The Unique Question of Equity Crowdfunding

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2002

With new laws taking effect in the US regarding equity crowdfunding, investment deals are transitioning from boardrooms to online platforms. Instead of a single sales pitch to a group of like-minded investors, equity crowdfunding poses the investment sales pitch to the entire world. That’s why startups and businesses with new ideas are taking a serious look at equity crowdfunding and whether or not it would be beneficial for them.

On the surface, it may seem like equity crowdfunding is something that could flop badly. There are about 8 million accredited investors in the United States right now and only 3% of them have ever participated in an equity crowdfunding campaign, even though it has been open to them for some time. Would pitching to non-accredited investors in the future, who are capped with a certain amount they can invest annually, have any better results?

Should startups go public? Or should they stay private and look to raise funds a different way? That’s the question of the day.

Why Choose Private Over Public?

If a product doesn’t seem to generate any interest or it doesn’t meet a specific need, the private equity crowdfunding tends to make more sense. This allows a platform to bring like-minded crowdfunding investors together for a sales pitch that is similar to what startups used to make in the boardroom. Millions in funding can still be achieved and because the project isn’t going public, there is less competition to generate a return and implement an exit strategy.

Private equity crowdfunding also helps organizations that have goods or services that the average person isn’t going to understand. Niche products may sometimes benefit the greater good of a large public demographic, but most of the time it only benefits a certain group. Bringing investors in from that niche group creates the best chance to experience success.

Why Choose Public Over Private?

Public equity crowdfunding brings out the social nature of what investing has become today. When someone stumbles onto an exciting project and they can invest $100-$1,000 into it with a reasonable expectation to receive a return, they’ll share that fact with their family and friends. With a large enough network, one person could easily generate 50 contributors to the equity crowdfunding campaign. Now expand that to 5,000 investors who stumble upon your campaign over 60-90 days and that’s a lot of cash potential.

We already know that this type of crowdfunding is successful. 99% of the rewards-based crowdfunding campaigns that are run today are based on this format. Investors are shown the benefits of what they get from investing, startups engage on a 1-to-1 basis with them, and this connects people to the product in a way that creates loyalty through relationship building.

There is, however, more risk to public crowdfunding when compare to private methods. 60% of public crowdfunding efforts typically fail to achieve their goal. In equity crowdfunding, that might mean the expected amount of capital doesn’t come in so a business plan has to be changed.

The Problem of Equity Crowdfunding

That brings us to the current problem of equity crowdfunding right now from a public perspective: every investor still must be accredited. Until rules are put into place for the non-accredited investor to get involved, the responsibility of determining an investor’s status falls on the startup and many don’t realize this. To stay within regulatory compliance, reasonable efforts must be taken to verify the accreditation status of every investor.

That may mean requiring tax return copies, income statements, verification letters from money managers, or a legal notification from an attorney that is on retainer. If a non-accredited investor is found during an audit of an equity crowdfunding campaign right now, then that business is officially banned from fundraising activities for 12 months. If the number of public investors hits 10,000 or more, it could be time prohibitive to look for 1 non-accredited investor in that mix.

The equity crowdfunding rules may be about to change, but the public or private equity crowdfunding decision is still going to be one that must be carefully considered no matter what rules are in place. Each has unique advantages and disadvantages for the startup, which is why setting clear goals before starting to crowdfund is the most important step every entrepreneur can take today.