Equity Crowdfunding

Equity Crowdfunding Guide

Equity crowdfunding is much different from any form of peer-to-peer lending in that you are not paying back a loan or otherwise in some sort of repayment schedule.  Instead, you are giving away a part of your company to the crowd, meaning that they own a part of any future profits or value that the company (or in some cases a specific product or service) has.  Equity based crowdfunding can be very compelling to potential investors given that the ultimate value can be sky-high if they are correct in their feelings about the potential of the company or product.  And equity crowdfunding can also be a great choice for a new business because in the beginning at least there is nothing to repay at a time when you need capital the most.

Forbes recently had an interesting article about “Blockbuster” crowdfunding involving equity

Of course the best know type of equity crowdfunding appears weekly on the show Shark Tank

Risks of Equity Crowdfunding

Despite the positives, equity based crowdfunding is one of the more risky ways to invest and to take money.  Unlike other forms of peer-to-peer lending, the investor takes the risk of coming away with nothing for their initial investment.  If the product or company does not make it, the equity is not worth anything.  And for the company, there is the risk that the initial investment made by the crowd will have to be paid off at a huge multiple if the product does make it big. In some cases the perfect balance is struck and everyone comes away happy, most commonly when the product or service does very well and the investor does a bit better than expected but the person receiving the funds is still quite happy with what the rest of the company is worth.

For the above reasons, equity crowdfunding leads to an initial push-pull between the investor and the company in order to find the percentage that will be given up and the amount that needs to be invested.  Invariably, at least at the beginning, the investor will want a very high percentage while the company will believe so strongly in the potential of the product that they will want to keep that percentage perhaps too low.  Sometimes the pair can work out some safeguards in both directions, capping how much the equity can be worth but also putting a floor on the value as well.

Advantages of Equity Crowdfunding

There are advantages of equity crowdfunding on both sides of the equation.  For an investor, equity based crowdfunding offers the opportunity for a variable payoff that can be quite high if the investor has chosen the right product or service to invest in.  Instead of there being a certain amount that the investor can expect back, she or he could get a lot more than expected if the product does particularly well.  And the payoff can last a long time – instead of there being a fixed time period after which the investment and the relationship end, equity crowdfunding leads to a lasting relationship which only ends if the investor decides to sell off or sell back his or her equity position.

For the person or company receiving equity crowdfunding, the advantages include not having to pay back any capital at a time where cash is needed for the business, and often having a motivated business partner who is in it for the long haul.  The former is probably the biggest draw – with regular financing the company or person has to begin paying things off almost right away or after a short period of time even if that money could be used for continued product or company development.   Equity crowdfunding also has a psychological advantage – everyone has decided that the product, person, or service is worthwhile.

Equity Crowdfunding Process

The process by which a person or business can attract equity crowdfunding may sound simple on the surface, but it is actually quite complicated and sometimes challenging.  It starts the same way any peer-to-peer lending agreement starts, with the person or business pitching the product or service that they are looking for funding for.  The reason why the product has potential, any market research that has been done about competition and how many people might purchase it, and any initial reactions to the product are presented.  But with equity crowdfunding the numbers also become quite important, such as how many sales there were to date or how many sales occurred within a controlled release of the product or the prototype.  For a product or service that has not yet been released, there must be information that backs some sort of estimate of how well the product or service will likely do.  Finally, there needs to be information about the profit margin – how much does it cost to produce the product or service and what will it sell for – and is that sales price realistic.

All in all, the investor needs to value to product or service in the marketplace to know what owning x percentage will mean.  Put simply, if 1000 units can be sold each year, but the product has slim profit margins, then the equity stake may not be worth that much.  On the other hand, if a lot of units can be sold and the profit margins are large then an equity stake can be quite worthwhile.  Sometimes, in fact, the presentation by those looking for an investment shows that the equity crowdfunding they will receive will actually lead to more sales or better profit margins.  For example, equity crowdfunding used to open a state-of-the-art factory can mean that profit margins rise.

