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Equity Crowdfunding Basics You Should Know

equity-crowdfunding.jpegYou may have heard of popular crowdfunding sites that help you to kick-start a business idea with funding donated by those interested in your product.  The nice thing about these sites is that the people who fund your venture will accept product samples, swag (posters, tees, associated merchandise), and even tokens like signed items or the chance to meet with you in exchange for the money provided.

In other words, you need not pay back your investors, at least not in the same way you'd pay back a loan.  It's a trade, of sorts, that helps you to get your startup off the ground with public support.  Equity crowdfunding is a little different, though.  Here are a few basics you should understand.

What is Equity Crowdfunding?

Like other types of crowdfunding, equity crowdfunding relies on a group of investors providing relatively small sums of money (as opposed to the lump sum of a business loan) to fund the startup of your company, provided it is not yet listed on the stock exchange.  There are many equity crowdfunding portals up on the Internet now, such EquityNet, which is one of the largest.

In equity crowdfunding, what investors get in exchange for their contributions are shares in your company; they actually become shareholders.  You get funded and they get equity.  As shareholders, they stand to profit through a variety of ways, including possible distributions of profits or dividends, or, if your business conducts a successful IPO (initial public offering), through selling their shares.

In some cases you'll work with an investment firm that handles equity crowdfunding and already has groups of investors lined up.  Many of them operate online as an economical means of reaching interested investors all over the world.

Filing with the SEC

Because you're offering shares in a company to investors, this is a securities transaction and you will have to comply with SEC (Securities and Exchange Commission) regulations.  These securities law compliance requirements typically include making an initial filing during the crowdfunding process to inform the SEC of your offering of securities to investors.  This filing is done on a federal Form D and includes such information as company size, location, the number of securities being offered, and the offering amounts.  The Form D can be amended later to report changes.  You would be wise to seek the advice of an experienced SEC and private placement lawyer before ever offering your securities to investors.

Pre-emption

One other important thing to understand before entering a crowdfunding agreement is the concept of dilution.  This happens when further rounds of funding occur, potentially making initial shares worth less than their original value.

Say, for example, the first round of investment involves 100 shares and 100 investors, each with one share.  Each therefore holds a 1% stake in the company.  If you do further rounds of funding and offer more shares, the initial investment will be devalued, unless they have pre-emption rights that protect their stake.

This is important for two reasons.  First, you have to make sure to build pre-emption rights into your portion of shares.  Second, you have to decide if you want to offer pre-emption rights to investors.  Most seasoned investors won't be interested unless you do, and rightly so.

Conclusion

As you are looking to build your business and secure funding for continued growth and success, it is wise to explore all of your available options. Equity crowdfunding can provide you with the financial backing you need, but be sure to consult with an experienced attorney that specializes in PPM services and agreements before agreeing to sell any shares of your company.

Tagged crowdfunding, Equity Crowdfunding, PPM, Private Placement Memorandum, Startups