Equity crowdfunding offers excellent potential for startups and growing businesses. However, gaining marketing exposure and raising external funding from investors is very challenging and stressful.
In this guide, I will explain what equity crowdfunding and what are the rules and best practices for investors is.
What Is Equity Crowdfunding?
Equity crowdfunding is raising capital from the crowd through the sale of securities (shares, debt, revenue share, convertible note, and more) in a private company that is not listed on stock exchanges.
In return, investors obtain shares in the company. If the startup progresses admirably, the investors who have put shares into it will benefit. However, if the business comes up short or fails, investors will also lose a part of their investment (or all of it).
The Benefits of Equity Crowdfunding
Equity crowdfunding has easy access to investors. If you are 18 or older, you can now make an equity investment in a company. Although there are some restrictions on the amount that you can invest based on income and net worth, access to investment opportunities is far expansive than before. You can now promote your business to the crowd and get a lot of small investments that can add up to a huge amount of capital.
Generates media exposure
A successful crowdfunding campaign is engaging, which draws the attention of the media. Crowdfunding is a unique industry and can help pick up extensive media coverage, especially as your campaign gains momentum.
Gains credibility with proof of concept
When approaching angel investors, a successful and effective equity crowdfunding campaign will give your venture credibility. The success of a crowdfunding campaign tells other investors that there is enough market validation for your company.
Raises something other than money for your startup
Your investors immediately become a group of people dedicated to making your venture successful. Business people can depend on their horde of speculators for input, remarks and thoughts, which regularly helps during the beginning phases of an endeavour. For reviews, comments, and ideas, entrepreneurs may rely on their community of investors, which also helps during the early stages of an endeavour.
Builds a network of investors for the future
Your supporters from your crowdfunding campaign are still involved when your endeavour goes forward. They are also more likely to invest in future projects.
Who Can Invest in Equity Crowdfunding UK?
The criteria on who can invest in equity crowdfunding may vary from platform to platform. Some platforms may allow you to register as an investor easily while other platforms will not. A few crowdfunding websites depend on the Financial Conduct Authority approved tests to evaluate whether people can register and invest on their platform. However, keep in mind that whichever platform crowdfunding you choose, you need to do your research carefully.
How does Equity Crowdfunding Work?
How equity crowdfunding works depends on the platform you choose to invest in. Once you find out and you've researched the company you want to invest in, you can invest through on your chosen platform's website. You will usually have a 5-day cooling-off period, in case you change your mind. When you decide to go ahead with the investment, you will obtain shares in the company. You will see a return on your investments once the company starts making a profit and chooses to pay dividends, or goes public, which allows investors to liquidate their shares.
Two types of equity crowdfunding
There are two types of equity crowdfunding: Investor-led or Entrepreneur-led.
Investor-led platforms only list companies that have investors leading the funding round by putting their own money in, giving online investors at ease.
Online investors can now access a previously unknown and inaccessible world to them. You can now invest in the same companies as the professionals and under the same economic terms.
You can only finance companies that have been screened by an adept investor on investor-led crowdfunding platforms. With their own capital, the specialist investor finances the company and negotiates the terms of the investment. The platform then offers the crowd the ability to invest in the company on the same terms that the leading investor has negotiated.
There is no lead investor in such platforms, and the entrepreneur sets the terms of investment. These are the percentage of equity offered, share price, and several more in return for investment. Before any negotiations, entrepreneur-led platforms allow you to invest.
Equity Crowdfunding UK - SEIS and EIS Tax Reliefs
To promote investment in startups, the UK Government has created both the SEIS and EIS Tax Relief.
SEIS Tax Relief
In April 2012, HM Revenue & Customs (HMRC) launched the SEIS (Seed Enterprise Investment Scheme). The United Kingdom government created it to help small, early-stage companies raise funds offering various tax reliefs on investments made into qualified companies through individual investors.
SEIS provides some of the world's best tax relief. SEIS makes it possible to claim back up to 50% of your investment in income tax relief, giving substantial reductions on capital gains tax.
SEIS allows you to collect the money you need to grow for early-stage startups by offering substantial tax relief to investors in your company, making a potential investment in your business more appealing.
When it begins to trade, SEIS helps your business raise capital by providing tax relief to investors who buy new shares with tax relief in your company.
EIS Tax Relief
The UK Government also developed the Enterprise Investment Scheme (EIS) to help younger; higher-risk businesses raise finance by offering investors generous tax reliefs to investors.
Investors can claim EIS relief on up to £1M worth of investments in qualifying companies per person per year (this cap rises to £2m if you're investing in knowledge-intensive businesses, such as those in the life sciences sector). Even better, the scheme's carry back feature means you can apply your EIS-eligible investments to the preceding tax year.
Risks of Equity Crowdfunding
Online forums and social media are perfectly suited for equity crowdfunding for they offer broad reach, scalability, accessibility, and ease of recordkeeping. However, these same features are also the reason why it is easy for scammers to set up suspicious schemes to attract equity crowdfunding from naive or first-time investors. Because of this, never skip the step of doing due diligence on any investment you're considering.
Greater Risk of Failure
A business that has been done through equity crowdfunding has a greater risk of failure than those that have been funded through venture capital or other traditional means that offers professionals to help a startup through its early development challenges.
A Long Time to Materialise
Every investor anticipates some future return. However, returns on equity crowdfunding ventures may take several years to materialise. For instance, the executives may stray from the business plan or experience issues in the business. After some time, this may lead to capital loss.
Security of the Crowdfunding Platform
In recent years, hackers have shown a disturbing ability to break into seemingly impenetrable sources of leading businesses and financial organisations and steal credit card information and other valuable client data.
Crowdfunding portals and platforms have similar risk and are also vulnerable to attacks from hackers and cyber-criminals. Additional to researching the investment itself, make sure to take a closer look at the platform, too.
Rewards of Equity Crowdfunding
Potential for Outsize Returns
Since the risks are high, the probability for huge returns on equity crowdfunding is high, too. Crowdfunding is affordable, making it available for most startups and entrepreneurs. To start your campaign, several crowdfunding platforms charge nothing and take a small percentage of your funds if the campaign is successful.
Opportunity to Invest Like Accredited Investors
Before crowdfunding, only accredited investors—high net-worth individuals who have certain distinct levels of income or assets could partake in the early phase, speculative ventures that held the guarantee of high reward and similarly high risk.
The minimum amount threshold for such investments was relatively high. Equity crowdfunding, nonetheless, makes it likely for the average investor to invest in a lot more modest sum in such ventures. In that sense, it has evened the odds between accredited and non-accredited investors.
Greater Degree of Satisfaction
Investing through equity crowdfunding can give you a greater degree of fulfilment than putting resources into a blue-chip or large-cap company. This is because you can decide to focus on businesses or ideas that resonate with you, or that are engaged with causes in which you have a profound belief. If you are environmentally conscious, you may decide to invest in a company that is developing a more effective way of helping the environment.
Equity crowdfunding may offer a more significant number of avenues for such focused investments than publicly traded companies.
Trendscout is a platform that links angel investors and entrepreneurs, specialising in the formation of purposeful, considered partnerships that drive profit and growth.
Every year, hundreds of startups are evaluated by our team of experts. We assess and examine the potential, mission and ethical standards of each organisation we work with, ensuring that every startup we serve always aligns with our values.
Our network of innovative startups and investors, with over 30 years of industry expertise and experience, enables us to spot up-and-coming opportunities before they hit the masses.
If you are interested in equity crowdfunding, schedule an appointment with us today. Rest assured that someone will get in touch with you and help you every step of the way.