The Basics
We are all familiar with equity investing. Even crowdfunding is becoming a ubiquitous term with today’s increased digitalization. But “equity crowdfunding” is a relatively new phenomenon creating waves in the investment world. Accredited organizations provide an online platform for a group of individuals (the ‘crowd’) to invest in an early-stage unlisted company, in exchange for shares of that company.
Previously only wealthy individuals, venture capitalists, and business angels could invest in startups. Equity crowdfunding platforms have helped democratize the investment process by opening the door to a larger pool of potential investors contributing lower and more affordable individual amounts.
History
The first known equity-based crowdfunding platform for startups was launched by Grow VC Group in 2010 (Butcher, 2010). Arguably the most important growth driver for equity crowdfunding was the introduction of the JOBS Act in USA in 2012. It was one of the first widespread regulations designed to encourage small business and startup funding by easing federal regulations and allowing individuals to become investors.
The market expanded rapidly as more equity crowdfunding platforms became compliant with regulations. In 2015, the total equity crowdfunding volume worldwide was $2.56 billion, according to the annual Massolution Crowdfunding Industry Report. That number has been roughly doubling each year since 2012.
Pros & Cons
Both entrepreneurs and investors stand to gain from the equity crowdfunding phenomenon. Most importantly, startups that could not raise capital from traditional sources find the opportunity to do so on these platforms. On the other hand, unaccredited investors with low funds can now participate in equity funding.
Another major benefit is that it does not require entrepreneurs to give up a large amount of equity in their company, allowing them to retain significant ownership (Gaynor et al, 2015).
The proliferation of more startups as a result of increased financing also results in an improved economy for the country, higher employment, and more options for consumers.
Although there are numerous benefits that can be experienced by using equity crowdfunding as a method to raise capital, there are also a few drawbacks. The most obvious problem with equity crowdfunding is the lack of a secondary market to buy and sell shares (Gaynor et al, 2015).
Moreover, since investing in business startups via equity crowdfunding is not limited to accredited investors, less sophisticated investors can be taken advantage of due to their lack of knowledge regarding investing, exposing them to fraud and financial losses.
Critics are also concerned with regulatory authorities’ ability to police fraudulent securities offerings made by smaller companies that take the crowdfunding route.
The Future
The most important aspects to make equity crowdfunding a success have to do with investor due diligence and strict regulations. Investors must make sure they carry out enough research on the company they are interested in before investing, and regulatory authorities have the responsibility of ensuring laws protect investors from fraud.
Equity crowdfunding has the potential to completely disrupt the investment industry along with other forms of crowdfunding, as long as its growth is carefully tracked and managed.
In order to learn more about equity crowdfunding, please check out the video below.
References
- Butcher, M. (2010, Feb 15). Grow VC launches, aiming to become the Kiva for tech startups. TechCrunch: https://techcrunch.com/2010/02/15/grow-vc-launches-aiming-to-become-the-kiva-for-tech-startups/
- Gaynor, G.Morse, J. and Pevzner, M. (2015, Oct 1). The Crowd-Funding Effect – 34-39
