The Pros and Cons of Equity Crowdfunding for a Business Startup

The Pros of Equity Crowdfunding

There are major benefits entrepreneurs can experience by utilizing the equity crowdfunding method to raise capital. However, just like any alternative fundraising option, it also has its drawbacks. One of the first major benefits of this capital raising method is that it enables entrepreneurs that cannot obtain financing elsewhere to fund their business startup. Another major benefit is that it does not require entrepreneurs to give up a large amount of equity in their company, allowing them to retain significant ownership.³  People who want to invest in a company via equity crowdfunding campaigns can also benefit in that they do not have to be highly sophisticated investors to invest.

Business startups and the people who invest in them via equity crowdfunding campaigns are not the only beneficiaries of this method of raising capital.  It also helps the U.S. economy as a whole.³ Gallup reported that the number of new businesses declined in comparison to the number of businesses that closed down (during the period 2008 – 2011) and it is becoming a continuing trend.¹ This is significant in that it means fewer new businesses are being started in comparison to the number of existing businesses that are closing down.

From an economic standpoint, this can be bad for the growth of the economy because it contributes to a decrease in the number of jobs available, which furthers contributes to a decrease in per capita income. As previously stated, the decline in new business startups has much to do with the amount of personal savings people have available to invest in starting a  business.¹ Equity crowdfunding gives aspiring entrepreneurs, who lack significant personal savings and access to other funding options, the chance to start a new business and contribute to the growth of the economy.

The Cons of Equity Crowdfunding

Although there are numerous benefits that can be experienced by using equity crowdfunding as a method to raise capital, there are also drawbacks. Firstly, intermediary platforms like Kickstarter, Indiegogo, and GoFundMe are subject to hackers taking over their sites, causing a loss of data as well as potential investment losses for crowdfunding investors.³   Furthermore, crowdfunding investors may be unable to sell their shares in a company unless they sell them at a huge discount (since these types of securities often have no secondary market).³    This can make equity crowdfund investing a less attractive investment option for people who want to invest in business startups.

Secondly, critics are concerned with the Securities and Exchange Commission’s ability to police fraudulent securities offerings made by smaller companies that take the crowdfunding route. There are currently not enough resources in place to catch this type of fraud before the sale of the securities.³ Since investing in business startups via equity crowdfunding is not limited to accredited investors, less sophisticated investors can be taken advantage of due to their lack of knowledge regarding investing. Less sophisticated investors do not usually request financial reports that reveal significant information about a company as do more sophisticated and/or accredited investors.³  For that reason, they may subject themselves to fraud and major financial losses. To protect and minimize the financial losses of less sophisticated investors, the Securities and Exchange Commission requires companies using equity crowdfunding to follow strict financial reporting rules.

The Bottom Line: Is Equity Crowdfunding the Way to Go?

An entrepreneur should fully understand the different types of crowdfunding to determine whether it’s the best capital acquisitions strategy for them. Equity crowdfunding may work well for entrepreneurs whose business startup offers an innovative (and realistic) product or service, wants to grow quickly and can handle the growth. It may also work well for those that don’t mind giving up some ownership in the company. However, rewards crowdfunding may work better for entrepreneurs that don’t want to give up ownership in their companies and desire to grow at a slower and steady pace. It all depends on the entrepreneur’s vision for the business startup.

It’s also important to take into account the significance of financial reporting in regards to equity crowdfunding.  The first question an entrepreneur should answer, when considering the equity crowdfunding route, is “will I have the resources to meeting financial reporting requirements?”  A highly experienced accountant is needed to create the financial reports required by the Securities and Exchange Commission. That accountant will come at an expensive price. It has to be something the entrepreneur can afford.

Not only do entrepreneurs have to concern themselves with the cost of hiring a highly experienced accountant, they have to plan their marketing and advertising campaign. Effective marketing and advertising is a crucial aspect of implementing a successful equity crowdfunding campaign.  Most entrepreneurs understand their business but have no idea how to reach the masses through an equity crowdfunding campaign. That means they’ll most likely have to hire a marketing and advertising company that specializes in promoting equity crowdfunding campaigns. That’s more money out of pocket for the entrepreneur before they can raise capital for their business startup.

The bottom line is that equity crowdfunding is a viable alternative to traditional business financing.  It has proven to be effective for many startup businesses. However, the costs associated with implementing an equity crowdfunding campaign along with its pros and cons, federal regulations and financial reporting requirements all have to be considered before an entrepreneur makes their final decision. A detailed study of companies that have succeeded and/or failed using equity crowdfunding is suggested to any entrepreneur interested in using this strategy to raise capital.

Sources:

¹Ryan, Benjamin. “Business Startups Have Declined in Line with Their Primary Source of Financing: The Business Startup Rate and U.S. Personal Savings Rate: 1977-2011.”Gallup.(7, Sept.2014): 1-13.Gallup, Inc.Web.14 Nov.2014.

²Dapp, Thomas F. “Crowdfunding: An Alternative Source of Funding with Potential.”Banking and Technology Snapshot: Digital Economy and Structural Change (18 Mar.2013): 1-7.DB Research, Deutsche Bank AG.Web.14 Nov.2015.

³Gaynor, G.Morse, J. and Pevzner, M. “The Crowd-Funding Effect.”Strategic Finance 97 (Oct. 2015): 34-39.UDM Libraries/Instructional Design Studio Research Portal.Web. 14 Nov.2015.