Equity Crowdfunding: How The New Wave of Startup Funding Works

Reward crowdfunding has seen a dramatic rise in the last decade and now, equity crowdfunding is opening up to global ownership of companies around the world Crowdsourcing is by definition the way to raise awareness, donations, or any type of source that feeds the end goal and crowdfunding is a type of crowdsourcing where financing growth is involved. Thanks to Kickstarter and Indiegogo, crowdfunding has become wildly popular in the last 10 years. However, crowdfunding has been around for centuries and we now live in an exciting period where the next wave of crowdfunding is emerging: Equity crowdfunding (EFC). Before I delve deeper into EFC, I want to share with you the story of a few crowdfunding stories that are meaningful and considerably large in scale. Let’s start with the first and possibly the most important one. Raising the Statue of Liberty as a Show of Solidarity Source: White Label Crowdfunding One of the most striking stories of crowdfunding is the first official campaign to fund the pedestals of the Statue of Liberty. By the summer of 1885, the Statue of Liberty was in New York in pieces waiting for assembly. There was a lack of funds to fund the granite plinth of the status. New York governor Grover Cleveland rejected the use of city funds, Washington couldn’t agree on a suitable funding package, and other cities such as San Francisco and Philadelphia wanted to fund the assembly with the condition that it was placed in their cities. Source: Vox Finally, Joseph Pulitzer, the renowned publisher, decided to launch a crowdfunding campaign in his newspaper, The New York World. It was a massive success. The required $100,000 was raised from 120,000 donors. It was so meaningful that the Statue of Liberty was raised by the donations of people mostly paying less than a dollar each. The Most Fortunate Crowdfunding Campaign Source: Kickstarter Oculus was an instant hit as it launched its campaign on Kickstarter raising $2.4 million and hype was so high that only 2 years later, Mark Zuckerberg made one of his casual acquisitions for $2 billion and this time, it was Oculus. Again, a company raising $2 million was valued at $2 billion in under 2 years. That’s a 100 fold appreciation in value. Most probably, Mark Zuckerberg saw the high demand and thought that VR is the near future as he decided to focus on mobile when he saw mobile was the future. This reminds me of 1984 by George Orwell. Looks futuristic and funny at the same time. Source: Forbes Then, he realized that the product isn’t that intuitive and the technology isn’t ready yet. He also admitted that he could have developed the product with the in-house team instead of spending $2 billion. What’s really amazing is that if Oculus made equity crowdfunding giving its donors certain equity for the amount they invested, then, those investors would have a 100-fold return in 2 years. The Biggest & Most Unfortunate Crowdfunding Campaign Here is the Kickstarter tagline: The COOLEST is a portable party disguised as a cooler, bringing blended drinks, music and fun to any outdoor occasion. The product was seriously “cool”, just the ideal picnic item you would want when you hang out with your friends. Coolest Cooler raised over $13 million from 62,642 donors and it ultimately went bankrupt because of a major miscalculation, logistics of a large product. The company announced that they went bankrupt as of late 2019 saying that high tariffs on China were the main reason. Interestingly, they also added the product to Amazon before they fulfill the Kickstarter orders. My Own Kickstarter Campaign Experience Back in 2015, I launched my own Kickstarter campaign with Downtown Shoes, the shoe brand of New York. The campaign was successful and I raised a modest ~$11,000. It was my design and I worked on it part-time for 1.5 years with a dream of starting a global fashion brand from New York and have lines of shoes and apparel from a variety of cities like Milano, Paris, London, Tokyo, etc working with the fashion talents over there. Overall, the campaign taught me a lot. What I realized was I needed to focus on my pre-campaign marketing and collect thousands of targeted emails from the people who are already fans of the brand. Also, super backers were definitely a very important part of the success equation. Then, as they rush into pledging to buy the shoes in the first few days to receive the early bird price, it’d create a snowball effect for the rest of the campaign and then, the press would be interested. Now, let’s move onto the main topic, Equity Crowdfunding as the new wave for the democratization of owning a share of success. The Era of Equity Crowdfunding is at Its Infancy Signed in 2012, The JOBS Act promises democratization for investment. Source: Swathmore Phoenix The Jumpstart Our Business Startups (JOBS) was the inception point for Equity Crowdfunding (ECF) in the US and basically, in the world. According to JOBS, any regular American is able to invest in companies through an ECF platform. The bill passed during the Obama period in 2012, on a 73–26 vote after amending it to tighten up for investment restrictions and requiring startups to disclose financial information to investors. Then, it wasn’t until May 2016 that ECF received the blessing of the Securities and Exchange Commission and that qualified companies to launch their ECF platforms. Yes, I hear you like asking why it took one presidential term to get SEC to allow the leeway for ECF. What happened in the course of those 4 years could be the topic of another story. The total amount that can be invested through unaccredited and accredited investors is $1 million in a 12-month period and ECF needs to be through a crowdfunding platform or a broker-dealer. The citizens earning less than $100k are able to invest up to $2,000 and become a shareholder in a company. Top 3 ECF Platforms The presentation of Indiegogo ECF venture. Source: Slideshare On the very first day that the JOBS bill passed the SEC front, more than 10 platforms applauded the move and registered with FINRA, which stands for Financial Industry Regulatory Authority. There are a number of criteria that a company should go through to select the right ECF for its goals. The most important criteria would of course be the total amount raised in the platform. Source: Kingscrowd As you can see from the chart above, there is a significant rise in ECF in the last 3 years especially for the top 3 players, namely, WeFunder, StartEngine, and Republic. Let’s see what makes them different which would give a way for you to analyze the ecosystem by using key criteria. 