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Equity crowdfunding for businesses and entrepreneurs
Raise funds without sacrificing control — but watch out for the high cost and complex regulations.
Equity crowdfunding is best for high-growth startups that want to avoid debt but stay in control of their company. It's also one of the few financing options available to the cannabis industry, which can't legally receive large investments.
But it comes at a high-cost — fees can set you back as much as $100,000. Regulations are also difficult to navigate. Consult an attorney before you decide to use this method to finance a new venture.
Equity crowdfunding gives small startups access to investors
Equity crowdfunding is a way for early stage companies to raise capital from a group of accredited and nonaccredited investors before they go public. This means that you can raise money from your social network as well as accredited investors, without sacrificing control of the company.
Also known as investment crowdfunding or crowd investment, this option is available through equity crowdfunding platforms. Like all equity transactions, it's regulated by the Securities and Exchange Commission (SEC).
There are two types of equity crowdfunding
Equity crowdfunding essentially exempts small businesses from filing requirements with the SEC while allowing nonaccredited investors partially fund a small business. Title III of the Jumpstart Our Business Startups Act, or JOBS Act, first legalized equity crowdfunding in 2012. This type of crowdfunding is known as Regulation crowdfunding, or Regulation D and CF crowdfunding.
In 2015, Congress amended the JOBS Act with Title IV, created another option to crowdfund larger amounts, known as Regulation A or Regulation A+ crowdfunding.
Some platforms offer both types of crowdfunding, though Regulation crowdfunding is more common.
Regulation crowdfunding: smaller funding limits, but fewer rules
Regulation crowdfunding offers the basics to small businesses that want to raise funds from a wide pool of investors. Here's how it works.
- Businesses can raise up to $5 million per 12-month period.
- The whole process can take between 21 days and a few months from start to finish.
- Entrepreneurs most often Regulation crowdfunding as seed funding to launch a new business.
Regulation crowdfunding document requirements
- Before starting a campaign, businesses must file Form C with the SEC, which includes two years of financial reports for business owners, officers and and directors.
- After raising over 50% of the target amount, businesses must file Form C-U with the SEC — which the platform often does automatically.
- Each year, businesses may also need to file progress and annual financial reports to the SEC.
Regulation crowdfunding is generally the simplest option. There are relatively few startup costs associated with Regulation crowdfunding — and it doesn't require SEC approval to start a campaign.
Regulation A+ offers larger funding limits with more paperwork
Also known as a mini IPO, Regulation A+ allows small businesses to raise larger amounts of funding.
- Small businesses can raise up to $75 million over a 12-month period.
- The whole process takes between six months and a year. It takes 300 days on average to get SEC approval to start a campaign alone, according to the New York Times. Some campaigns can run for several years.
- Companies most often use Regulation A+ to fund Series A, B and C rounds of funding.
This option is more complex, and can be more difficult to qualify for. Some platforms have minimum revenue requirements. Others might ask that your business have a minimum valuation. Even if the platform doesn’t require this, you’ll still need to convince investors that putting money into your business has a good chance of becoming valuable.
Regulation A+ document requirements
Because businesses can raise more funds using Regulation A+, this option requires more documentation than Regulation equity crowdfunding:
- Before you launch your campaign, you must submit an offering statement to the SEC, Form 1-A, with two years of audited financial statements.
- After you complete an offering, businesses must submit and an exit report, Form 1-Z, within 30 days.
- Each year, businesses with campaigns over $20 million must also submit audited annual report, Form 1-K, and a semiannual report, Form 1-SA, to the SEC each year.
- Whenever there are significant changes to the business — like a change of CEO — businesses that raise over $20 million must also submit a current report, Form 1-U .
How the equity crowdfunding process works for entrepreneurs
Crowdfunding transactions must be conducted through either an online platform that's registered with the SEC and the Financial Industry Regulatory Authority (FINRA), or a broker-dealer.
While each equity crowdfunding platform has its own process, entrepreneurs typically follow these steps to set up a campaign.
- Apply to set up an account with the platform. You may need to provide financial statements for the business and all owners, directors and officers, as well as a business plan and a pitch deck.
- Submit your initial paperwork to the SEC once you're approved, with the platform's assistance.
- Set up a campaign on the crowdfunding platform, set a fundraising goal and determine an end date. Some platforms offer marketing services, for a fee.
