Equity crowdfunding is a type of investment crowdfunding, just like peer-to-peer lending and business loans. With equity crowdfunding, you invest in (future) company shares. This type of investment has its risks, but can be hugely profitable for investors.
How does equity crowdfunding work?
With equity crowdfunding you are not investing in a loan, but in company shares. Unlike crowdfunding a business or consumer loan, there is no debt to be paid back. Instead, the returns are based on future company results.
If the company you invest in makes a profit, you will get your part just like all the other shareholders. Your company share is proportional to the investment that you make at the start. Investing in equity crowdfunding makes you a shareholder and therefore partial owner of the company.
With equity crowdfunding many people can invest in a company, and so there are a lot of smaller co-owners. This means startups do not overly depend on a handful of big investors. Usually, it is also less expensive than entering the stock market.
Equity crowdfunding in Europe
Crowdfunding in general is on the rise in Europe: between 2015 and 2018 the European alternative finance market tripled. In 2020 the European crowdfunding market amounted to a total volume of 19 million euros. The most popular forms of crowdfunding are peer-to-peer lending, real estate crowdfunding and business loans. Equity crowdfunding is a small but growing part of the European market, with Finland, France and Sweden as its frontrunners.
Equity crowdfunding is a small but growing part of the European market.
According to the Cambridge Center for Alternative Finance, companies that most often use equity crowdfunding are service providers, software developers, bio and medical tech companies and entrepreneurs in renewable energy.
Benefits of equity crowdfunding
An important upside of equity crowdfunding for the lending party, is that there is no debt on the company’s balance sheet. The investment is part of their own equity. Because there is no debt, the company you invest in has a higher solvency.
And since their equity increases, this type of crowdfunding can be used as collateral for a loan at the bank. In this way, equity crowdfunding can be leveraged to raise more capital for starting and growing companies.
Because equity crowdfunding does not create debt, the company has more funds to invest in growth scenarios. For this reason equity crowdfunding is typically used for companies that are expected to grow fast, such as promising tech startups.
Equity crowdfunding is mainly used for companies that are expected to grow fast.
This benefits you as an investor because your share can be worth a lot in the future. First of all, this is good news for your payout. And besides that, your shares can be sold at a much higher price than the amount you bought them for. This is an important source of profit for investors in equity crowdfunding.
Risks of equity crowdfunding
When you invest in crowdfunding for a business loan, you can be fairly certain what you will get in return. There are detailed estimates of your monthly payback and interest rate. With equity crowdfunding, there is more uncertainty. It can be difficult to predict the company’s profits.
For this reason, first time investors will usually not choose this type of crowdfunding. Equity crowdfunding is instead much more popular with experienced investors with quite a lot to spend, such as private equity investors or venture capitalists.
Although much is uncertain, there are a few things you can control beforehand. You can make arrangements on when and how shares will be bought back and at what price, for example. Additionally, you can agree upon a minimal payout for your stocks. By doing this, you reduce the risks. Your investment becomes more like a hybrid between a business loan and equity crowdfunding, if you prefer.
Another way to minimize risk, is to first invest in a convertible business loan. Since future profits can be very difficult to predict beforehand, the loan can be converted into shares at a later time. When the company turns out to be profitable, for example, or once you can make a more detailed estimate of your stock payout.
Your main source of returns from equity crowdfunding will usually not be dividends. This is because startups often don’t make a profit for a while. And so, it is rare that a starting company will hand out profit shares. Instead, your return on investment will mainly come from capital gains. In other words, from the increased value of your share.
In equity crowdfunding, your main source of return won’t be dividends.
Keep in mind that it will take some time before the value of your share increases. Although equity crowdfunding is usually meant for startups that are expected to grow fast, the investment horizon is at least three to five years. And sometimes it can take longer. This is in part because you want to sell the shares. Therefore you will have to keep them until the company is sold or enters the stock exchange. Alternatively, you can resell them on the crowdfunding platform, but this is not always possible or even profitable.
There are a lot of popular crowdfunding platforms. Below are some of the biggest platforms that offer equity crowdfunding in Europe.
CrowdedHero is a global marketplace for growing, non-listed companies' equity offers. It provides Anti Money Laundering (AML) and Know Your Customer (KYC) checks and has a strong focus on promising early-stage startups that already have a clear exit strategy with an aim on return on equity of 16-20% per year.
The English startup investment platform Seedrs is a platform for equity crowdfunding-campaigns all over Europe. It has many campaigns for startups all over the European Union, including some well known scaleups. It also has a monthly Secondary Market included.
Crowdcube is about the same size as Seedrs. The biggest difference between the two of them is of course the offer of investment opportunities. They are both well-known startup crowdfunding platforms, so see for yourself which one you prefer.