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August 15, 2019

What is equity crowdfunding and how does it work?

By Asena Degirmenci

The number of start-ups and early-stage companies that rely on equity crowdfunding campaigns to grow their business is on the rise.

Specialised online platforms are used to carry out the crowdfunding process to allow for a mo re free financing experience.

What is equity crowdfunding?

Equity crowdfunding is a method of raising funds by allowing a large group of people to invest in start-ups that are not listed on the stock market, in exchange for shares or a small stake in that company.

Equity crowdfunding is also known as investment crowdfunding and crowd investing.

You can compare it’s function to a Kickstarter or Indiegogo campaign – investors visit an online funding portal and explore different investment opportunities regarding equity crowdfunding.

One of the ways that a business can raise investment is through equity crowdfunding. A more traditional method is by getting a loan or seeking institutional investment.

Equity crowdfunding campaigns typically require that all funds that are raised go into a third party account and stay they until the funding goal is met or returned to the investors if the goal is not met.

In order for the platforms to get access to the funds, the third party is needed to fulfill the requirements.

How does it work?

Equity crowdfunding works through a crowdfunding website – also referred to as a crowdfunding platform.

First, a start-up or business decides how much money it wants to invest by setting up an online profile that states details about the business and its finances.

Investors registered on the platform will be able to view your platform and draw up a deal if they are interested.

If the company does not reach its desired target by the end of the deadline, the money will be returned in full (see above).

What are the benefits/risks associated with equity crowdfunding?

Benefits

  • Support start-up businesses
  • Reduces overall risk since crowdfunding relies on a large pool of investors investing at lower levels
  • Network building – after your venture, investors from your crowdfunding campaign are still involved and are more likely to invest in future ventures
  • A successful crowdfunding campaign will attract free media attention which will benefit your campaign to grow further

Risks

  • It might take a while to see your company shares increase in value, directly affecting your ability to make a return if you sell them
  • It is unlikely that you will receive dividends because the companies involved are likely to not make enough profit to pay out to shareholders
  • Risk of dilution – the value of your investment is ‘diluted’ due to companies letting more people buy shares to raise additional funds

Regulations

One of the major purposes of regulation in equity crowdfunding is to protect investors because the fundraising model is prone to fraud.

Equity crowdfunding is still a fairly new phenomenon. Due to these circumstances, only few countries have implemented regulations regarding such fundraising methods whereas other countries have looser regulations.

The Jumpstart Our Business (JOBS) Act established in 2012 was one of the biggest leaps for equity crowdfunding regulation in the United States.

Both accredited and non-accredited investors in equity crowdfunding are allowed to participate under this law. The act also establishes limitations on the amount of funds that companies can raise and the amount that can be invested by each investor.

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