• Equity crowdfunding allows startups and early-stage companies to issue ownership stakes to many investors in exchange for capital.
• Shareholders stand to profit if the company does well, but can lose all of their money if the company fails.

Every startup needs capital, and securing that money can be a challenge. Traditionally, businesses looking to get going would look to some of the most common sources of funding, including business loans, angel investors, venture capitalists, or even an initial public offering of stock.

Nowadays, crowdfunding is an increasingly popular form of fundraising that lets founders raise capital on their own, bypass institutional funding, and retain more control over their companies. The idea behind crowdfunding is to convince large numbers of people to invest in or donate to a cause or business. There are several different types of crowdfunding, including an approach that allows companies to offer partial ownership in the form of equity.

What is equity crowdfunding?

Equity crowdfunding is the one type of crowdfunding that most closely mimics conventional methods of raising capital. It's used primarily by startups or early-stage companies. The founders, following a regulated process, issue securities (stock) to the public on a crowdfunding platform in exchange for cash.

Other types of crowdfunding include rewards-based crowdfunding in which investors receive a new product or other reward and donation crowdfunding where investors neither receive nor expect a reward. Debt-based crowdfunding operates much like a bank loan, except the "loan" comes from the crowd.

Note: Equity crowdfunding is overseen by the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA).

Among the most well-known and successful equity crowdfunding platforms are:

Wefunder

Wefunder has attracted a broad range of startups including an online encyclopedia, bionic pancreas, and film production. Any US-based startup can apply to join the platform, which charges a flat fee of 7.5% of funds raised only if the campaign is successful.

StartEngine

StartEngine carries a wide variety of listings including environment-friendly startups, tech companies, and a smattering of Cannabidiol (CBD) entries as well. Companies pay a fixed fee plus a dollar percentage of capital raised and an equity share.

Republic

Republic, owned and maintained by OpenDeal Inc., was set up in 2016 for US-based companies. The platform includes health and wellness startups, fintech companies, and cryptocurrency platforms. Startups pay a 6% charge on funds raised, but only if the funding goal is reached.

Mainvest

Mainvest, founded in 2018, specializes in supporting small brick-and-mortar businesses by letting investors deploy "community capital into the neighborhoods where they live, visit, and enjoy." Mainvest does not charge an upfront fee to launch a campaign and if the raise is not successful, there is no fee. Otherwise "in-network" funds (those you raise) are charged a 3% fee and "out-of-network" funds from Mainvest investors carry a 9% fee. Additional fees may apply.

SeedInvest

SeedInvest is an exclusive marketplace that accepts just 1% of the startups that apply. The platform entertains a broad range of US startups seeking funding from robotics to food and beverage to several different types of healthcare platforms. Startups pay a 7.5% placement fee and 5% equity.

3 steps to raising capital with equity crowdfunding

Before you start, determine the amount of financing you will need, refine your business plan, and prepare for the questions you're likely to face in the due diligence phase of your campaign.

The amount you raise determines the certification requirements for your financial statement. Less than $107,000 only requires a company officer to certify. Amounts from $107,000 to $535,000 require independent review. Anything more than $535,000 requires independently reviewed or audited financial statements.

Once you've laid the groundwork, the process of choosing a platform and conducting a campaign begins.

1. Choose an equity crowdfunding platform

• Start by researching platforms and zeroing in on those that tend to support projects similar to yours. "Many platforms specialize and have a pool of investors looking for specific types of investments," says Chris Rawley, founder and CEO of agriculture crowdfunding platform Harvest Returns.
• Learn about SEC regulation of crowdfunding platforms including Reg CF, Reg D, Reg A+, and others. "Each of these has implications regarding the marketing of the offering, future reporting requirements and future capital raise implications," says Jay Jung, managing partner and founder of Embarc Advisors, who urges founders to make sure the platform is knowledgeable when it comes to these regulations.
• Ask pointed questions about the platform to ensure you will get the support you desire.

CEO Jason Frishman at private fundraising company Netcapital advises founders to ask three questions as part of the platform vetting process: "How expensive is this funding portal going to be for me to use? How quickly can I get my deal live on the platform? And how will the platform help me get attention for my offering?"

Warning: Safdar Alam, CEO of the equity crowdfunding platform Maydan Capital Select, cautions that platforms that don't commit to significant due diligence pass all this risk onto retail investors and provide less support to founders.

Once you've chosen a platform that meets your needs, register and prepare for the next step — selling yourself and your company.

2. Pitch your business

Your pitch to potential investors can be in writing or a video, depending on what format the platform accepts or prefers. Factors to consider with either include:

• Take a personal approach. Share who you are and why you started this project. Be relatable.
• Share the mission. Explain the goal and the impact it will have on people, society, and the world.
• Explain what's in it for investors.
• Be transparent about how the funds will be used. Explain why outside funding is needed.

