How to invest in equity crowdfunding, a way to give small private firms a boost - and possibly profit yourself
Equity crowdfundinglets individuals invest in private companies in return for an equity stake.
- You can invest via equity crowdfunding platforms, which vary in their standards and specialties.
- Equity crowdfunding investments are riskier and less liquid than publicly traded securities.
Have you ever made a donation to a worthy cause or budding business enterprise in response to an online crowdfunding appeal? If you're looking for a reward beyond a stuffed animal or a branded pen, you might be interested in a variation of Kickstarter, GoFundMe, and other crowdfunding models we've come to know and love: equity crowdfunding.
Equity crowdfunding provides a platform for private companies and individual investors to meet. Individuals provide funds for firms seeking capital to grow, in exchange for an equity stake in that company. It can be risky since these young companies don't have much of a track record, but it can also present a chance to earn some substantial money - and of course help a business you believe in.
Anyone who wants to invest can get involved with equity crowdfunding, but there are rules as well as risks. Let's take a closer look at how you can invest, how equity crowdfunding platforms differ, and some overall strategies.
What is equity crowdfunding?
Also known as crowd-investing, equity crowdfunding allows startups and small companies to raise capital from investors, in exchange for an ownership stake - shares of stock - in the business.
Investing in private companies - that is, ones who don't trade on public stock exchanges - used to be the province of extremely wealthy or institutional investors. But in 2016 the JOBS Act, which enabled more companies to sell shares without going public, was expanded to allow less-affluent individuals to play, too.
"So someone who doesn't have a million-dollar net worth, can now diversify their investment portfolio into startups, which, prior to now, was completely off-limits," says Brian Belley, founder of Crowdwise, an online equity crowdfunding community.
And with COVID-19 lockdowns encouraging online investing, equity crowdfunding really took off in 2020, raising $214.9 mi lion in 2020 (a 105% growth from 2019) for 1,035 new companies, according to data gathered by Crowdwise.
Types of equity crowdfunding investments
Actual crowdfunding investments can be in the form of different financial securities. These include:
- Common stock: This method may come along with dividends, depending on the company's maturity and success. Later-stage startups are more likely to offer shareholders returns in the form of either fixed dividends per share or a percentage of profits.
- Preferred stock: Like common stock, but without voting rights for shareholders.
- Debt: This also comes in various forms, with some companies offering simple loans with fixed repayment schedules and others offering revenue shares, which return a fixed amount of money in a time frame that depends on the company's success.
- Convertible notes: This method will eventually convert your debt investments to stock if the company raises a "priced round" from major investors. A priced round is an equity investment based on a company's negotiated valuation. Essentially, investors serve as equity-owning shareholders and will see a return if the value of that stock goes up over time and can be sold for a profit.
How much can I invest in equity crowdfunding?
Anyone can participate in equity crowdfunding, regardless of income. But because these are highly speculative investments - your funds are tied up in untried, unregulated companies and you might not see a payout for years, if ever - the Securities & Exchange Commission (SEC) dictates how much and how often individuals can invest in equity crowdfunding offerings. Calculated on a sliding scale, the exact amount is based on your annual income and net worth.
How to find equity crowdfunding projects
Equity crowdfunding takes place through online platforms - websites that put companies and investors together. Although the companies seeking crowdfunding capital may not be subject to government oversight, the equity crowdfunding platforms are.
An equity crowdfunding platform must be either operated by a licensed broker-dealer or registered with the SEC as a "funding portal." A platform must also become a member of the Financial Industry Regulatory Authority (FINRA), which oversees brokerages.
The platforms all are pretty user-friendly, generally working along the same lines. Investors sign up on the platform's funding portal site and verify relevant financial information, like their income and assets. Then they can see all the offerings from companies soliciting capital: info on the firms, their plans, and details of the deal, like the company's price per share.
Investors select the offerings they'd like to participate in, and submit their funds - you can even charge them on a credit card. Investment amounts range widely, starting as little as $100.
Investors often can track their investments via a dashboard online. In addition, you'll receive an annual report and, in some cases, quarterly updates on the company.
