The advantages and misconceptions of equity crowdfunding

The advantages and misconceptions of equity crowdfunding

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In 2017 almost 130 billion euro has been raised by using different types of crowdfunding in the Netherlands. From this amount, only 0.75% is coming from equity crowdfunding campaigns, which is funding in exchange for shares. Chris Thomas, co-founder of the international equity crowdfunding platform Eureeca explains why more entrepreneurs should consider this form of crowdfunding and tackles the two most significant misconceptions.

Different crowdfunding forms

Crowdfunding is a form of public funding where the money for a project or company is collected from the crowd. It is an alternative form of financing of which four types exist in the Netherlands. Besides the most popular form of crowdfunding based on donations, the forms based on rewards and loans are doing very well this year. Equity crowdfunding is the less common form of crowdfunding. Here are the differences between the crowdfunding forms.

1) Crowdfunding based on donations

Within this kind of crowdfunding, entrepreneurs ask the investors to donate a certain amount of money, without obligation, to make the concerned project a success. There is no return to the investment. This form is mainly used by people who want to bring a creative idea to life. At the same time, entrepreneurs are testing their concept they seek to fund through crowdfunding. There aren’t any risks linked to this form of crowdfunding, neither for the entrepreneur nor the investor.

2) Crowdfunding based on rewards

The name says it all. With this form of crowdfunding the investor gets a reward in exchange for the donation. For example: an unknown writer who wants to publish his first book, will reward every investor with a copy of his book. After the reward has been received, the collaboration between the entrepreneur and investor is finished. The following agreement applies for a lot of crowdfunding platforms; when the intended amount is not collected in time, every investor receives their donation back.

3) Crowdfunding based on loans

With crowdfunding based on loans, investors provide a loan to the entrepreneur which they want back after a certain period of time in addition to a certain amount of interest. When successful, this form gives the investor a quick chance on return of investment. However, this form of crowdfunding is also accompanied by the risk of the entrepreneur not being capable of returning the loan.

4) Crowdfunding based on shares

Crowdfunding based on shares, also known as equity crowfunding, is based on the principle of crowdinvesting. Through an online platform, entrepreneurs and investors are being linked together and funding is exchanged for shares, depending on the size of the investment. This form of crowdfunding is being used a lot in America and the United Kingdom. In the Netherlands this form is hardly offered.

Which crowdfunding form is suitable for an entrepreneur depends on the phase of the lifecycle of an enterprise. While a starting entrepreneur can be helped most successfully with funding based on donations, funding based on loans or shares can be a smart choice for entrepreneurs who have had some sort of revenue or profit. ‘’Equity crowdfunding is a form of funding which is not suitable for some parties, but can yield advantages for SME-businesses who want to grow,’’ says Thomas. In a world where the amount of SME-businesses and startups is growing rapidly, Thomas expects that the percentage of equity crowdfunding campaigns will increase over the next couple of years.

The advantages of equity crowdfunding

Crowdfunding entails, compared to traditional forms of funding, a lot of advantages. Advantages which mostly have to do with the high accessibility and use of online platforms. This alternative form of funding ensures that enterprises who are not supported by traditional forms of funding, get a chance to scale-up. Because crowdfunding happens online, entrepreneurs have access to a large number of potential investors. “Where one does not see an opportunity in a project, this does not have to apply to the other,’’ says Thomas.

International crowdfunding platforms increases the chance of success through their worldwide coverage of investors. Next to this the minimum stake is often very low, causing investors to take more risks in their investments. Last but not least, crowdfunding is not just a way to collect money. It is a way to attract attention to a project or product as well. Therefore, crowdfunding is a way to market your product or project.

In addition to the above mentioned advantages of equity crowdfunding, the exchange of funding for shares also has two big advantages which differentiates equity crowdfunding from the rest.

Advantage 1: Investing in your own enterprise

One of the biggest advantages of equity crowdfunding is that it ensures that the collected funding stays within the enterprise. This is not the case with other forms of crowdfunding, such as funding based on loans. The result is an increased cashflow and working capital on the balance sheet. This is partly the reason why equity crowdfunding is highly suitable for enterprises which are in a phase of growth. The generated earnings, can be invested directly into the company.

Advantage 2: A chance to grow together

The principle of ‘’what’s in it for me’’ is often used in crowdfunding. Investors are willing to fund, but there is a big chance they want something in return. Shares give the investors the chance to grow with their investment and, when successful, receive a higher Return On Investment (ROI), which is a great advantage for both entrepreneur and investor. Equity crowdfunding also ensures a close cooperation between both parties. Investors become a part of the enterprise and, therefore, are dependent on the performances and success of the project or product. Therefore, the investors want to do their part in making the enterprise a success. They can often open doors for the entrepreneurs which otherwise would have stayed closed.

The misconceptions of equity crowdfunding

There are some aspects of equity crowdfunding which can put off entrepreneurs to use this form of funding. However, in many cases this is caused by misconceptions, according to Thomas. He tackles the two most named misconceptions.

Misconception 1: Administrative hassle

The choice for corporate funding looks limited for a lot of entrepreneurs. It is expected that managing an investorsportfolio takes a lot of time and effort. This is the first and biggest misconception of equity crowdfunding. By choosing the right crowdfunding partner, the opposite is true. Platforms like Eureeca manage the administration and shares for the entrepreneurs. This way the entrepreneurs deal with a group of investors functioning as one shareholder. “Eureeca takes the perspective of the entrepreneur and offers what they need’’, says Thomas.

Misconception 2: Safety first

The second misconception of equity crowdfunding has to do with safety. Because equity crowdfunding acts in shares, this is being evaluated as a bigger risk than forms of funding in which shares have no part. Once again choosing the right crowdfunding platform is essential. There are big differences in which crowdfunding platforms are regulated and the way they handle the confidential data of the entrepreneurs. Entrepreneurs should evaluate potential partners on the policy they have around handling confidential data, insight into the business profiles and certifications such as the Dutch Authority of Financial Markets (AFM). Choose a crowdfunding platform which supports you with making the right choices,’’ recommends Thomas.

Prior to collecting funding, it is important to check what funding the concerned enterprise needs and make a decision based on this. Equity crowdfunding is underexposed. Unfairly according to Thomas: this form can offer entrepreneurs and investors unique opportunities and result in an increased chance of growth.’’

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