"Beware of platforms that ask you to bring a large number of investors long before you can launch a raise," cautions Rawley. "Additionally, ensure you fully understand the fees and any equity splits the platform may require."

3. Promote your campaign

All platforms have a system for running a campaign. Some are tightly structured, and others are more flexible. Make sure you understand the promotional structure of the platform you choose.

"The way the bigger platforms work is that they have certain events that get triggered which then leads to your startup being promoted on the platform," says Anna Gudmundson, CEO and founder of the startup, Sensate BioSelf Technology."It's a bit like if you build a website or a blog. Unless you promote it, not many people are going to visit it, and it's important that the founders understand the dynamics and algorithms that the platforms use to promote it to the crowd investors."

Warning: Many sites will only let you access your funds if you reach your fundraising goal. Otherwise, the money raised is returned to investors.

What happens after you've raised the money?

What's next for startups once they raise funds through equity crowdfunding? Some use it for the stated purpose of the campaign and concentrate on growing the business. Others move on to banks or angel investors for their next or follow-on campaigns. Many return to the original crowdfunding platform for a second or even third round.

Much of what happens next depends on the platform you select.

If you have wisely selected a platform that does its due diligence and isn't full of low-quality candidates, ask about post-investment involvement, Alam says. "Platforms that request regular updates from founders should be valued compared to platforms that do not want any contact with the founders post-investment."

What are equity crowdfunding's benefits and drawbacks?

As with any funding system, equity crowdfunding has pros and cons, both for founders and investors.

Pros

The biggest benefit to investors and founders alike is that nonaccredited investors are able to participate, increasing the pool of potential backers. "Depending on the way you structure your traditional raise, you may be limited to the number of nonaccredited investors, or you may not be able to have any," says Andrea Sager, a lawyer and owner of The Legalpreneur, a legal advice subscription service for small businesses. "Crowdfunding allows you to let any number of nonaccredited investors in."

The convenience for backers of investing online also makes raising capital easier for founders. "Anyone can invest with the click of a button. It doesn't get any easier than that for someone to be able to invest in your company," notes Frishman.

Alam points to the versatility of equity crowdfunding. "This approach can also be used alongside more traditional fundraising from venture capital firms – as the entire round does not need to be executed on a crowdfunding platform."

The ability to control the pace of the raise, is another issue that falls in favor of equity crowdfunding according to Steven Weinstein, CEO of early-stage growth investor Seismic Capital. "Typically when working with venture capitalists, startups are tied to quick turnaround times and deadlines to bring the product or service to market, regardless of whether or not it aligns with the time needed to refine the offering. With crowdfunding, startups are able to take a patient capital approach, forgoing immediate returns with the intent of gaining more substantial, lasting returns as their company grows."

Equity crowdfunding is also a good way to engage the community and allow your customers to become part of the business, says Gudmundson. "Your customers are people who actually understand your product, so you're allowing them to be part of the round, as well as professional investors who find valuable early-stage companies to invest in as part of their high risk/reward portfolio."

Cons

Equity crowdfunding is time consuming and the involvement it requires from founders can hurt the bottom line. "It can quickly become a distraction to the true business if you don't have a solid marketing plan in place," notes Sager.

Capitalization tables listing hundreds of small investors may scare off larger investors or worse, trigger disclosure requirements that can be costly and complicated, says Jung. "Thankfully, several crowdfunding platforms have introduced workarounds that allow the investors in the crowdfunding campaign to be aggregated as one registered shareholder on the cap table."

Frishman points out that while equity crowdfunding platforms can be a big help in marketing a company, they do not underwrite or guarantee a successful capital raise. "A big trap when launching a campaign is assuming the platform will raise all the money for you."

Alam points to another potential shortcoming that founders and investors should watch for. "Platforms that do not commit to significant due diligence, and pass all this risk onto retail investors without support, will treat the founders and the startup very differently than a platform that focuses on a lower volume of deals and specializes in specific sectors."

Crowdfunding campaigns require intense involvement on the part of founders. As Gudmundson says: "The main thing is to understand that it doesn't run itself. Simply creating a page with your product on it is unlikely to raise much money."

Is equity crowdfunding right for you?

Since equity crowdfunding is similar to traditional fundraising in many ways, it will seem more familiar to founders with prior experience. Strong support from the right platform along with an easier process makes equity crowdfunding a good match for inexperienced first-timers as well.

Review the pros and cons, especially the amount of involvement required. If you decide equity crowdfunding is for you, read and take the advice of experts to heart:

"Marketing is key when it comes to crowdfunding. Having an existing audience or community tends to make crowdfunding easier," says Sager.

Remember that just being listed on on a platform with tens of thousands of potential investors doesn't necessarily mean you're reach your funding target, Rawley says. "Investors are still looking for a solid team, executable business plan, and a path to an exit."

Also remember that a large "anchor investor" will lend credibility to your campaign, Jung says. "Sometimes we will see a $2 million raise with an anchor investor coming in with a 10%-30% of the offering."