How equity crowdfunding platforms work
While the basic investing procedure is the same, equity crowdfunding platforms do operate in different ways. Some charge investors processing and other payment fees, while others take their compensation out of the money the company raises - a percentage cut of a company's capital campaign.
They also screen companies differently. Some platforms basically list anything; others, more exclusive, present thoroughly vetted deals. Some provide a lot of intel, others call on investors to do additional research themselves. Some stick to tried-and-true industries; others feature less traditional enterprises, like a new indie film.
Finally, platforms vary in their areas of specialization, with some focusing on specific industries like technology and others offering a wider array of investment opportunities.
"Looking forward, I see a lot more vertically-integrated or industry-focused portals popping up," says Belley. "I think as more people come in, more people are going to start needing to find a way to sort through the noise of all these offerings, and I think they will start gravitating towards those portals."
Which are the major equity crowdfunding platforms?
Here's a list of a few leading players in equity crowdfunding:
- WeFunder: This is the largest equity crowdfunding site and top funding portal in terms of capital raised. It offers notable transparency in terms of investment results, but does not require featured companies to be focused in a specific industry.
- StartEngine: As the #2 funding portal in terms of capital raised and the #1 ranked portal by number of deals, StartEngine specializes in technology companies.
- Republic: In 2019, Republic became the third biggest platform in terms of capital raised, and stands apart because of the extra due diligence required for startups to get approved and featured on its site.
- SeedInvest: This site also emphasizes how highly vetted its offerings are. They're a diverse lot too, ranging from financial apps to sports gear to biotech.
- Netcapital: This platform has a strategic partnership with Techstars, a start-up mentor and company for investment and innovation.
- MicroVentures: This platform's a generalist, but known for some savvy picks. Past investment opportunities it's offered have been from such firms as included Slack, Pinterest, Uber, and Lyft.
- NextSeed: Investments are focused on ventures that support the growth of local communities: existing small businesses, startups, and commercial real estate.
Tips for successful equity crowdfunding investing
Be aware that equity crowdfunding is a business: You're investing money, not donating it, as you do with regular crowdfunding. As such, it behooves you to be careful. Here are some things to bear in mind.
- Be aware of the risks: These are usually young firms with not much of a track record. The fact that they're not publicly listed means they are unregulated, and therefore can be less transparent. Also, your money is less liquid here than it would be if invested in traditional stocks, ETFs, or mutual fund, which trade daily and have posted prices.
- Do your due diligence: Find out exactly where your money is going by reading about how the company plans to use its capital. The Q&A portion of a campaign page can serve as a valuable resource, giving you a sense of how the company's management thinks. You may also benefit from reading available financial paperwork, where information can sometimes be hidden away.
- Always go through the platform: Beware of companies reaching out directly to seek money from you. All transactions should go directly through a credible, SEC- and FINRA-registered platform. In fact, many companies use the platform to communicate and solicit investor feedback, with platforms like Republic allowing businesses to regularly survey their many small investors.
- Think long-term: Think of equity crowdfunding as a speculative, growth investment rather than one that will offer a current return. With so much uncertainty surrounding early-stage businesses, it's nearly impossible to predict which will or will not succeed. The amount of time it takes to see a return varies significantly, depending on both the type of investment and the company's success.
The financial takeaway
Equity crowdfunding gives large groups of everyday investors the ability to support businesses they believe in, in exchange for an ownership stake. It's done online, via equity crowdfunding platforms.
Equity crowdfunding platforms don't all follow the same model, charging different fees, offering different types of financial securities, and specializing in different sectors.
Equity crowdfunding is open to all, but the SEC limits investors in how much they can put in annually, depending on net worth and annual income.
Equity crowdfunding investments are long-term, illiquid ones. Your shares are tied up for an indefinite period - no unloading them quickly, as you can with publicly traded stocks and other securities. There is definitely a high degree of investment risk, too, as these companies are untried, unregulated, and may be hard to get information on.
Equity crowdfunding is definitely on the more speculative end of the investing spectrum. While it can have enormous payoffs, don't go betting your retirement nest egg on it.
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