How does equity crowdfunding differ from other types of crowdfunding?
/Equity crowdfunding is quite different from other crowdfunding methods such as traditional/rewards crowdfunding and debt crowdfunding. The model provides a more conventional capital-raising method by offering financial securities to investors.
The equity crowdfunding process is carried out on specialized online platforms such as DealMaker, Wefunder, and StartEngine.
Unlike conventional capital-raising methods for early-stage companies, which primarily rely on investments from a small group of professional investors, equity crowdfunding targets a broader group of investors. The main idea of equity crowdfunding is to raise the required capital by obtaining small contributions from a large number of investors.
To learn more about equity crowdfunding, check out our article: Introduction to Equity Crowdfunding.
Equity Crowdfunding vs. Traditional Crowdfunding
You may be familiar with platforms like Kickstarter and Indiegogo, where the traditional crowdfunding model operates on a rewards or donation basis. When you launch a project or product on a traditional crowdfunding platform, you will offer your supporters cool perks, rewards, or simply the warm fuzzies of supporting a cause they believe in. This type of crowdfunding is perfect for certain businesses that focus on products or creative projects.
Equity crowdfunding allows your backers to shift from supporters to shareholders. They become part-owners, and their potential financial returns are directly tied to the company's future success.
Here are some of the key differences between equity crowdfunding and traditional crowdfunding.
Investor Motivation:
Traditional crowdfunding is all about supporting a creative project or cause without expecting financial returns. It's like saying, "Hey, I believe in your product or cause, and I want to contribute!"
Equity crowdfunding is all about the potential for financial gain and supporting a cause or project you believe in. Investors in equity crowdfunding become partial owners of the business they support. It's like becoming a business partner with the potential to benefit from the company's success through dividends, profit-sharing, or capital appreciation. So, it's not just about supporting the project, it's about being an ambitious investor who wants to see a return on their investment.
Risk and Return:
In traditional crowdfunding, backers bear minimal risk since their contribution is often a one-time transaction. The return is non-monetary and can come in the form of rewards or the satisfaction of supporting a cause. It's a win-win situation without too much financial risk for the supporter.
In equity crowdfunding, investors have a higher level of risk and the potential of a higher reward. Their capital is directly tied to the performance of your business.. By becoming a shareholder, they have the opportunity to enjoy a share in your company's profits or future valuation.
Regulations:
Traditional crowdfunding models, like reward and donation crowdfunding, are relatively straightforward with fewer regulatory hurdles. It's similar to making a donation or pre-purchasing a product.
Equity crowdfunding is subject to more stringent regulations. Governments want to protect investors from risks associated with early-stage investments. So they put measures in place to make sure everything is on the up and up.
Investor Involvement.
In traditional crowdfunding, backers usually have minimal involvement beyond their initial contribution. They're not part of the project or business's decision-making process or day-to-day operations. They are a brand ambassador or supportive cheerleader from the sidelines.
In equity crowdfunding, it can be a little different. Your shareholders may have voting rights and the ability to influence certain company decisions. Depending on the terms, your shareholders may engage with the company beyond financial support and have a say in the direction of the business.
So to break it down, in traditional crowdfunding, backers get a product, a reward, or a sense of philanthropic achievement. However, in equity crowdfunding, backers become shareholders and have the potential to enjoy financial returns if the company does well.
Equity Crowdfunding vs. Debt Crowdfunding
Debt crowdfunding, or peer-to-peer lending or crowd lending, is when investors lend funds to businesses. In return, investors receive interest payments on top of getting their original loan amount back. Usually, this type of crowdfunding is used by companies that are beyond the startup phase and already have stable revenues to make regular loan repayments.
On the other hand, equity crowdfunding allows startups to focus on long-term growth and development without the pressure of immediate capital repayment. The only catch is giving up a portion of ownership in the company to the investors.
Here are some of the key differences between equity crowdfunding and debt crowdfunding.
Nature of Investment:
Debt Crowdfunding: Investors lend funds to businesses and earn interest payments, but they don't gain any ownership in the company.
Equity Crowdfunding: Investors become part-owners of the company they back, earning an ownership stake in exchange for their investment.
2. Risk and Return:
Debt Crowdfunding: Investors receive fixed interest payments and get their principal amount back, with lower risk compared to equity investment.
Equity Crowdfunding: Investors take on the risk of the company's performance but also have the potential for higher returns if the company thrives.
3. Suitability:
Debt Crowdfunding: It's versatile and can be used by small businesses at any stage of their journey and for projects of all sizes, without giving away any profits or ownership.
Equity Crowdfunding: Perfect for established companies and major projects, as investors become shareholders and can enjoy a piece of the profits and, unfortunately, the losses too.
4. Regulatory Framework:
Both equity and debt crowdfunding are regulated, so companies have to follow specific disclosure requirements to protect investors.
To sum it up, equity crowdfunding is about sharing ownership with investors, while debt crowdfunding focuses on raising funds through loans and interest payments. Each approach has its unique implications for investors and businesses.
Conclusion
When it comes to funding your startup, the road can be a bit winding and full of possibilities. As a founder, it's crucial to take a moment and carefully consider your options. Look at the pros and cons of each funding type and assess how well they align with your startup's specific needs and long-term objectives.
