Investing in unlisted startup companies was previously only a possibility for business angels, venture capitalists or wealthy individuals.
With the rise of crowdfunding, or more specifically equity-based crowdfunding, the process has been democratized and is now possible for everyone. In fact, The World Bank has predicted that crowdfunding between 2020 and 2025 could reach heights of approximately 90 billion dollars.
Looking at this situation from a newly established business’ perspective rather than an investor’s perspective, it has now become possible to find outside sources of capital as a way of creating sufficient runway to establish a profitable business, for instance through equity-based crowdfunding.
How Does Equity Crowdfunding for Startups Work?
All businesses need money to start, grow and live out their mission, and with the rise of the internet, a new way for companies to raise the capital they need has emerged and rapidly grown throughout the last decade:
Crowdfunding for startups.
Equity crowdfunding for startups has made it possible to fund money from a lot of people instead of just a selected few – the crowd.
Startup equity crowdfunding is a type of crowdsourced equity funding that enables investors to fund private early-stage companies and small businesses that have not yet been listed on stock exchanges in exchange for equity.
In other words, by investing in a company through equity-based crowdfunding, investors receive shares in the invested company in return for their cash. As a shareholder, you become a partial owner of that company in which you have invested.
This means that if the company succeeds and its value goes up, so will the shares investors have acquired through their investment, and investors will be standing to profit in case the company performs well. On the contrary, if the company fails, you will lose what you have invested. Most investors will therefore benefit from spreading their risk by building a diversified portfolio.
Why Invest in Startups through Equity-Based Crowdfunding?
When you invest in small and early-stage startup businesses who are not seeking major amounts of capital but rather smaller investments in order to be able to establish itself you have the possibility to earn very high returns because you invest in an early stage where the risk of the business failing is also high.
As a return for your investment, you become a partial owner of the business and, in this regard, you get the chance to benefit from a profit that might happen in the future. In this context, it comes as no surprise that individuals are investing more and more money in startups through crowdfunding platforms.
When investing in startup companies, the main source of return on investment will be capital gains rather than dividends, since it is very rare for startups to distribute dividends from their profits in an early stage.
Therefore, the main source of return on investment from this investment type will be capital gains, which are gains that may arise due to a rise in the market price of a given share in the company.
How Do Investors Choose The Best Crowdfunding Site for Startups?
The first step in getting started with early-stage investing is to pick out the best crowdfunding site for startups depending on your experience with and knowledge of this type of investment.
In startup equity crowdfunding there are two types of platforms:
- Platforms with investment opportunities led by a co/lead-investor
- Platforms with investment opportunities led by the company/entrepreneur.
Below, the article will take you through the two types of platforms and how they differ from one and another.
On investor-led platforms, the investment terms will be concluded based on a negotiation between a lead investor and the company looking for financing. These terms include legal agreements and company valuation.
As an outside crowd investor on this type of platform, you will invest alongside the lead investor meaning you will get the same class of stock at the same price as him/her.
The fact that an experienced investor is willing to risk and invest a large amount on the terms you are given gives smaller and more inexperienced investors security knowing that the deal is good enough for that investor.
On company-led platforms, the entrepreneur/company raising finance will set its own investment terms. This means that you will need to be extra careful about choosing the right projects as the company will, unsurprisingly, try to get the best possible valuation and rights for themselves – just as you would as an investor.
That said, it is still highly possible to find interesting projects on this type of platform!
First of all, some entrepreneurs have no experience in raising funds, which might cause them to value their business higher or lower than the market would. To offset these problems, some company-led platforms allow the crowd to make counter offers and the final value of the company will thus be negotiated fairly between companies and investors.
Secondly, equity-based crowdfunding for startups comes with another purpose than solely raising funds; startup companies are looking for other benefits such as marketing for their company, as well, which might add another dimension of interest from an investor’s perspective.
5 Biggest Startup Equity Crowdfunding Platforms in Europe
If you are looking to invest in a European business, the list below containing the top equity crowdfunding platforms in Europe will come in handy.
- Seedrs: This UK equity crowdfunding platform was founded in 2009 and has since become the biggest crowdfunding platform in Europe. One of the most interesting things about Seedrs from an investor’s point of view is the secondary market which allows investors to get returns by selling shares or increasing liquidity by buying new shares.
- Crowdcube: This is another UK based crowd equity platform that allows small and medium businesses to raise capital within a wide range of industries such as art, design, electronics, movies, etc. and the options for raising funds are via debt, equity or investment.
- FundedByMe: Founded in 2011 in Sweden, FundedByMe offers both reward-based and equity crowdfunding. The main focus of this platform is internationality and, in this regard, facilitating cross-border investments that are beneficial to both the entrepreneurs raising money for their businesses and the investors.
