Is Equity Crowdfunding a Good Alternative to Venture Capitalism?

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Crowdfunding is becoming a popular way to raise capital for your business. It relies on a model of relatively small investments from a large number of sources. The idea is that it is easier to raise small amounts of money from a lot of people than it is to raise large sums of money from just a few people.

Types of Crowdfunding

There are a few different types of crowdfunding. Donation crowdfunding—spurred on by sites like GoFundMe and IndieGoGo—has become incredibly popular. Donators offer money without the promise of anything in return. Generally, it’s the idea of supporting a good cause, or a company they believe in, which leads donors to commit to these arrangements.

There’s also rewards-based crowdfunding, which occurs when you get a perk or something similar in exchange for monetary investment. This is a common method of crowdfunding used on sites like Kickstarter. A t-shirt company might offer a limited edition design for investors. A production company might offer free passes to the movie premiere for its investors.

In the debt crowdfunding model—like the one used on LendingClub—investors give money to the company and receive repayment plus interest in return. Though this sounds a lot like traditional investment models, the crowdfunding aspect means that it includes smaller payments from more investors than traditional investment models.

How Is Equity Crowdfunding Different?

Equity crowdfunding—sites like AngelList and EquityNet—differs from all of these other sorts of crowdfunding in that the investor gives money to the business in exchange for a percentage of ownership in it. In most other crowdfunding scenarios, the transaction is fairly short. Money is received and then the investor gets a reward or a repayment with interest within a designated amount of time.

Equity crowdfunding allows the investor to participate in the ownership of the company. Each of the investors gets a stake in the company and a percentage of the profits. That investor will continue to own that percentage until they divest themselves.

This arrangement can be beneficial to startups because it’s a quick way to gain access to capital. However, it can get complicated when it comes to legal regulations. It also allows for a large number of equity investors in your business. Depending on the structure of the business, it is possible that you’ll lose some power there. You may think that having a lot of investors is beneficial, but when there are a lot of cooks in the kitchen, it can get crowded. And these investors are not as likely to be knowledgable about your business or industry.

Equity crowdfunding tends to attract money but not necessarily specific expertise.

Keeping this in mind, however, equity crowdfunding can still be a good alternative to venture capitalists and other types of investors, depending on your specific situation.

Consider These Questions Before Deciding

Are You a New Kid on the Block?

If you’re a first-time entrepreneur or a startup without much history, you might find it hard to attract the attention of traditional investors. Equity crowdsourcing can be the way to go because it’s easier to get someone to take a risk on an unknown company with $100 rather than $100,000.

What Do You Need the Funding For?

Equity crowdsourcing can be very effective when it’s for a specific product or project. Instead of asking for a blanket amount of money, start a crowdfunding campaign for a specific expansion project or product campaign.

How Much Time Do You Have?

It takes time to seek out venture capitalists that would have an interest in your business. Asking for a big sum of money from one person can be a delicate process. You’ll have to work to gain access, pitch your business, and prove that you’re a worthy risk. On the other hand, the timeline to convince a large number of people to give you $500 is much quicker.

How Much of Your Company Are You Willing to Part With?

Equity crowdsourcing requires you to give out percentages of ownership to investors. If your company makes money, those investors will, too. If it doesn’t, they’ll take a loss on their initial investment. But dividing the company into pieces for investors dilutes your ownership. Before you start on this process, decide how much of your ownership you want to retain. 

As with any type of business investment, you need to weigh your options very carefully before determining which type of crowdfunding is right for you.