What is Equity-based Crowdfunding?

On LIVERIX, we have discussed a lot about equity-based crowdfunding and explained what a useful tool it can be for small businesses and startups to get much need funds to grow their business directly from small investors around the world, without an intermediate layer in between. But it has always fascinating us that, regardless of how much hype there is around crowdfunding, there is such little understanding of what it truly represents and its great potential as a game changer for startups.

In this in this context that we talk about equity-based crowdfunding, which is an entirely different kettle of fish than donation-based crowdfunding. Donation-based crowdfunding is essentially crowdfunding as we know it. It has been around for several years now, with popular sites such as Kickstarter.

Donation-based crowdfunding is easy to explain. Essentially, people donate money to a business or project without any expectation of an ownership. In return for their contribution, they receive some sort of a tangible reward. This is based on how much they donate. A small donation, for example, may get you a T-Shirt with the company’s logo or a bumper sticker.

A larger donation may get you a first edition product, an invitation to the product launch party or an all expenses paid vacation. In return for facilitating the exchange, crowdfunding platforms such as Kickstarter and Indiegogo take a small percentage of the cut – amounting to around 5% to 10%.

Equity-based crowdfunding is different, and gives you a lot more power over the company, as it gives you a share or equity in the company, based on your contribution. You get to own a small part of the company and quite possibly sell it later for a sizeable profit. So you can profit as an early investor if the company goes on to become something significant, or, on the flip side, be prepared to take a hit if the company fails to succeed.

The advantage of this model is that you get to own a part of a promising new start-up without the intervention of a financial intermediary who would corner some of the money invested in it. You get direct shares of ownership of the company for your investment, which is so much more significant than getting a T-shirt for efforts, as you would in the case of donation-based crowdfunding.

So, if the young startup funded by you goes on to become the next Facebook, Uber, LinkedIn or Twitter – you get all the immense financial benefits associated with its growth and your money will be worth several times the original investment.

But it’s not as simple as it sounds. Equity crowdfunding is as yet allowed only in the few countries in the world as there are many regulatory hurdles to deal with. In the US, the passing of the JOBS Acts has paved the way for equity-based crowdfunding and this is expected to come into effect starting in 2016. In Europe, Germany and the UK are planning to allow equity-based crowdfunding as well. It has already been introduced in Spain.

For a company to enjoy the full benefits of equity-based crowdfunding, they should first be ready with a business plan, a comprehensive financial model with audited and certified financial statements, an objective evaluation of their offerings and several other considerations before their crowdfunding campaign can be opened to the public. If they are based in the US, their crowdfunding campaign will need to be listed on an SEC-approved crowdfunding platform.

So it’s certainly not as simple as you might have thought. But clearly, equity-based crowdfunding is the way to the future and we do expect to see it take the business world by storm once it is officially accepted in all the major countries of the world.

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