Wednesday, May 27, 2015

On Equity Crowdfunding

In the environment of tight credit that characterizes the global economy’s tepid recovery from the Great Recession, many entrepreneurs are turning to unconventional sources of startup financing. Equity crowdfunding, mediated through registered online funding portals, is one of the available alternatives.

In order to ascertain whether EC would be right for you, there is some basic information you need to know.
What is equity crowdfunding, and how does it differ from standard crowdfunding?

Unlike standard crowdfunding, EC involves more than simply donating money to a cause in exchange for rewards, perks, or goodwill—instead, equity crowdfunders acquire an ownership stake in the company-to-be.

EC differs from traditional equity financing in its potential to attract numerous prospective investors offering modest quantities of capital. Conventional equity financing, by contrast, often involves a small number of deep-pocketed investors capable of advancing large sums.


   Democratization (sort of): EC can foster investment opportunities for people of comparatively modest means. However, the rules governing EC (including accredited-investors-only restrictions) vary by jurisdiction, along with the required documentation. The situation is fluid, as governments learn more about a relatively novel investment tool and modify their regulatory frameworks accordingly. It’s a good idea for businesses and entrepreneurs uninitiated in EC to seek legal counsel, so as to ensure compliance with local securities regulations.

   Breadth of investment pool: Not only can EC enable entrepreneurs and business owners to benefit from a broader pool of potential investors than might otherwise be available; the relationship is a two-way street. As EC expands and develops, small- and medium-scale investors will also have the opportunity to dedicate a portion of their savings to a vast array of endeavours that might otherwise have received little exposure.

   You set the fundraising commitment. When businesses attempt to raise early funds through venture capital firms, they receive whatever those organizations are prepared to give—usually a small sum, unless you already run a thriving business with a steady revenue stream. EC, by contrast, offers entrepreneurs relative freedom to establish and adjust their own targets.

   Your funders have a vested interest in the success of your startup. After all, the more profitable your venture, the more lucrative the returns for them. If you encourage equity funders to promote your business idea on social media and within their friend circle, they will likely be keen to oblige.


   Legal complexities: As noted above, the rules governing EC vary by jurisdiction. A lot of entrepreneurs just starting out in the business world may not be familiar with financial disclosure rules, licensing, comprehensive business plans, and other requirements, and will need to undertake a lot of advance research and due diligence.

   Small- and medium-scale investors may lack business and investment experience. Sometimes it helps to be able to defer to the advice of an experienced angel investor, venture capitalist, or business professional, especially when it comes to dealing with adversity and managing the expectations of your funders. In particular, new investors may not fully appreciate the risks associated with online and startup investments.

   Some of your funders may be people you’ve never met. Obviously, this entails issues of trust and fraud prevention, and there is a risk that disgruntled investors may try to litigate against you in an effort to recoup a portion of their losses if your business doesn’t pan out. This is another reason why seeking legal advice is a good idea.

To equity crowdfund, or not to equity crowdfund?

EC may not be suitable for startups that lack a strong social media following, or that don’t offer a product or service that is marketable and compelling. For example, many of your Facebook friends may be interested in funding a bicycle store or a pet daycare; relatively few will be keen to support a more esoteric or specialized venture, like a business that designs refrigerator door hinges.

If you’re still interested in EC, I recommend this article in the Globe and Mail, by founder Sandi Gilbert, as a basic guide to help you get started.

Equity crowdfunding portals, and useful links:—one of the first EC portals in Canada.—a page devoted to EC, from the National Crowdfunding Association of Canada.—another Canadian EC portal, in development at the time of this writing.

Alixe Cormick is a securities and small-business lawyer with expertise in Canadian EC regulations. She has penned an informative blog post on the subject, available here.

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