Companies and corporations have been established and operating for ages. In this modern digital age, easy access to information and an increase in the allure of entrepreneurship have changed the fundamentals of doing business.
Social innovators, entrepreneurs and artists are heading towards newly formulated ‘online marketplaces’. In finance and fundraising, this has manifested itself in the form of alternative financing models such as peer-to-peer (P2P) lending, venture capital, social and impact financing platforms and crowdfunding.
What is Crowdfunding?
Crowdfunding is a process of raising funds or capital for startups, new ventures/ideas or even artistic and creative projects. Using this mode, startup owners and entrepreneurs are able to reach out to the public including venture capitalists as well as angel investors to seek fund for their ventures.
Crowdfunding ranges from Investment, Rewards (non-cash incentives for the crowd) and to Charity. Crowdfunding investment includes peer-to-peer financing (P2P) and Equity Crowdfunding (1).
P2P is the most common type of investment financing in the US, China and Europe – mature crowdfunding markets. P2P allows the crowd to earn profits by providing loans to either businesses, projects or individuals. Equity crowdfunding on the other hand enables the crowd to purchase shares in private companies (1).
Despite gaining momentum and considerable interest from the public (the ‘crowd’), crowdfunding is still nascent in most parts of the world and an emerging field. Thus, popular and academic conceptions of crowdfunding are in a state of evolution.
What is Equity Crowdfunding?
Syndicate Room explains that equity crowdfunding (also called ‘crowd equity’) is the process whereby a company seeks investment from the ‘crowd’ in exchange for its stocks or shares.
This mechanism is primarily used to generate funds/capital in the early stage for unlisted companies, start-ups or small businesses. The investor holds partial ownership in the company and gains profits from dividends or the sale of their shares.
This has helped to democratize investments in companies which were previously dominated by wealthy venture capital firms and business tycoons.
Highlights of Equity Crowdfunding
With thousands of successful campaigns and ventures, the number of crowdfunding platforms has also increased. Furthermore, these platforms are able to cater to the needs of various investor groups through different business models and focus areas.
Here is some information about equity crowdfunding that could come in handy
Highlight #1: Equity Crowdfunding tends to be regulated
Since equity crowdfunding resembles a share trading platform similar to the traditional stock exchange, it naturally falls under the capital market structure. Therefore, it is regulated in many countries such as the US, Malaysia and Italy.
Highlight #2: Recognised by 20 countries
Our observation shows that more than 20 countries have recognised equity crowdfunding as a mode of investment/financing.
Highlight #3: Helping the small powers
Raising funds can be a difficult task; banks usually tend to avoid lending to early-stage ventures while investments from angel investors are often difficult to secure and manage or even non-existent in some countries. Therefore, most entrepreneurs would have to rely on self-generated funds or even worse personal loans. On the other hand, small investors have limited access to high-growth private companies which are usually accessible to those with relevant networks and relationships.
Equity crowdfunding with the power of the internet has become the new intermediary to match start-ups with a wide range of investors.
Highlight #4: Fundraising models
When intending to raise fund for companies, equity crowdfunding platforms will first conduct due diligence before the company is typically offered two funding models to choose from to raise the funds. The models are Direct Investment Model or Nominee Model.
In the Direct Investment Model, the platform only facilitates the transactions between the investors and the founder. Once transactions are concluded, the investor(s) name will be on the company’s Shareholder register.
As for Nominee Model, the platform plays an active role in the investment and becomes the shareholder on behalf of the ‘crowd’ – crowdfunding investors.
Highlight #5: Win-win ownership model
Equity crowdfunding essentially preserves ownership and can bridge the early-stage funding gap new companies. In addition, it also potentially generates above-average returns for investors and offers them a chance to invest in startups that are attractive to them.
Risks of Equity Crowdfunding
Just like any types of investment, equity crowdfunding investment also comes with its own risks and disadvantages.
Risk #1: Crowdfunding costs
For companies or entrepreneurs seeking to raise funds through crowdfunding, they should consider the costs, such as platform or service fees. Although crowdfunding has countless benefits but mounting a campaign does incur some cost.
Risk #2: Short of fund
One of the main risks of any equity crowdfunding is the possibility of campaigns not being fully funded. In this case, the raised funds are either; returned to investors or channelled to the intended company. Both outcomes still leave the company in need of more funds.
In addition, low liquidity and profits as well as a delayed return may pose issues for the investors.
Risk #3: Ideas Theft
Another possible issue is the risk of ideas and plans theft by investors or even well-established companies. This is due to the lack of experience and grasp of entrepreneurs in protecting their ideas and creativity.
Several ways to mitigate these risks are by diversifying investments, signing of non-disclosure agreements or choosing a legitimate crowdfunding platform such AngelList, CircleUp and Fundable. Ethis is well known for impact investment crowdfunding but focuses only on real estate, not startups.
Equity crowdfunding is a great way for entrepreneurs and small business owners to raise fund to expand their ventures. It also offers small investors multiple avenues for investment.
- Ethis Islamic Crowdfunding Report Volume 1 (Click here to request this report)