How does equity crowdfunding work?

Crowdfunding has been used to raise money for various causes and projects, including once-in-a-lifetime holidays, cryptocurrencies and charities. There was even a crowdfunding campaign to support a young man in his dream to meet musician Dave Grohl. Although similar, equity crowdfunding is almost exclusively used to raise capital for businesses and is vastly more complicated.

So, what is equity crowdfunding?

Unlisted companies generally have a number of means to raise capital, but despite this it can still be difficult to fund projects and grow a business.  In 2017, the Australian government legalised another avenue for companies to raise money: equity crowdfunding. Just like crowdfunding, money is raised by a number of individuals who have chosen to fund a project or business, but with equity crowdfunding donators become investors. By funding a company in this way, the ‘crowd’ gains part ownership of the business and have the potential to make a return.

Related article: What is a share?

How does equity crowdfunding work?

How equity crowdfunding works depends on the platform you choose to invest in. However, generally once you have researched the company you want to support, you can invest through the website and will typically have a 5-day cooling-off period, in case you change your mind. If you decide to go ahead with the investment, you will receive shares in the company. Generally, you will see a return once the company starts making a profit and decides to pay dividends, or goes public, which should allow investors to liquidate their shares.

Who can use equity crowdfunding in Australia?

Equity crowdfunding is available to companies with an annual turnover or gross assets of $25 million or less. Companies using equity crowdfunding are also limited by how much they can raise, it is capped at $5 million annually.

Retail investors are also restricted by how much they can invest. At the time of writing, they can invest $10,000 per company annually. Those who earn a gross income of $250,000 annually and have net assets of at least $2.5 million, as known as sophisticated or wholesale investors, have no limit on how much they can invest.

\

What are the fees?

The fees you have to pay are dictated by the platform. Some platforms charge investors transactions fees, some charge fees on exit and some may charge both. However, you may be able to find platforms which don’t charge any fees. So, as well as carefully selecting the company you choose to invest in, the same consideration should be taken with determining the platform you use.

Some things to consider before investing in equity crowdfunding

Investing in an early stage business

With equity crowdfunding, businesses are generally at the beginning stage of their development and have not necessarily made any revenue. This can make it quite a risky investment and also difficult to crunch the number and assess the company by quantitative means. So, when deciding which company to invest in you should understand:

  • the stages of growth of a typical early stage business
  • why the company is seeking equity finance
  • how the company plans to use the funding to accelerate growth
  • how you will realise a return on your investment

You may also be able to mitigate the risks by diversifying your investments.

Illiquidity could be a problem

Unlike traditional shares, for the most part, equity crowdfunding shares cannot be bought or sold on an exchange, making them a low-liquid asset. Therefore, they are generally a long-term investment. This doesn’t suit all investors, especially those who might need to access their funds sooner rather than later.

Does the platform check out?

Firstly, any platform you choose to invest through should be licensed by ASIC. You should also check to see if a platform has a long-term record of crowdfunding and how thoroughly they do their due diligence regarding all the companies listed on the website.

Risky business

Equity crowdfunding is risky and deciding to invest in this way should not be taken lightly. Typically, companies that raise capital through crowdfunding are speculative and carry high risks. Make sure you thoroughly research the company and platform before you invest, and consider your own personal circumstances and investment goals.

For more articles like this sent straight to your inbox, sign up to our newsletter below. 

Cover image: Rawpixel.com (Shutterstock) 

Similar Topics:

Share this article