Equity Crowdfunding: How It Can Help Your Startup

Traditional small-business financing generally involves a need for collateral or a personal guarantee, a mandatory credit check and, of course, paying the funds back with interest. What if you could avoid all that and still receive cash for your business? Actually you can. Thanks to the Jumpstart Our Business Startups Act of 2012, equity crowdfunding is available as a financing alternative. This option can give startups a shot at needed seed capital.

What is equity crowdfunding?

Equity crowdfunding differs from many other types of financing in that it has no debt component. Tailored to businesses with strong growth potential and the ability to pitch their cases persuasively, this funding comes from a pool of accredited investors via secure online platforms.  Rather than having to make payments, the business offers shares of its company in return for funding.

The financing option’s closely related counterpart is rewards-based crowdfunding.

Financed amounts typically range from $50,000 to $1 million, and it takes about three months or more until funds are disbursed. Collateral, personal guarantees and credit checks are generally not required. Instead, investors examine the growth potential of a business idea and the odds that company shares will appreciate over time.

Although you won’t make loan payments, raising capital through an equity crowdfunding platform isn’t free. Most platforms charge from 7% to 12% of funds raised for their services, and additional payment processing fees may also apply.

Equity crowdfunding pros and cons

Offering shares of the business is a novel alternative to taking out a traditional loan.

Pros:

  • No credit check or collateral required.
  • A great business idea is more important than money in the bank and a proven track record.
  • Funding sourced from multiple investors increases the potential to raise larger sums of cash.
  • Because the platform generally pools funding into a single investment, accounting and financial reporting are simplified.
  • Offering equity instead of cash repayment means you do not need to budget for loan payments.
  • A successful crowdfunding campaign drums up buzz about your business to connect you with potential customers and establish a brand.

Cons:

  • Giving away pieces of your business could prove problematic if investors decide to assert their influence on company operations.
  • Businesses must supply investors with detailed information about their operations, including audited financial statements if over $500,000 is raised. Companies are legally allowed to only raise $1 million in a 12-month period through equity crowdfunding. If you need to raise larger amounts, it will have to be done in increments over several years.
  • Platform-use fees of 7% to 12% of money raised and payment processing fees of 3% to 5% can make equity crowdfunding somewhat expensive.
  • Because errors in reporting and other aspects of equity crowdfunding could lead to serious penalties, the guidance of an accountant is often necessary, adding to the cost of this financing.

NerdWallet’s verdict

Even though funds don’t have to be repaid, equity crowdfunding can still be costly. Business owners also need to be sure they’re comfortable parting with company shares and maintaining the required high level of transparency. For startup businesses lacking collateral or perfect credit, however, equity crowdfunding offers a terrific opportunity to turn exciting ideas into profitable reality.

How to get equity crowdfunding

To be considered for equity crowdfunding, apply on one of the many online platforms. What will make or break your application is the ability to prove your idea is worth funding. Be prepared to dazzle investors with a persuasive presentation that includes marketing and project plans, financial projections and a captivating video that leaves no doubt your idea is unique and will pay off handsomely.

Here are a few of the platforms offering equity crowdfunding:

As with all financial decisions, be sure to compare all of your business funding options before starting an application:

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For more information about small business loans and other small business essentials, visit NerdWallet’s Small Business Guide.

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