Equity crowdfunding occurs when private companies raise capital from the public through the sale of securities. These financial instruments can include shares, convertible notes, revenue shares, debts, and tokens. Today, equity crowdfunding is an important part of the global financial markets because it provides SMEs a more cost-effective strategy to raise capital versus traditional IPOs.
Interestingly, equity crowdfunding is a relatively new investment tool. President Obama enabled equity crowdfunding back in 2011 when he signed the JOBS Act, but it wasn’t until the last five years that the practice became popular. One of the reasons it took so long for equity crowdfunding to gain popularity is that it took until May 2016 for key regulations to come into effect.
How Does Equity Crowdfunding Work?
Equity crowdfunding works very similar in function to the popular crowdfunding website, Kickstarter. Basically, investors seek out private firms that meet their criteria. Once a suitable investment is found, an investor visits a funding portal website that gives them access to the opportunity and its details. Here, investors are able to explore different equity crowdfunding investment opportunities for the firm.
Key Differences from Kickstarter
Unlike Kickstarter, investors don’t receive early access to a product or service for their contributions. Instead, investors in equity crowdfunding campaigns seek to make a profit for their participation. In most instances, investors receive shares, rights, and other benefits for their investment.
Different than Stocks
It’s important to understand why equity crowdfunding provides entrepreneurs with different opportunities compared to trading shares on the stock markets. For one, equity crowdfunding firms are private companies and in most instances, startups. In the past, IPOs were the only form of crowdfunding a company could engage in. This practice restricted access to the markets for SMEs for many entrepreneurs.
Many companies simply lacked the funding to cover the huge financial and legal requirements needed to host an Initial Public Offering (IPO). In turn, only the largest firms could generate the funding needed to launch an IPO successfully. Consequently, studies show that IPOs continue to see a decline in use as more affordable options are now available.
Additionally, these practices left investors out of the loop as well. Many IPOs are only open to accredited investors. Accredited investors make at least $200,000 per year, or can show over $1 million in assets. Notably, your assets must exclude your home. As you could imagine, this system left your average investors shut out from the most lucrative investments.
Thanks to the rise of equity crowdfunding platforms, now everyone has access to these valuable opportunities. Prior to the rise in internet crowdfunding platforms, investors were mostly VC and angel investors. These were the only individuals that…