Equity crowdfunding can generate much confusion among both entrepreneurs and investors. Here are 5 things you may not know about equity crowdfunding.
You could be forgiven for feeling slightly bewildered by the topic of equity crowdfunding. After all, since its inception in 2013, it has continued to change face and evolve from 'alternative' financing to increasingly mainstream. In this series of blog posts, we will de-mystify this type of investment-based crowdfunding, which can cause much confusion.
In a nutshell, equity crowdfunding is where 'the crowd' (often made up of a diverse range of investors, including individual 'everyday investors') invest in businesses. In return for capital, entrepreneurs release a percentage of the ownership of their company (usually shares) to investors. The crowd may be incentivised to invest by attractive tax relief schemes or rewards offered by the investee company, such as discounted products.
You can also see our earlier article for an introduction to crowdfunding and for a legal and regulatory overview: Crowdfunding: restriction on ‘offers to the public’.
To start, here are 5 key features of equity crowdfunding you may not know:
- Most equity crowdfunding platforms work on an 'all or nothing basis'. This means that the investee company’s minimum funding target (commonly referred to as the ‘pitch progress bar’) must be set at the launch of the pitch. If the investee company does not reach 100% of this target before the campaign expires from the platform, it won’t receive any of the funds. Alternatively, if the investee company has reached this target before its campaign has expired, it may be able to release further equity and ‘overfund’ for a limited period of time.
- Equity crowdfunding can include an institutional component. ‘The crowd’ are often assumed to be exclusively individual ‘everyday investors’, which usually includes investment from the entrepreneurs' own network of family and friends. While this remains a key investor base, institutional investors, such as venture capital firms, routinely form part of the same investment round - although for institutional money to be reflected on the progress bar, certain requirements apply; for instance, the institutional money must be invested on the same terms available to individual investors through the platform.
- Investee companies raising capital through equity crowdfunding often offer different classes of share to investors. If an investee company makes available more than one share class, the type the investor receives is usually contingent on the amount of their investment. For example, you may need to invest over a certain amount in order to receive ordinary shares with voting and pre-emption rights. The applicable financial threshold will be listed on the investee company’s pitch.
- Investors may not become direct shareholders of the investee company. A common structure, which is used on both the Crowdcube and Seedrs platforms (two key players in the UK equity crowdfunding market place), is for an investee company to issue shares to investors via a nominee entity. In other words, rather than issuing the shares to investors directly, the shares are instead issued to a nominee company (which is usually a nominee entity incorporated by the equity crowdfunding platform). The nominee will then hold the shares on trust for the investor, the beneficial owner. There are pros and cons to the direct and nominee models for both entrepreneurs and investors and these should be considered carefully.
- Many investee companies will apply for EIS and/or SEIS advance assurance prior to the pitch going live on the crowdfunding platform. The advance assurance is an indication from HMRC as to whether the investee company may be eligible to apply for EIS and/or SEIS tax relief for their investors. If the investment opportunity is listed as EIS and/or SEIS eligible on the pitch, the equity crowdfunding platform will not complete the investment round before advance assurance is obtained from HMRC.
In future posts, we will explore how equity crowdfunding platforms work and some key issues on which investee companies are likely to require legal advice during the process.