The final step is a negotiation of the percentage that the investors will get for a certain amount of money.  For a well established company this is a little easier because the value of each percent of the company can be determined.  But for a new product or service both sides must estimate what the value will likely be in order to figure out what amount of money should be invested for a given percentage.  Obviously the investors tend to go in very conservatively, while those behind the product or service have high hopes.  This is the part that can be challenging – yet in some ways fun.

Equity Based Crowdfunding Choices

If equity crowdfunding strikes you as a good fit for you as an investor or you think it may be a good way to fund your project or purpose, the next step is to begin to look at crowdfunding sites where equity crowdfunding is being done.  This first step is not meant to have you jump in too quickly, but rather to have you watch the process and get to know how it all works.  No amount of explanation here or elsewhere can provide all the information and advice you need.  Rather, you need to see how people describe their project or purpose, how the negotiation works, and what the end result is.  In addition, knowing what types of projects and presentations tend to work is good for those looking to get equity crowdfunding, while knowing how investors choose and negotiate is good for the investor.

Once you have a good idea of how the process works in real-time, the next step is to choose a site or two where you will post your project or look for an investment.  As we’ve said, we do not endorse any particular equity crowdfunding site in order to stay unbiased and independent, but there are many out there and even if we did provide ratings that would not necessarily mean we could help you find the one that is the bast fit for you.  Choose carefully, and if possible do not limit yourself to just one.

Of course the most important step if you are looking for funding is to create the perfect pitch, with a summary up front that captures the investors attention and then details to back that up that are compelling, well-organized, and easy to read.  And investors need to do their homework about everything from the market, competitors, and price – everything that can forecast how well the project will do.  Equity crowdfunding through online platforms has created a new breed of pitch – you are up against a ton of competition and unlike in person pitches you only have a few seconds to capture the investor’s attention before they move on.  And investors are faced with the difficulty of wading through many pitches – knowing when to move on and when to keep pursuing one that catches your eye.

Applying for Equity Based Crowdfunding

Applying for equity crowdfunding revolves around your product and its potential.  You need to first capture the attention of potential investors with a great product idea, and then have them see the possible value of an equity investment in your product and company.  Both steps are quite important.  If you fail to capture their attention with a compelling product idea they’ll never check out your value proposition, and on the other hand if you do capture their attention with a great idea but cannot link it to great future value you are not likely to get an offer.  This section is designed to help you navigate the process of applying for equity based crowdfunding from beginning to end.  As with all of this website we cannot take the place of a more unique assessment of your product and approach, but we should be able to point you in the right direction.

The Equity Crowdfunding Pitch

The first step in applying for equity based crowdfunding is to fully develop your product or service idea.  Make sure that your idea is detailed enough to seem realistic, and you have facts and figures about how many people will want or need it and why it is different from their current choices.  Always remember that the crowd is assessing you on two levels.  First they are literally reading the pitch for its content, but then they are also assessing you – how much time and effort are you putting in and what is the quality of the result.  So your initial product description has to be clear, well thought-out, and compelling.  The potential investors will like multimedia and other ways for them to truly understand what you want them to invest in.

Here is the most challenging part about applying for equity based crowdfunding: You only have 10 seconds but you need to be compelling.  There are a ton of pitches out there and they are easily accessible for any potential investor.  And the majority of the pitches are quite compelling and interesting, so there is a wonderful number of choices that the investors can make.  You need to make sure you’ve wrapped your idea into a quick and compelling pitch that grabs their attention and keeps it so that they do read the details and see what more there is to the idea.  Do not skimp on that first look pitch to investors and think of ways to use everything from multimedia to attention grabbing graphics to get their attention.

Equity Based Crowdfunding Follow-up

Now that your hook is out there and you are hoping that a potential investor will bite you should be ready to respond quickly if you get any inquiries.  The key word there is “quickly”.  Some investors may reach out to several projects and ask a few questions that will help them decide whether this is the right one for them, and just like we mentioned above there are two reasons why you need to be responsive.  First, they do truly want the information so they can decide whether to invest in your equity crowdfunding project, and second they want to know a little about you and whether you are going to be responsive to them if they do invest.  Make sure you are completely up front when you do answer their request for information – exaggeration or leaving information out will only serve to come back around.  Give a fully open and honest view of whatever they ask, and do not be afraid to say you need time to get the answer they need.

