Education - June 18, 2018

What is Equity Crowdfunding?

Equity crowdfunding has become an increasingly important component of today’s capital markets with the concept emerging in 2009. But what exactly is the definition of equity crowdfunding? Equity Crowdfunding (sometimes referred to as simply “crowdfunding” or “Crowd Investing”) refers to the process by which average investors can invest as little as a few hundred dollars in early-stage private companies. Equity crowdfunding contrasts with older methods for small and medium-sized businesses to raise capital: venture and private equity investors.

How it works

Equity crowdfunding is a mechanism that enables average investors to fund a startup. Investors give money to a business and receive ownership (equity) in exchange.

Ownership of a company through crowdfunding is no different, legally than owning publicly-listed common stock. As the business flourishes (or fails) its value will track the success of the business itself.

The Equity Crowdfunding phenomenon took off in recent years thanks to the April 2012 passage of the JOBS Act by President Barack Obama. The purpose was to give average investors the chance to invest in early-stage, high-growth companies.

Title III of the JOBS Act, passed in May 2016, changed the space forever. Giving everyone the opportunity to invest money in accredited businesses through crowdfunding companies.

Essentially, Title III granted any U.S. citizen that has attained at least 18 years of age the right to invest in an equity offering. This process was once highly regulated and only reserved for “accredited investors,” aka millionaires.

While “Investment Crowdfunding” can take the form of any part of the capital structure (debt-based or equity-based) equity remains the common path. Almost all investment crowdfunding takes place on any one of the 42 FINRA registered equity crowdfunding platforms that have sprung up.  Today, leading equity crowdfunding portals include:

Potential risks

As with any investment, there are risks to equity crowdfunding. Since most companies involved are new and untested, the chance of loss is high. This risk can be balanced out by owning a broad-portfolio of numerous different companies. As with all investing, diversification is key and helps to protect the average investor.

By only investing through well-recognized portals and only investing in what you know, you too can safely participate in the equity crowdfunding revolution.

What you need to know

Fortunately, Crowdfunding is regulated to protect investors. Though not as safe as traditional public companies that are overseen by the Securities and Exchange Commission (SEC), all companies listed on equity crowdfunding platforms are vetted and ranked for their safety.

The true benefit of equity crowdfunding is the chance to identify companies the investor believes in — an d being along for the ride as an owner from the beginning. By only investing through accredited equity crowdfunding portals, sticking with what you know, and diversifying your crowdfunding investment portfolio, you too can join in on the equity crowdfunding revolution.

About: Sean O'Reilly

View more articles by Sean

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