- Companisto: Many people associate Germany with quality, and the German equity crowdfunding platform Companisto is no exception with its network consisting of recognized business angels, corporate finance experts, and VC companies.
- Invesdor: Invesdor is a Finnish equity-based crowdfunding platform that is highly competitive and strongly committed to the long term growth of the companies registered on the platform – they are, for instance, offering legal advice and branding development.
5 Best Startup Equity Crowdfunding Sites in USA
With former President Barack Obama’s signing of the JOBS Act in 2016, he made it possible for small businesses to turn to a nearly unlimited group of investors to get funding, and with this new SEC rule, companies could start raising capital to establish their business for free.
Naturally, in the months and years following the JOBS Act, a lot of equity crowdfunding sites emerged in the USA in order to meet the increased demand for crowd equity.
One downside of this huge supply of equity crowdfunding sites is that it can be extremely difficult and time consuming for investors to figure out what sites to use when investing. To facilitate the process of choosing the best equity crowdfunding website for your specific needs as an investor, the article lists some of the best equity crowdfunding sites for investing in startups in the USA below.
- WeFunder: The special thing about WeFunder is that their minimum investment threshold is rather low (100 USD), which makes investments available to almost everyone and not only to well-off investors.
- StartEngine: This portal is one of the largest equity crowdfunding sites in the world. They offer a ‘Platinum’ service which includes additional support from StartEngine’s team of experts.
- Fundable: Besides equity crowdfunding, Fundable offers reward-based crowdfunding much like Kickstarter. The downside of this crowd equity site is that you cannot invest directly through the platform; instead you have to contact potential companies directly.
- Republic: With the purpose of helping startup companies with regulation crowdfunding (another term for equity crowdfunding), Republic has a very low entry barrier with a minimum investment of as little as 10 USD.
- SeedInvest: Forget all about low entry barriers with this crowd equity portal; SeedInvest is specialized in highly vetted investment opportunities, mostly in tech startups, and favours accredited investors.
What Are The Risks Involved When Investing in Startups?
Before you get started with crowdinvesting in startups, you need to be fully aware of and accept the fact that investing in startup equity crowdfunding carries high risks as, unfortunately, many startups will end up failing.
Here, data from the US shows that the survival rates of businesses with employees are as follows:
- About 80 % survive their first year
- About 70 % survive their second year
- About 50 % survive their fifth year
- About 30 % survive their 10th year
These rates are surprisingly consistent over time but vary from country to country and industry to industry. Digging deeper into the statistics can therefore provide you with useful insights before you invest in a startup.
That being said, when done right, investing in startup equity via crowdfunding can be highly profitable as well as an existing and rewarding venture.
Besides the risk of the startup company failing and your investment disappearing into thin air, there are several other risks to be aware of when investing in startups. Below you will find some of the most important ones.
Highly Illiquid Shares
Depending on the platform, the shares you receive can be highly illiquid.
If you invest on equity crowdfunding platforms without a secondary market you will probably have to keep your shares until the company is listed on an exchange (IPO or ICO) or the whole business is sold to another company (trade sale).
And even though a secondary market is in fact available on the platform, you cannot know for sure whether it will be possible to sell the shares or not. If so, you are not guaranteed a reasonable price.
As a consequence, most crowd equity investors end up owning the shares until a larger acquisition deal is put in place or the company is listed on a coin or stock exchange.
Returns from Stock Value Appreciation
It is not unlikely that you will have to wait a good amount of time before seeing a substantial increase in the value of your shares.
Most venture funds and angel investors work with investment horizons of between three and five years, but sometimes it can take much longer before you see any stock value appreciation. Therefore, you will need not only patience but also the ability to cope financially for an indefinite period of time without having access to the invested money.
Usually, startup companies expand by growing revenue and not necessarily the net profits. It is, for instance, common to see high valued tech startups that have never had a profit yet. This also means that you shouldn’t expect any dividends because of low or no direct net profits in the company.
Dilution of Shares
When investing in crowdfunding for startups, there is a risk that your shares can be diluted.
Metaphorically speaking, dilution can be explained as a cake that gets bigger and cut into more pieces.
Almost all unlisted startup companies will raise more capital along the way. Normally, this is done by issuing new stock to the new investors. With more stocks outstanding, each existing shareholder will own a smaller percentage of the company. Thus, this will result in a decrease in your ownership percentage.
Also, the new shares might contain stock options that can dilute your percentage even further if exercised. Therefore, make sure you have the right investor protections in place before investing.