Many small businesses, including several in PCV’s network, are utilizing crowdfunding as an alternative form of funding. Recently, our company Kuli Kuli ran a successful campaign on Kiva Zip, while another of our companies, Core Foods, is running a Kickstarter. But one method of crowdfunding remains untapped in the United States: equity-based crowdfunding. The U.S. Small Business Administration is taking a look at this new source of crowdfunding, and exploring how this new funding option could unlock additional capital.
While only 5 percent of all crowdfunding globally is equity-based, a new regulation being promulgated by the Securities and Exchange Commission (SEC) may shift this trend. Equity-based crowdfunding was created under Title III of the Jumpstart Our Business Startups (JOBS) Act (signed into law by President Obama in 2012), and the rule is still being written by the SEC to expand the ability for entrepreneurs to sell equity to prospective investors online. Until the SEC issues the final rule, equity-based crowdfunding for the vast majority of Americans remains off-limits.
You can read the entire SBA brief here.
What Is Equity-Based Crowdfunding?
According to Forbes, equity-based crowdfunding “allows entrepreneurs to reach investors interested in purchasing equity in their small business. In stark contrast to your average fundraising effort as seen on platforms such as Kickstarter and Indiegogo where founders do not give up a percentage of ownership in exchange for the cash.”
Equity-based crowdfunding could be preferable to traditional methods of debt-based funding for a few important reasons. Equity-based crowdfunding doesn’t require collateral to receive funds, like a typical bank loan might. There are three types of equity crowdfunding:
- Equity I: allows for accredited investors to view private investment opportunities on a password-protected website. This type of crowdfunding suits entrepreneurs who want to avoid public exposure of their fundraising campaigns.
- Equity II: allows entrepreneurs to publicly advertise their need for funding. Founders who engage in Equity II can raise an unlimited amount of capital from an unlimited number of accredited investors — all done through equity crowdfunding portals which make it simple to advertise their offerings across the web.
- Equity III: (Not yet in effect) will allow unaccredited investors to participate — in other words, the 99% of investors.
What Does This Mean For Your Small Business?
Currently, a gap exists between small businesses’ desired capital and the capital being made available to them. Although the SEC has not yet finalized the rule which would fully permit equity-based crowdfunding, there is already a promising future for this funding model.
By having a large group of investors, equity becomes diluted amongst many investors. This may be a preferable option for entrepreneurs who fear an investor or small group of investors may have an outsized impact on the direction of their firm. However, this may not be a guarantee, as funders with heavy investments of capital may demand more of a decision-making stake in the business via voting shares of the firm. As investment grows and interest from investors becomes clear, the possibility for larger investors to provide funding may increase. This could be an effective method for small businesses to break through capital constraints.