Equity crowdfunding is a method through which small businesses and startups can raise capital from the public. Equity crowdfunding is also referred to as crowd equity/crowd investing/investment crowdfunding. In this method, startups/businesses offer their securities in exchange for financing.
Many confuse one type of crowdfunding with another. So, before diving deep into equity crowdfunding, we would like to throw some light on various types of crowdfunding.
Types of Crowdfundings
1. Donation Crowdfunding
Donation-based crowdfunding raises donations for various “causes”. The cause may vary from one individual to the other. Donation-based crowdfunding is legal in India. There is no minimum and maximum amount a donor can offer. In this method, the one who needs funds creates a campaign on a crowdfunding platform like Milaap and does the marketing using social media. Anyone who is supporting the cause can donate.
2. Reward/Pre-order Crowdfunding
Through reward-based crowdfunding, the general public/individuals can fund a business or startup. In exchange for their contribution, the business offers early access to the product/service to which they funded. Indiegogo and Kickstarter are some of the famous reward crowdfunding platforms. It is legal in India.
3. Debt Crowdfunding
This is a kind of peer-to-peer lending. Using debt crowdfunding, investors can lend money to the needful. In return for the funded amount, the investor/lender receives monthly interest on the principal amount. In India, debt crowdfunding is legal. But, the platforms should take required permissions from the concerned authorities.
4. Equity Crowdfunding
Equity crowdfunding is a mechanism through which a company obtains funds online, particularly early-stage fundraising, by selling its shares to investors. Businesses seeking money through this method generally advertise on a crowdfunding platform which acts as a middleman between investors and start-up firms.
Advantages of Equity Crowdfunding
- Equity Crowdfunding can act as an alternative for banks. It can fulfil the financing needs of startups and SMEs.
- Basel 3 norms constrained banks’ lending ability.They cannot lend money to startups or small businesses where the risk is high. Equity crowdfunding can solve this issue.
- With equity crowdfunding, startups and small scale businesses can raise funds without going through complicated methods.
- For investors, equity crowdfunding offers diversification along with good returns.
Disadvantages of Equity Crowdfunding
- In India, venture capitalists and private equity investors are financing the startups. These investors have skills and do research about the risks involved. After the introduction of equity crowdfunding, the risk will be shared among individual retail investors. The chances of investing without analysis are high in the case of retail investors. Their risk tolerances are also low. If anything bad happens with the company, investors may lose their invested capital.
- Due to high risk and less liquidity, equity crowdfunding can be considered an aggressive investment. This is not suitable for conservative investors.
- There may be the risk of default or fraud. The frauds may arise from the side of the issuer or the crowdfunding platform
- Equity crowdfunding does not offer investor protection scheme.
- Lack of secondary market for these startups, exiting from these investments is difficult.
Is Equity Crowdfunding Legal in India?
In India, SEBI (Securities Exchange Board of India) regulates all security transactions. Its main goal is to protect the interests of the investors. SEBI did not approve equity crowdfunding because of the risks involved in it. It is illegal in India. There will be a considerable amount of risk involved in equity crowdfunding. Because of huge returns, small investors with little funds may be drawn to such high-risk investments without risk assessment.
However, because there are no restrictions in place and the issuer of the asset has limited recourse. Such instruments are unsecured and might limit the liquidity of a low-risk investor. Furthermore, the investor depends on soft data and is unable to conduct due diligence to the level that VCs, PE firms, and other financial institutions can with precise data.
Equity Crowdfunding Platforms for U.S Investors
AngelList, which was founded in 2010, is one of the first and most well-known equity crowdfunding sites. It was created to link cash-strapped technology entrepreneurs with high-net-worth angel investors.
MicroVentures is a full-service investment bank. It has a thriving equity crowdfunding division that serves both accredited and non-accredited investors. Offerings cover a wide spectrum of industries, with a preference for consumer-facing businesses (such as beverage and athletic equipment companies) and high-growth niches like cannabis and biotechnology.
Fundable provides both rewards-based and equity-based crowdfunding, similar to Kickstarter or GoFundMe. It assists firms interested in equity crowdfunding with onsite profile creation, pitch creation, and even business plan preparation. Fundable is a software, hardware, and consumer goods accelerator that is now part of TheStartups.co, whose portfolio companies include virtual assistant platform Zirtual.
StartEngine has a smorgasbord of consumer and business-facing startup funding possibilities. High-potential sectors such as robots, space exploration, and renewable energy are well-represented, but more mundane niches like craft drinks and home automation aren’t completely missing.
EquityNet, which was founded in 2005, touts itself as the “first equity crowdfunding platform” and claims to be the only company to have patented the concept. The company’s stated entity mix favours consumer goods and social businesses. Single-asset initiatives, such as assisted-living homes and medical clinics, tend to be more appealing to EquityNet than product-based companies or multi-asset funds.
Investing through equity crowdfunding entails a higher risk of failure, fraud, questionable returns, hacker susceptibility, and poor investments. It does, however, come with benefits such as the potential for large profits, a higher level of personal satisfaction, the ability to invest like accredited investors, and the possibility of stimulating the economy via business and job creation. Read more related articles here