The crowdfunding market has ballooned in recent years as entrepreneurs take advantage of new avenues to raise venture capital and investors cast their net wider for new opportunities. But what exactly is crowdfunding, and more particularly, equity crowdfunding and how can your business benefit from it?
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What is equity crowdfunding?
Crowdfunding is a method of raising funds by asking a large number of people to invest small amounts of money towards a business or venture. This is done normally via an online platform where fundraisers can promote their ideas and seek contributions towards their venture in return for incentives, such as rewards or a share of equity in the business.
Its success is tied to the development of online social networks and cloud computing, which allow groups of people to feel comfortable about engaging in financial transactions with others online.
Crowdfunding websites, such as Seedrs and Crowdcube act as intermediaries between people with money and businesses seeking investment. Companies qualifying to pitch on these websites attempt to attract a target investment from the collective interest of ‘the crowd’.
What is equity crowdfunding?
Equity crowdfunding, sometimes known as crowd-investing or investment-based crowdfunding, allows investors to contribute money to a business in exchange for shares. You will typically only get your investment back if the company is sold or is listed on a stock exchange.
Equity crowdfunding is a relatively new fundraising channel aimed at (predominantly) small and growing businesses. What makes equity crowdfunding different is that businesses pitch for small amounts of money from a large group of individuals, whereas with business angels or private equity you'd typically pitch for substantial amounts of money from a smaller and more selective group of individuals.
Investors might only want to risk £10 on a single venture for a tiny slither of equity, hoping that the business’ future success will transform this small stake into something more significant. Pick the next Facebook or Netflix and they’ll be laughing all the way to the bank.
Investors like crowdfunding because businesses are vetted by a third-party, there is very little red- tape, they get added assurance because a crowd agrees with their bet, and businesses are boosted by a new audience of, potentially, thousands of new customers whose loyalty is guaranteed.
What do crowdfunding investors look for?
As with all investors, the main priority is securing the best possible return. But people who back businesses on crowdfunding sites also look for tax relief in the form of EIS or SEIS, as well as a foreseeable exit and a strong team.
But because crowdfunding allows for small investments, many are also open to fun or quirky investments as well as those with good stories or ethical ambitions. They are risk averse, but less so than banks or venture capital firms.
Is equity crowdfunding a good way to raise money?
Whether you’re seeking investment from crowdfunding or any other channel, it’s important to do your research and consider the pitfalls as well as the benefits, which we will look at in more detail below.
Advantages of equity crowdfunding
- Access to funding: this is the main attraction for businesses as crowdfunding opens up access to a large number of investors who can invest small amounts which will then add up to the larger funding target. It avoids the need for traditional bank lending hurdles and red-tape
- Marketing: the process of crowdfunding is essentially a PR campaign, and crowdfunding websites have an interest in helping your business attract the biggest possible audience. Businesses can broadcast positive messages to a large audience and potentially develop a new group of customers or followers, whether they hit their funding target or not
- Ambassadors: if you’re successful in your fundraising, then it’s likely you have built a large group of ambassadors with a vested interest in promoting your brand. In other words, as well as money, you get your own army of promoters
- Customers: by drawing attention to your product or service, businesses can acquire not only investors but a new following of customers, who you know have cash to spend. Potential customers can also be a useful source of feedback on the product or idea which gives businesses a chance to tweak and improve their offering
- No win no fee: crowdfunding platforms take a small percentage of successful fundraises. In most cases, you only pay a fee if you meet your stated target and if you fall short, you might not be granted any cash, but you won’t be charged either
- Small stakes: you can decide how much equity you want to exchange in return for investment meaning you keep control of the process
- Regulation: the Financial Conduct Authority (FCA) regulates all equity crowdfunding platforms in the UK. This provides a safer space in which people can invest their money and will reassure investors
- Potentially high returns for investors: if the business grows and becomes more successful, the value of the shares will also increase
- Advice: many platforms offer help and support during the various steps in the process.