1. WeFunder. Startup capital raised (2020): $70.9M Platform Fees: 7.5% of the amount raised (best price match offer) Other Fees: none (credit card fees of 3.5% paid by investors) Referral Discounts on Fees: Yes — 10% off fees and $0 upfront (this can be $8,000+ in discounts) — Extra Due Diligence / Deal Curation: No Primary Securities: SAFE, Equity, Revenue Share Registered Broker-Dealer: No 2. StartEngine. Startup capital raised (2020): $68.6M Platform Fees: 7–12% of the amount raised; $10k service fee. Other Fees: 0.5% escrow fee Referral Discounts on Fees: Yes — up to $1,000 Extra Due Diligence / Deal Curation: No Primary Securities: Equity (Common), Convertible Notes Registered Broker-Dealer: Yes Secondary Platform: launching in Q4 2020 3. Republic Startup capital raised (2020): $37.7M Platform Fees: 6% of the amount raised, 2% of securities sold Extra Due Diligence / Deal Curation: Yes Primary Securities: Crowd SAFE Registered Broker-Dealer: No Below are the top 10 criteria that I think are keys to selecting the right ECF platform. Number of active investors Types of investors (average check size, type of deals) Funding history (of the platform itself) Number of campaigns Types of companies (niche or local offerings vs. more broadly-appealing businesses) Platform fees Discounts on fees Due Diligence process Securities offered (e.g. SAFE, Equity, etc.) Funding history (of the platform itself) Who Should Think ECF as a Viable Alternative Top Equity Crowdfunding Platforms. Source: Lab 172 There are two sides to the coin and it is no different for ECF. An unaccredited investor can now own equity in a company. That corresponds to the majority of the US. However, unaccredited investors mostly consist of amateurs who are putting their faith in the company without having extensive experience investing in companies. Accredited investors are aware of the fundamentals of a business and the numbers that really matter. I always wonder what Warren Buffett checks when he reads the financials of a company for hours before investing. Therefore, ECF involves a high-risk factor for the unaccredited investors since investing as everything else is like going to the gym and you need practice and training to be one in reality. Thanks to due diligence requirements and regulations brought by SEC and FINRA such as the ability to invest up to $2,000 if the investor earns less than $100k, the level of risk is reduced significantly. If you come to think of it, even though it involves high risk with due diligence, an investment can ideally have a 100-fold return only in a few years, which occurred in the Oculus (reward) crowdfunding campaign. That would hardly be possible with any other investment alternative. From a company point of view, when a company raises funds via ECF, it is also a viable strategy when carefully managed and executed. Like reward crowdfunding (RCF), companies are able to raise funds and at the same time, raise awareness seeing it as an alternative to PR, marketing, and social proof. Also, equity crowdfunding can be seen as a pre-IPO for companies that have just started their growth journey. Companies can raise up to $1 million from a pool of such a big population, which did not exist before. That increases their chance of growth significantly. A possible disadvantage for companies would be the dilution of their shares and established VCs could have less interest in owning shares of the company in the later stages. Final Thoughts Reward crowdfunding (RCF) platforms such as Kickstarter and Indiegogo have been big hits in the last 10 years, rightfully so. The reason why RCF worked so well is mainly that it is donation-based which stimulates the senses of becoming the first to own a new and exciting product and supporting an exciting startup. Most importantly, the risk is low and even if the products aren’t delivered, the loss is mostly around a few hundred dollars at most. Equity Crowdfunding (ECF) is a totally different ball game. The risk is higher since the reward isn’t a perk or the product of the company delivered right after the campaign. The reward is the equity, which is possibly a long-term investment in the company, believing in its fundamentals and product. The pool of investors is much larger with equity crowdfunding and it brings democracy to investment, which brings the chance to raise funds for any company from the majority of the population. All in all, ECF will surely grow substantially in the coming years around the world as we can see especially from the numbers of the last 3 years. Thanks to the internet, both companies and people will become smarter in their steps towards ECF by educating themselves in time. And as there will be few bright stars among the many companies, which use the ECF for early-stage success, the popularity of the concept will highly likely soar. I would definitely recommend moving forward with ECF while taking careful and small steps educating yourself with case studies, asking knowledgeable people, watching Youtube videos, and taking small actions in the beginning because what really teaches us any game is actually playing it. Then, you will have a much more aware interaction with ECF whether you are raising funds for your company or becoming a shareholder in one of the exciting startups.