What Is Equity Crowdfunding?

Raising the capital necessary to successfully launch a small business is perhaps the most difficult hurdle for most entrepreneurs. Common options include maxing out multiple credit cards or taking out bank loans, both of which present personal financial risks. Venture capitalists and angel investors, meanwhile, are focused on multimillion-dollar investments in companies poised for rapid growth.

With the advent of equity crowdfunding, however, even individuals with just a few hundred dollars to invest can get in on the game and take an ownership stake (however small) in the company. Below is an overview of this emerging area of business financing, which is well-suited to smaller businesses typically passed over by larger investors.

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The Basics of Equity Crowdfunding

At its essence, "crowdfunding" is a form of fundraising in which a startup (or even just an individual) raises small amounts of capital from a large pool of investors, typically through an online intermediary. Many of these intermediaries, such as Kickstarter and GoFundMe, are limited by the inability of companies to offer equity in exchange for contributions. Instead, they typically offer unique rewards that correspond with the funding level. For instance, someone making a modest contribution toward the publication of a book may receive a signed copy of the book once it's in print.

Equity crowdfunding, on the other hand, involves an exchange of capital for equity. As with traditional equity investors, those investing through an equity crowdfunding intermediary risk losing their money entirely but also may see exponential returns. What's different is the platform, which allows direct interaction between the company and the investors, and the size of the investments. Equity crowdfunding intermediaries include AngelList, Early Shares, and Crowdfunder.

Equity Crowdfunding and the JOBS Act

On Sept. 23, 2013, the Securities and Exchange Commission (SEC) enacted rules under the Jumpstart Our Business Startups (JOBS) Act that paved the way for companies to sell securities (equity) through crowdfunding. Companies may raise up to $1 million -- in aggregate -- through crowdfunding in any 12-month period. As of this writing, the SEC limits equity crowdfunding to accredited investors only. To be considered an accredited investor, individuals must meet one of the following criteria:

• $1 million net worth;
• $200,000 annual income; or
• $300,000 joint annual income (with spouse)

Those who are considered accredited investors may invest as little as $1,000 in a deal, depending on the intermediary, in exchange for a proportional slice of the company's stock. Investors usually hedge their bets by investing in several startups, since most ventures do not succeed, but just one success has the potential to make up for the losses.

Title III: Equity Crowdfunding for the Masses

The SEC enacted Title III of its Regulation Crowdfunding rules on May 16, 2016, opening up equity crowdfunding to lower-income individuals, with certain limits. Within a given 12-month period, investors with a combined net worth and income of less than $100,000 will be able to invest up to $2,000 or 5 percent of their annual income or net worth (whichever is greater). Those with an annual income or net worth of at least $100,000 will be allowed to invest as much as 10 percent of their annual income or net worth (whichever is greater), limited to $100,000 worth of crowdfunding-based securities in a 12-month period.

Disclosures

Title III of the JOBS Act will require companies engaging in equity crowdfunding to file certain disclosures with the SEC and the online intermediaries conducting the transactions, while making this information available to current and potential investors. Companies will be required to disclose information about the following:

• Officers, directors, those with a 20-percent (or more) ownership stake of the company
• Company description and explanation of how the proceeds will be used
• Price of securities being offered to the public, deadline to reach target amount, any applicable limits to investments in excess of target amount
• Company's financial condition
• Transactions among related parties (subsidiaries, partners, other investors, etc.)
• Certain financial statements

Learn How Equity Crowdfunding Can Help Get Your Business Off the Ground

Raising capital is tough, especially for small businesses that aren't necessarily on the radar of the venture capital community. For many entrepreneurs, equity crowdfunding presents a unique opportunity to raise substantial capital from a large number of small investors without the need for risky loans. Get a head start today by ordering Crowdfunding: Practical Guide to the SEC's Final Rules for Raising Capital, published by Thomson Reuters.

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