Disadvantages of equity crowdfunding
- Fees: platforms may charge fees and expenses
- Risk of failure: you risk putting your business or idea out there in the public domain with a risk of not raising the target funds. This may also harm the reputation of the business for any future funding campaigns
- Due diligence: crowdfunding platforms must do due diligence on those seeking funding which could affect both your personal and your business credit reports
- Vulnerability of intellectual property: your ideas or creations may be subject to replication by others when they are freely accessible to such a large number of people
- Low liquidity for investors: cash will only be realised on the sale or listing of the business which may take years to happen or never happen.
How do you crowdfund your business?
Before you embark on a crowdfunding campaign, do some research. Ensure that this really is the right route to go down. Check whether businesses like yours have achieved their funding targets before and ask yourself what their strengths and weaknesses were. Being organised and having a good team in place are also crucial preliminary steps – this will allow you to have all the information you need to hand and be able to communicate with potential investors promptly and professionally.
Step 1: Pick your platform
Every crowdfunding platform is different so it is important to find the one which best suits your business. While many offer investors the chance to take equity in a business, others let you dangle goodies and rewards as an incentive to back your organisation. Some welcome individuals and others are great for charity fundraising. Even among the equity crowdfunding platforms, fees, policies, administration and audiences will vary. So do your homework before diving in.
Step 2: Create your campaign and story
You will need to create a campaign in which you provide details about the business, including a description of the product or service, the story behind the business, your funding target and the equity exchange details.
The most important aspect of your campaign is the marketing pitch and the video which accompanies it. Some platforms emphasise the video more than others, but all the best ones give you the chance to tell your business story visually.
Your video doesn’t have to be a blockbuster, but it must meet a decent production standard, so most businesses spend some money to get their videos just right. Also consider your script, which above all must be clear and honest, and be prepared to justify any claims you make in it.
It also goes without saying that a well-thought out campaign page will generate more interest than one that has been thrown together. Cast around for popular pages that have exceeded their funding target, particularly those in a similar market to your own, and consider what they did well.
Key elements of a good page include:
- A snappy, well-written description of the product and its reason for existing
- An exciting story about your passion for the business, how it started and its journey so far
- Evidence of demand and a strong track record
- A competent team with qualified individuals in the right places
- Professional images of your product or service
- An eye-catching heading that draws people in from search pages
Step 3: Set your funding target
This is probably the trickiest aspect of creating a crowdfunding page. Just like setting a product price, the figure must be high enough to generate the money you need, but not so high that it feels overvalued.
A neat trick that many successful crowdfunders use is to secure a proportion of your intended fundraising before your page goes live. They do this by approaching friends, family, colleagues, customers and business partners. Investors will identify that your product is in demand, instead of being confronted with ‘0% of target’ when they browse onto your page.
Step 4: Market your campaign
While the crowdfunders will put their marketing resources to work for you, you’re expected to work hard to draw attention to your page as well. Consider which assets might come in useful, for example, social media sites, a social media following, hosting a ‘live’ event on social media, blogs, email databases or content marketing (writing articles for websites to publish, linking back to your funding page).
Many companies sign PR agencies on short contracts to boost their visibility during a campaign. This helps both by attracting new audiences to your fundraising and by providing interested parties with further reading about your business.
Step 5: Launch your campaign
Use your social media and other marketing platforms to announce the official launch. Ensure that you are being seen by investors either through online channels or by attending industry events. This will ensure that you are available and present to tell your story to potential customers and investors and answer any questions they may have.
Step 6: Deliver on your commitments
If you meet your target, congratulations, but now you must deliver on your commitments, including honouring any rewards offered and issuing shares in the business. This should be done as quickly as possible to reassure investors and maintain a professional status.
Ensure that you keep in contact with investors and give them regular updates as you build the business to involve them in the journey.
In return, it is hoped that they will bring loyalty, advice and a guaranteed market for future products and services.
Next steps
Equity crowdfunding could be an excellent option for you and your business to raise funds quickly and relatively painlessly. It does come with its downsides though and it is vital to understand the different types of platforms available and the risks involved.
If you would like to find out more information about equity crowdfunding and what this could mean for your business, then please get in touch with our team of corporate lawyers.