Forbes has a nice article that asks the question of whether crowdfunding for equity is right for your start-up business.  Please feel free to use the comments section to let us know how you made you case, or if you are an investor what you look for when someone is applying for Equity based Crowdfunding.

Crowdfunding Equity Investments

Crowdfunding equity investments are challenging and take a good bit of homework, especially if you are going to put a lot in.  Finding the product or service that has the most potential is only the start; you also need to then negotiate the percentage of equity that makes sense to both sides as far as what you are willing to invest.  But equity based crowdfunding investments also can be quite exciting and have high rewards if you choose right and get a favorable percentage.  The bottom line is that you and the person you invested in are both hoping for the product or service to take off, and even if one side or the other is a little disappointed – you for not getting a higher percentage or him/her for giving up too much, you both will be quite happy anyway if things go well.  This page should give you a starting point if you are thinking of equity based crowdfunding.

Crowdfunding equity investments steps

Of course the first step in Crowdfunding equity investments is choosing a product, service, or business to invest in.  You can look at any number of well-known crowdfunding websites or look for pitches that are made independently by business owners on their own sites.  You might read about a company looking for funding in a trade or business publication as well.  Or, if you are someone who has made this type of investment before you might hear directly from the business.  But how to narrow down all your potential choices if you want to invest in startups for equity?  Here is a start:

1. The first thing you need to wonder about the product or service in question is whether it is scalable.  In other words, will a lot of people want it.  There may be many very creative and interesting new products or services on the market each year, but you want one that can sell across the country or the world.  Your goal needs to be that the product you choose can grow into a large market, or at least a market that will fulfill the goals the company has set.

2. Now look at the management of the company.  What are their qualifications on paper and their intangibles off of it.  Do you trust this management group to carry forward the business plan they have presented?  Are the right people in the right jobs when it comes to this company?  Where are there weaknesses and can they be overcome?  The people behind any company are so important because even the best idea must have a solid management group behind it.

3. The business plan is key to your investigation of a product or service before you decide whether to invest in startups for equity.  How realistic is their plan, and have they sufficiently explored threats and challenges that might arise?  In some cases you can ask questions, whether they are designed to pull out more information or just to elaborate on what is there.  You need to agree with the overall business plan, and you also need to assess the people behind the company on the thoroughness and thoughtfulness of the document.

4. Finally, you need to look at the deal itself.  Coming to an agreement about exactly how much of your Crowdfunding equity investment is worth exactly what piece of the company can be a challenge.  You have to understand that the person or company is going to be very enthusiastic about their product or service’s potential, and that may mean that they inflate it’s future value.  You need to make sure you are getting the potential of a generous return for your money.

Equity Crowdfunding Rules

There are certain restrictions for equity based crowdfunding that you should be aware of.  The main restrictions for equity based crowdfunding, at least at the time of this writing, is that you have to have a certain income or net worth to invest.  The reason behind this regulation is that the government wants to ensure that the market is stable, and people to not invest in equity based crowdfunding beyond their means.  Others would argue that this is unnecessary interference given that the government does not regulate other forms of investment in this way.

It is quite possible that the equity crowdfunding rules might change at some point, so we will keep you posted!

Equity Based Crowdfunding Summary

Equity crowdfunding is not for everyone, as it presents risk for both the investor and the company or person seeking the investment.  You may end up giving up a significant portion of your company, in essence paying back too much money for the amount of the initial loan.  Then again, the remaining equity that you own will also be highly valued so you may not be so upset.  As an investor, equity crowdfunding is obviously high risk and high reward.  While on the one hand you may literally get no payback, you might also get quite a bit more that you otherwise would have if you chose correctly.  Some investors may choose to diversify their portfolio and have only some of the money tied up in equity crowdfunding investments.

Basically the key to equity-based crowdfunding is doing your homework.  As an investor you need to very carefully choose the most promising investment while sometimes not reaching too high and taking on too much risk.  And as a person with a promising business plan or product, you need to find that perfect balance between offering enough equity based crowdfunding to make things interesting for the investor, and not offering so much that you end up not owning enough of a valuable product or service.

When both sides do their homework, equity crowdfunding can pay off!