recession, these limits made it difficult for early stage startups to raise capital. Three entrepreneurs—Sherwood Neiss, Jason W. Best, and Zack Cassady-Dorion—got together and created the Start-up Exemption Regulatory Framework.
Then, they lobbied congress. Partly due to their efforts, President Obama signed the JOBS Act into effect in 2012. In 2016, Title III of the JOBS act went live, allowing private companies to raise money from investors, within certain limits (discussed below).
Prior to that, private companies could only approach accredited investors with stock offerings. Accredited investors are, almost literally, “The One Percent”; in fact, they comprise roughly the wealthiest 2% of Americans.
Now, private companies can raise money from any investor, so long as they abide by the rules of SEC exemptions Reg CF and Reg A+.
SEC exemptions for equity crowdfunding
SEC exemptions Reg CF (Title III of the JOBS Act) and Reg A+ (Title IV of the JOBS Act) are at the heart of equity crowdfunding; by applying for one of these exemptions, your private company can legally solicit investors and sell securities.
Under Reg CF, you are able to sell up to $1.07 million in securities to investors over a 12 month period.
In order to qualify for this exemption, you must:
- Go through a broker-dealer or funding portal (crowd equity platform) approved by the SEC
- File Form C with the SEC, which includes basic information about your company
- File annual reports with the SEC (covered below)
Take note: The SEC does not review Form C—that is, by allowing you to take advantage of Reg CF, they are not approving or endorsing your securities in any way.
Additionally, you need abide by the following:
- You may close the funding round a minimum of 21 days after making the initial offering
- If there are any material changes to your offering, you must notify investors. They have 5 business days to reconfirm their purchase
Investors are limited to investing:
- The greater of $2,000 or 5 percent of their annual income, if their income is below $100,000
- Ten percent of their annual income, up to a limit of $100,000, if their annual income is over $100,000
Financial disclosure under Reg CF
When you file Schedule C with the SEC, you must disclose:
- Information about you (the issuer) and the offering
- Description of the business, including your intended use of proceeds from the offering
- The target offering amount and deadline
- The offering price
- Debts you owe
- Number of employees
- Information about prior exempt offerings
- Risk factors (as undertaken by investors)
- Information about any intermediaries
For a deep dive into disclosure and reporting requirements, check out Regulation Crowdfunding: A Small Entity Compliance Guide for Issuers.
Sometimes referred to as a “mini IPO,” Reg A+ allows private companies to raise up to $70 million from accredited investors and the general public over a twelve month period. You can even list your offering on major stock exchanges.
This comes at a trade-off. Qualifying for Reg A+ is a more involved process than qualifying for Reg CF. It’s still considerably less involved than an IPO, but as one of the requirements, you must have enough money to hire the lawyers and accountants called for in the application process.
For a full explanation of Reg A+ reporting requirements, see Amendments to Regulation A: A Small Entity Compliance Guide.
A note on SAFEs and convertible notes
During equity crowdfunding rounds, issuers typically sell securities in the form of SAFEs and convertible notes. If you’re unfamiliar with either of these products, check out our guide, Startup Fundraising: Key Differences Between SAFEs and Convertible Notes.
Equity crowdfunding vs. venture capital
Both long-term and more recently, equity crowdfunding is on a path to comprise a larger portion of the startup investment market than venture capital.
Between 2013 and 2015 alone, equity went from raising a total of about $3 billion annually in investments to raising more $30 billion. During that same period, VCs went from raising just under $30 billion annually in 2013 to just under $50 billion in 2015.
More recently, while the COVID-19 pandemic has pushed VCs to invest more conservatively, equity crowdfunding hasn’t flagged. In fact, the crowdfunding platform StartEngine has shown 300% growth in equity crowdfunding since the pandemic began.
Major equity crowdfunding platforms
There are dozens, if not hundreds, of equity crowdfunding platforms to choose from. Here are five of the big players, and what makes each unique.
Smaller, everyday investors tend to favor Republic, which boasts minimum investments as low as $10 (though many funding rounds set higher minimums). That means you’ll get access to both accredited and non-accredited investors. If you successfully complete a funding round on Republic, you’ll pay 6% of the total amount raised as a fee.
Claiming that it has raised more money for startups than any equity crowdfunding platform, StartEngine is, like Republic, a popular choice for smaller investors; for most offerings, the minimum investment is less than $500. Issuer fees are based on the type of payment used by investors—for instance, expect to pay 7% of the amount raised by wire fee, 11% of the amount raised by credit card, and so on. See a full list of StartEngine fees.
As well as being one of the biggest names in equity crowdfunding, AngelList is favored by larger investors. Only accredited investors are able to use the platform, and most of them invest in funds: rolling funds are themed, and have quarterly funding rounds; and access funds hold multiple rolling funds. In addition to these, syndicates raise money for individual deals.
Breaking the mold just a little, Netcapital lets established companies sell securities on their platforms, with investors able to make minimum purchases of $99. If your company has already made it through early seed rounds already, Netcapital could be a good choice for you. The platform charges issuers 4.99% of the amount raised.
Founded in 2009, MicroVentures is one of the oldest crowdfunding platforms. They specialize in early stage companies, and accept both accredited and non-accredited investors. Minimum investments can run as low as $100. MicroVentures also operates a secondary market for users to buy and sell shares.
Equity crowdfunding pros and cons
Like any method of raising money, equity crowdfunding comes with its pros and cons. Considering both can help you decide whether it’s right for your startup.
Equity crowdfunding: the Cons
- Disclosure and transparency: By making information about your company public on trading platforms, you may end up showing your hand too soon. For companies that require stealth, equity crowdfunding isn’t a great fit.
- Cost: You’ll likely still need to pay legal and accounting fees to prepare the documents you need to file for an equity crowdfunding exemption.
- Reputation: The jury is split on this one. Some thought leaders in the startup sphere claim that relying on equity crowdfunding early on makes it seem as though you’re unable to find VC investors—and that, in turn, puts off VCs during future rounds. Other thought leaders say it doesn’t make a difference—equity crowdfunding is so common now, and so many successful startups (Cruise and Wish, among others) have used it that any negative connotations are gone.
Equity crowdfunding: the Pros
- Control over your company: Equity crowdfunding lets you offer non-voting, common shares to investors—meaning founders can hold on to control of the company.
- Exposure: You’ll be able to reach new audiences—smaller, everyday investors, who aren’t necessarily part of the Silicon Valley milieu—by putting your offerings on major investment platforms.
- A street team: Almost overnight, your hundreds of investors become brand ambassadors for your company, helping to spread the word in advance of future funding rounds.
- Special deals: To help sell shares, you can offer special deals—like discounts on your software, for instance—to buyers. That can encourage customers to become investors.
Perhaps the most popular form of equity crowdfunding comes in the form of startup syndicates. To learn what they are, how they work, and whether they’re the right funding route for your startup, check out our guide on startup syndicates.
Find out what is a bridge round financing, its importance for startups, unique mechanisms, and the strategic balance of its pros and cons.
Written by Capbase Staff
Capbase is a team of designers, engineers, and business professionals spread across 6 time zones on 3 continents united by our passion for dogs, coffee, and great software.
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