What is equity crowdfunding?
Following the Federal Government’s announcement in September 2018 about changes to the equity crowdfunding legislation, there has been a lot of hype from the startup community about the positive impact this will have.
Equity crowdfunding is still a largely misunderstood concept, and whilst it can be a great way to put your business in the spotlight and raise funds from the ‘crowd’, understanding what it really means for your business to take on ‘retail investors’ is important.
What is crowdfunding?
Broadly, crowdfunding is the process of the public investing in your business, irrespective of their financial net worth. Traditionally, investment in private companies could only be from ‘sophisticated investors’ or investors ‘known to’ the founders or existing shareholders.
Equity crowdfunding - as a specific type of crowdfunding - is a process where the public can invest in public unlisted companies (and private companies from October 2018). Equity crowdfunding must take place via an approved licensee, such as Equitise, VentureCrowd, PledgeMe, Birchal and others.
So what businesses should consider equity crowdfunding?
Equity crowdfunding is not for every business and understanding what businesses have been successful can save you a lot of money, time and effort in preparing your business for this type of raise. Since the initial changes in legislation to allow companies to equity crowdfund as public unlisted companies, we’ve seen companies such as ManRags, Xinja, Car Next Door and others successfully raise via this method. Each of these businesses also allowed their investors to participate in some way in the business (i.e. through sock subscriptions, use of digital bank etc) and therefore obtained ‘buy-in’ for the product or service they provide. This meant that instead of feeling at arms’ length with the company and providing a cash investment for merely equity, the investors would be able to use or have access to the product or service that the company deals in, and feel more like a part of the company as a whole.
It sounds risky - what are the advantages?
There are a multitude of advantages that can come of investing in early-stage startups in this manner:
Investors are provided with shares - and therefore own shares or ‘have equity’ in the company;
ECF for private companies opens up the market for business, particularly early-stage startups, to obtain funds and raise capital from a larger pool of investors, which traditionally has been restricted to investment from angel investors or venture capitalists;
Investors can take smaller risks by investing quite a small amount of money (some as low as $250) to get into the market; and
The process inherently allows for the diversification of share portfolios, and to spread the risk across a number of different sectors.
The key potential benefit is to ride the upside of a business’ success by taking the initial risk with them at the early stages. A successful financial year, a liquidity event (such as a large capital raise) or an IPO could lead to dividends or a higher return on the investment going into the future.
What happens though if the startup fails?
In any investment, there is always the risk that investors will lose their money - that is the risk assumed when embarking on the journey with a startup. As a potential investor, it is important to understand the business and consider things like:
How much money is the company looking to raise?
How much control will investors have over the company?
How will the money be spent?
How long will it take to generate a return on investment?
What is the company’s track record like?
Although statistics show that 60% of Australian startups fail within the first three years, this looming figure shouldn’t deter a business or investor from taking the plunge.
With ECF - and crowdfunding in general - there is a level of assumed risk by investors. But those who take the risk have the potential to be involved in the business’ wins and their successes as well. And with the extension of the ECF regime to private companies in Australia now from early October 2018 - with the passing of the Corporations Amendment (Crowd-sourced Funding for Proprietary Companies) Bill 2017 - potential investors in the ‘crowd’ may be spoiled for choice.
Learn more about equity crowdfunding in our blog.
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