Equity Crowdfunding
What is equity crowdfunding? 💸
Equity crowdfunding is the online offering of a private company to a group of people for investment. Depending on the startup's terms for investment, investors can receive a (usually small) percentage of ownership, a financial stake in the company, or the right to a return on future revenues, amongst other things.
Equity crowdfunding is a process that enables middle-class people to invest in startups before they become a public company or get acquired. So venture capital firms and high net worth angel investors don't steal all the fun with fruitful exits in the private markets, where real wealth is accelerated.
Leveling the playing field. ⚖️
In the past, only accredited investors could invest in private companies. The logic behind that law was to protect everyday people from being duped into investing more than they could afford to lose (basically the business model behind Las Vegas 🙃).
The JOBS Act, Title III 👩⚖️👨⚖️
However, this all changed in 2016 when the S.E.C. enacted Title III of the JOBS Act, which enabled middle-class Americans an opportunity to invest in startups.
But the S.E.C. doesn't just authorize things without rules…and since we’re all law-abiding citizens, here are the rules:
Entrepreneurs can raise up to $1.07M in a 12 month period from anyone.
Who is anyone? Non-accredited investors over the age of 18 (depending on their annual income).
These investments need to go through funding portals (I’ll talk about some of these later).
Below is the S.E.C.’s non-accredited investing limits within a 12 month period:
Title III of the J.O.B.s Act was a significant step in democratizing private markets. This will also give startup founders another option for funding besides being pressured to sign a V.C. firm’s predatory term sheets. Those term sheets force the startups to hit specific milestones, which may not even make sense at some point. In many cases, if they don’t hit those milestones, a founder can lose their company. Another battle-tested fundraising option could create some correction in the venture capital space regarding how term sheets will be written.
Building a community🤝
Equity crowdfunding can also help a startup build a massive community of loyalists. A successful crowdfunding round could generate tens of thousands of investors. These investors not only believe in the startup enough to invest in it, but they will also act as ambassadors. They’ll promote the startup in so many different ways. They’ll share on their social channels, buy the product(s), wear the company merch, and tell everyone about their investment and the startup. So not only is the startup getting another round funded, but they’re building a community around their startup. A strong community is one of the best assets a company can have. We’re even seeing a lot of companies hiring Cheif Community Officers.
Funding portals🏦
Investments in an equity crowdfunding round have to go through funding portals. Funding portals are S.E.C. sanctioned intermediaries that facilitate fundraising transactions. A registered funding portal is prohibited from:
Offering investment advice.
Soliciting purchases, sales, or offers to buy securities displayed on the platform.
Holding, managing, possessing, or handling investor funds or securities.
One funding portal platform I like is Republic. Republic has an impressive platform filled with education. They also have a great UX on their website and app. I highly encourage you to take a look. My favorite part about Republic is how thorough and process-oriented they are when selecting startups that applied.
Per Republic's website, they select less than 5% of startups out of the thousands that apply to be on their platform. The selection process is pretty rigorous, including an initial screening process that focuses on the founders, product, traction, and mission (also known as the “FPTM model”).
Republic will run their due diligence by doing the following:
Review the startup’s pitch deck.
Conduct screening calls.
Complete an independent research on the company and potential market fit.
Tap into its network of industry experts.
Review the potential social impact of the startup.
Review the market the startup is in.
Review the startup’s technology and if it can scale (important!).
Review the company’s personnel to make sure everyone’s roles are structured efficiently.
Fact-check all the information presented by the startup.
Why is all of this important? Well, evaluating private companies is very difficult, especially if you're not in the pitch meetings or getting direct access to the entrepreneurs and the company. But because of Republic’s comprehensive selection process, you know these companies are legitimate. However, I still recommend practicing your due diligence when evaluating companies you want to invest in; just because a company is legitimate doesn’t mean it will scale.
Here is a list of other companies that provide funding portals.
My take on equity crowdfunding🧠
Will equity crowdfunding level the wealth creation playing field? Hard to tell. It’s still early. One thing is for sure, the V.C.s and the high net worth angel investors will still receive the bulk of the return, as they should; they’re bringing the most to the table. But equity crowdfunding can give the “small investor” a chance to have a seat at that table. They might be sitting on a small stool and squished at the corner, but it’s still a seat.
Making small investments in a couple of different crowdfunding rounds can be a great opportunity to learn as an investor. If you can give yourself a chance to sit at enough tables, you could eventually turn in that stool for a nice chair at the head of the table. But only if you do the work. This work is obviously not for everyone, and it’s absolutely not a guarantee you’ll come out profitable. However, if you do decide to partake in equity crowdfunding as an investor, here is what I would recommend:
Be thorough.🧐
Be very selective.
Read the full report on the funding portal multiple times.
Take notes.
Learn about the industry the startup is in.
Find its competitors.
Think about the consumer’s psychology (Will they buy the product? Will they understand the product?).
Learn about the tech the company is using if you can. Then try and find experts and ask if that tech can scale.
Find out why they’re doing a crowdsourcing round.
Do research on the founder(s) - podcast interviews, written interviews, background, social channels, etc.
Make small bets. In some rounds, you can invest as low as $100.
Reach out to the founder(s). 🤝
Not enough people do this or consider it. A majority of startup founders aren’t exactly movie stars. They’re reachable. Tell them you’re thinking about investing and want to learn more about the company. It’s very easy to connect with people in today’s world. Not living in Silicon Valley (or Miami and Austin now) is not a good excuse for you not to do this.
Find out who else has invested. 🕵️
Find out if there are big-name angel investors that have backed them. Let them know you’re thinking about investing (or already have) and want to connect. Ask them why they invested. In many cases, these angel investors have already probably posted a memo about their investment. Find that, read it, read the comments, see what people are saying. Connect some dots.
If you do diligent work, meet with the founder(s), and meet with co-investors, you could argue you’re already getting rewarded for your small investment. You’re building valuable experience, you’re learning about new industries, and you’re building a rolodex filled with entrepreneurs and angel investors. All of this for the same price as a nice pair of sneakers. You do all those things well enough, and it will no doubt lead to other opportunities.
As for the societal impact:
Equity crowdfunding enables more investors.
More investors mean more startups will get funded (survive).
More startups mean more competition.
More competition means more innovation.
More innovation means more jobs.
Capitalism at its finest, baby! (Adam Smith would be so PROUD)!