In the last year, a new class of angel investor demonstrated that startups could raise money from a new source.
Crowdfunding refers to raising money online from the public — AKA the “crowd” — through social media and dedicated crowdfunding platforms. Equity crowdfunding is a subset allowing small investors to receive a slice of equity in proportion to their cash investment in a for-profit enterprise.
Equity crowdfunding occurs when small amounts of capital from many individuals is used to finance a startup or fast-growing small business. Equity crowdfunding makes use of networks of people (mostly through social media and crowdfunding platforms) to bring investors and entrepreneurs together. Increased entrepreneurship has resulted from an expanded pool of investors.
Historically, startups have looked to friends, colleagues, family members, local banks, broker-dealers, angel investors, private equity funds, family offices, venture capital firms and other sources of private equity. With equity crowdfunding, they have another option, a new source of private equity. Long-standing private equity practices are bending to accommodate the mass adoption of a niche corner of the alternative investment universe.
Today almost anyone can be an angel investor.
Traditionally, angel investing was off limits to most investors. The SEC and an array of state securities regulators restricted access exclusively to accredited investors. But things are changing.
- The SEC definition of “accredited investor” has expanded, allowing many investors to quality for alternative investments for the first time.
- Equity crowdfunding under Rule 506(c of Regulation D has exploded in popularity with an array of online campaigns.
- Equity crowdfunding under Regulation CF ($5,000,000 limit) and Reg A+ ($75,000,000 limit) have found immediate and warm acceptance from Main Street’s mostly non-accredited) investors.
- There has been a general run to alternative investments driven by stimulus money, low interest rates, and sometimes a new What-Me-Worry attitude.
Many of today’s angel investors are not the VIP insiders that have normally been invited into deals. Some of them are broadcasting their investments on social media; some have turned the investments into branding opportunities; some treat their investments as a networking play or a measure of social status.
Before crowdfunding only high net-worth individuals with defined levels of income or assets — usually referred to as accredited investors — could participate in early-stage, speculative ventures with the promise of high reward. Now the average investor can get involved; in that sense, equity crowdfunding is creating a level playing field for both accredited and non-accredited investors.
Crowdfunding has created the opportunity for entrepreneurs to raise millions of dollars from almost anyone with money to invest. At the same time, it has created a forum for anyone with an idea to pitch it to almost anyone else.
Of course, equity crowdfunding has its downsides.
Greater Risk of Failure: Startups need more than funding. Without an adequate business plan and strong founder team, a good idea is not enough. Fraud: Online forums and social media are ideal for equity crowdfunding because they offer wide reach, scalability, convenience, and ease of record keeping they also make it easy for bad actors to attract funding from naive investors. Delayed return: Investors assume some delay to a return on their investment. Returns on equity crowdfunded ventures may take years to materialize if they ever do. Crowdfunding Platform: Hackers are everywhere. Credit card details and other valuable client information may be at risk.
Bottom line: Equity-based crowdfunding is growing in popularity because it allows startup companies to raise money without giving up control to private equity firms or broker-dealers while offering small investors equity in high-risk startups. For the first time in its 87 years of existence the SEC is permitting private placements to be offered publicly.*
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