In this post you will learn about equity crowdfunding and the author has created a free webscraping tool you can use to source deals! Read on to get access to this bonus file!
Introduction: What is equity crowdfunding?
Equity Crowdfunding is a form of fundraising that allows startup and small business owners to publicly sell equity to retail investors (i.e. “The crowd”). Since title III of the JOBs act was enacted in 2016, the equity crowdfunding space has grown substantially. Multiple platforms have launched and acted as a bridge between entrepreneurs and investors.
Equity crowdfunding is becoming increasingly important to both founders and investors. Here are a few of the key reasons:
More favorable terms for founders: Founders often have more favorable terms on their company valuations when compared to traditional angel/VC funding since the founders set the terms. Additionally, companies can build and strengthen consumer advocacy by allowing their customers to own a part of the company.
Opens doors for retail investors: Meanwhile, retail investors can access the potentially life-changing returns of startup investing that used to be reserved for accredited (high net worth) investors.
Increased transparency/network effect: The most important benefit, in my opinion. End-to-end transparency continues to grow in the equity crowdfunding space due to the number of people involved. This results in underrepresented founders being able to access capital, broader retail investor education, crowd-sourced due diligence (on top of one’s own, hopefully), more detailed SEC filings, and more!
Setting expectations
Although the Equity Crowdfunding space is relatively young, the traditional VC and Angel investing industries are the most similar, and have decades of data and insights on startup investing. In this article, I’ll leverage those insights as our north star, though these will still be general, and not necessarily indicative of startup performance. Understanding success rate, return potential, liquidity, and investing limits will already give you a leg up ahead on your EqCF journey!
- Startup Success Rate: Most startups will fail. Depending on which data you’re referencing, you may hear anywhere between 65-95% of startups fail within 10 years. I’d recommend erring on the higher side when considering your portfolio allocation to investing in startups. Expect that the large majority of your investments will go to 0.
- Return Potential: Your next question should be “If most investments go to zero, why do the venture capital and angel investment industries exist?” Because the returns, if you’re lucky enough to be a part of them, can be life-changing. For example: Let’s say you’ve decided to invest in a seed-stage company at a 10 million dollar valuation. If it ends up becoming a unicorn (worth 1+ billion), you’re seeing a 100x+ return (not factoring in dilution).
- Generally Illiquid: illiquidity is probably one of riskier components of startup investing. In addition to a 3-7+ year timeline to determine whether you’ll see any return at all, there are rarely ways you’ll be able to sell your shares before that time period passes, even if you wanted to! Recognizing the illiquid nature of these investments, and factoring them into your decision-making is crucial to ensure you’re not locking up money that you may need in case of emergencies.
- Investing Limits: Equity Crowdfunding offers are generally filed through either Regulation CF, or Regulation A. Each of these come with their own investor limits based on your income, net worth, and/or whether you’re an accredited investor.
- Valuations and perks: Company valuations are often higher than what one would see vs traditional VC/Angel Investing. This is because founders set the terms, rather than a negotiation between the founder and VCs/Angels. Additionally, companies raising may offer additional incentives like bonus shares based on early timing or amount invested, company discounts, etc.
Browsing Deals
Now that you know the risks and potential, the next step is finding companies you like! Deal Flow, or the amount of deals you have access to, is critical. More deals to review = more opportunities to not only invest but to develop your due diligence process and investment thesis. In my experience, the most common deal flow channels in the equity crowdfunding space are as follows:
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- Equity Crowdfunding Platforms – Equity Crowdfunding Platforms are the most common sources of deal flow and usually curate the highest quality deals. Each platform has its vetting process before a company is allowed to list and offer various services to founders/investors.
- Facebook/IG Ads – Facebook ads are a mixed bag, and contain deals from the major platforms, lesser-known platforms, or even companies hosting their crowdfunding raises independently. I’ve found a gem or two via an Ad!
- SEC Filings – You can manually review SEC filings using their EDGAR system. Here, you get the most up-to-date filings and will likely see upcoming raises that have not yet gone live on crowdfunding platforms. However, the tradeoff with this speed is that the information is limited to their SEC filings and usually doesn’t contain the complete pitch decks or curated summaries of all pertinent information. I’d recommend at least practicing reviewing SEC filings, so you have a sense of the minimum requirements for Reg CF and Reg A, even if you end up with a preference for more curated information.
- P.S. I created a very bare-bones (and questionably-functional) RSS feed using Google sheets that curates and stores direct links to Reg C and A SEC filings. Feel free to use it and let me know if there are any improvements to be made! 🙂
- Lead-generation services: Lead-generation services will send you deals and potentially conduct due diligence on your behalf. I subscribe to a couple of services, but the most impactful value has been the networking opportunity rather than the deals. Note: Not all lead generation services charge, but the largest do. Beware of upsell funnels in this space as well—some companies will offer you multiple tiers of service at increasing prices, while also putting you into a network that will attempt to upsell you on unrelated services. I’m still getting solicited for cryptocurrency and forex trade services, on top of random stock picks. Being mindful of these ahead of time, and using relevant emails/spam filters when signing up may save you some sanity.
- Networking/Social Media groups
- Although the Equity Crowdfunding space has grown considerably over the past 2-3 years, the community specifically surrounding this space is still relatively sparse. In the meantime, angel investment groups and channels will likely be your best bet to bounce ideas and ask questions.
Refining your investment philosophy
- Target Return Potential
- While we previously spoke about 100+x return potential, that’s only part of the story. Typically speaking, the younger the company, the more risk you’re taking, and the longer it’ll take to see any potential returns, if at all. Late-stage startup investors may be looking for 3x-5x returns, but they’re investing in more mature companies. Before investing in startups, you should have a clear sense of your expectations and comfort level.
- Mission, Interests, and Values
- When I think of purchasing publicly traded stocks, there’s not much choice in terms of aligning with missions, interests, and values I hold personally.
- For me, equity crowdfunding has been a facilitator of introspection and learning via investing. I’m discovering likes, preferences, and learning lessons as I build my portfolio. The first company I invested in (2019) was an AI company focused on creating voice-first commerce platforms for stores and restaurants. At the time, I invested because it “sounded cool”. Although the investment hasn’t done particularly well, I learned valuable lessons that I still apply to this day! “Is the founder receptive to my (and the community’s) questions?”; “What are the terms of the deal you’ve outlined in your pitch?”; “What is the founder’s track record?”; Many of these questions and perspectives are in my ever-evolving due-diligence process, and I’m confident that the small check I wrote for my first investment has already returned more than the price of admission. 🙂
Conclusion
In conclusion: Equity crowdfunding is a relatively new form of fundraising that is mutually beneficial for both startup founders and retail investors. From an investment perspective, investing in startups is high-risk/high-reward, have a 3-7+ year time horizon, and are generally illiquid in the interim. There are many paths to browse deals, and equity crowdfunding platforms are the most accessible/curated.
Finally, investing is a continuous learning process! Refining your mission, expectations, and processes, are the most important aspects of the journey!
Thanks for taking the time to read about equity crowdfunding! If you have any appetite for adding startups to your portfolio, I highly recommend checking out the space! If you have any questions, or want to bounce ideas on startup investing, feel free to reach out to me; here’s my bio for my contact details. Happy investing!
