Learn more about Jeremy on NerdWallet’s Ask an Advisor
What Every Entrepreneur Needs to Know
When it comes to getting funding for your latest business venture, crowdfunding may seem like a no-brainer. Crowdfunding websites raised more than $5 billion in 2013, and to get a piece of that wealth, all you have to do is set up an online profile and watch the dollars roll, right? Not so fast. While crowdfunding can be a viable way for entrepreneurs to raise capital, it’s more complicated than many people realize, and it might not be right for every business.
What Is Crowdfunding?
Fundable.com defines crowdfunding as “a method of raising capital through the collective effort of friends, family, customers and individual investors. This approach taps into the collective efforts of a large pool of individuals—primarily online via social media and crowdfunding platforms—and leverages their networks for greater reach and exposure.” Equity crowdfunding is a subset of crowdfunding that involves raising money from investors in exchange for an equity share in your company. Popular equity crowdfunding platforms include Gust, AngelList and Fundable.
Why Consider Equity Crowdfunding?
Access to capital is the main reason people pursue equity crowdfunding. Equity crowdfunding is especially appealing to entrepreneurs because it offers an alternative to seeking cash from banks or angel investors. Plus, a successful crowdfunding campaign can have other benefits, including generating buzz for a business, helping to gauge support for a product or idea, establishing a brand, and connecting with potential customers.
Who Can Invest?
Currently, only accredited investors can participate in equity crowdfunding. Accredited investors have a net worth of at least $1 million or an annual income of greater than $200,000. But the Jumpstart Our Business Startups (JOBS) Act, passed in 2012, contains a provision to open up equity crowdfunding to all potential investors, regardless of net worth or income (with certain restrictions on the amount of money those people could invest). That aspect of the act is still pending implementation following SEC review. But if it does take effect, the pool of potential investors will grow significantly—which could be a boon to small companies. To get an idea of just how big the investor pool could be, consider this: in the past, there were about 258,000 accredited investors in the U.S., according to Entrepreneur.com. If the rules are relaxed, there will be nearly 234 million—every person over the age of 18, according to Entrepreneur.
Not Right for Every Business
Equity crowdfunding could help some entrepreneurs, but it comes with rules and costs, and it won’t be appropriate for every business. A few things to keep in mind:
- Companies can’t raise more than $1 million in a 12-month period.
- Cash can’t be raised directly by businesses; instead they must go through a broker/dealer or SEC-approved crowdfunding portal.
- Companies pursuing crowdfunding will need to provide detailed information about finances, company officers, directors and owners, and what they plan to do with the money they raise. If you raise more than $500,000, you’ll need to produce audited financial statements. Not every business will be prepared for that level of transparency.
- Crowdfunding won’t necessarily be cheap. Current estimates are that most crowdfunding platforms will charge between 7% and 12% of the total capital raised. You may also need to pay a payment-processing service to actually get your money, which could cost another 3% to 5%. Finally, the cost of having accountants review and/or audit your financial statements could run into the tens of thousands of dollars.
Entrepreneurs who are considering equity crowdfunding for their business would be wise to seek professional guidance. It’s especially important to make sure that you understand the legal risks and reporting requirements, since a misstep in this area could lead to big penalties. But for those business owners who are well-prepared, equity crowdfunding can be an amazing opportunity.