- Wait for potential investors to view and fund your campaign. You can share your campaign with friends, family and other members of your social network.
- Close out the campaign at the end date and pay the platform fee, usually a a percentage of the funds raised.
- Wait to receive your funds, and be ready to be patient. The SEC requires businesses to wait at least 21-days between submitting Form C and receiving funds. Regulation A+ campaigns take even longer.
- Submit any additional documentation to the SEC, as required.
Most platforms offer services to help you submit the documentation for Regulation equity crowdfunding — and some will even foot these costs upfront. But you may need to rely on your business's own accounting and legal resources for Regulation A+ .
Common equity crowdfunding expenses
Equity crowdfunding platforms charge a fee when you complete the campaign — but there are also several upfront costs associated with setting up and running a campaign. Here's what you might expect to pay in fees and expenses:
- Platform fee — around 7.5% of funds raised. Many platforms only charge a fee after you’ve been funded, while others charge a monthly fee.
- Form C or Form A preparation — around $1,500. Startups are required to fill out and file a form with the SEC and its investors that describes its offering. Some platforms offer a service to help startups fill out this form, though your business might have to pay an additional fee on top of the filing costs.
- Escrow agent — around $1,500. Getting funds from an investor involves setting up an escrow account — where the money sits until the deal is done. It can get complicated, so some startups choose to hire an escrow agent to handle it.
- CPA — around $1,000 to $4,000. If your company doesn’t already have its finances in order, it might want to hire a CPA to make sure everything is in top shape — or risk losing out on investments.
- Legal fees — around $1,500. Setting up an investor agreement and reviewing forms to submit to the SEC takes some legal expertise. You won’t need to pay this if you have in-house attorneys. Otherwise, some platforms might require you to hire legal services.
- Credit card processing fees — around 2.5% per transaction. Some platforms accept investment funds from credit or debit cards — and pass along the fee to the borrower.
- Marketing — varies. Investing in marketing isn’t a necessity, but having a strong video and infographics can help your campaign succeed — especially if you’re using a platform that allows both consumers and accredited investors to fund your business.
Some platforms cover these upfront costs or wrap them into their fees, but not all do. The total cost of Regulation A+ deals can be even higher — it can cost between $50,000 to $100,000 in legal expenses alone.
Benefits of equity crowdfunding
These are the main benefits to using an equity crowdfunding platform.
- Access to seed capital to start a new business — without having to pitch to angel investors or a venture capital firm.
- Lets you stay in control of your business, even while receiving private equity funds.
- Nonaccredited investors can fund your campaign, making it more accessible for small businesses.
- Available to high-risk industries — including cannabis — which can struggle to qualify for traditional financing.
Risks of equity crowdfunding
For many small businesses, consider these risks before you set up a campaign.
- Upfront costs add up. Legal fees can reach $100,000 for Regulation A+ campaigns and some companies may need to hire a CPA.
- Time-consuming application and onboarding process that might not fit the schedule of a busy entrepreneur.
- SEC filing requirements can extend for years after you receive the funds.
- Newly legal financing options come with regulations that can be difficult to navigate on your own. You'll likely need to hire an attorney if you don't already have one on staff.
Alternatives to equity crowdfunding
Equity crowdfunding isn't the only way to finance a new business. Here are some startup financing alternatives you may want to consider, including other types of crowdfunding.
- Donation-based crowdfunding comes with few regulations and doesn't require anything in return. Typically the only cost is a platform fee.
- Rewards-based crowdfunding works like donation-based crowdfunding — but contributors to your campaign receive a gift in exchange. Typically you also have to pay a platform fee.
- Startup business loans offer financing during the early stage of your company, which you repay plus interest and fees. These typically require the owner to have good or excellent credit.
Read our guide to startup financing to learn more about your options. Or, use our table to compare small business loans your company may qualify for. Before you apply, make sure your business meets the lender's requirements, otherwise your application will be rejected.
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Sources
- 17 Code of Federal Regulations § 227, US Government Publishing Office, accessed August 2021
- "SEC Harmonizes and Improves 'Patchwork' Exempt Offering Framework," US Securities and Exchange Commission, November 2020
- "New Rules Let Companies Sell Stakes to Investors of Modest Means," New York Times, June 2015
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