Introduction
Equity crowdfunding is a popular method of raising capital that has gained momentum in the financial world. This innovative method allows startups to secure funds from a large number of investors through online platforms.
Unlike traditional crowdfunding, where investors or backers receive rewards or products, in equity crowdfunding, investors receive a stake in the company. This democratised approach to investing has gained traction due to its potential to provide startups with much-needed capital while offering investors the opportunity to support promising ventures and potentially reap financial rewards.
This article provides a beginner’s guide to what is equity crowdfunding, exploring how equity crowdfunding works, and its benefits and risks.
What is equity crowdfunding?
Equity based crowdfunding in India is a type of fundraising method where a large number of individuals invest in a private company in exchange for ownership shares or equity. This crowdfunding type operates through online platforms, where entrepreneurs present their business ideas and investment opportunities to potential investors.
Unlike traditional crowdfunding, where backers may receive rewards or products, in equity crowdfunding, investors receive a financial stake in the company.
This allows startups and small businesses to raise capital from a broad pool of investors without the need for traditional sources such as venture capitalists or banks.
Equity crowdfunding democratizes investing by allowing ordinary individuals to invest in early-stage companies and potentially benefit from their growth and success.
Equity crowdfunding legislation
Unfortunately, equity based crowdfunding In India is illegal. In India, crowdfunding rules are overseen by SEBI (Securities and Exchange Board of India), the market regulator. Initially, there were no specific regulations for crowdfunding. Thus, there are no equity crowdfunding platforms in India.
However, as the practice evolved, SEBI introduced guidelines to ensure transparency and investor protection.
It’s important to note that equity-based crowdfunding is currently prohibited in India. However, donation-based and reward-based crowdfunding models are fully permissible under the existing legal framework.
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Types of investors in equity crowdfunding campaigns
In equity crowdfunding campaigns, various types of investors participate, each with unique motivations, risk tolerances, and investment strategies. Here are some common types of investors:
1. Individual retail investors
These are regular people who invest their own money in equity crowdfunding campaigns. They might be excited about supporting new and innovative startups, spreading out their investments to manage risk, or hoping to make some extra money if the startup succeeds.
Being individual investors means they don’t represent big companies or funds—they’re just everyday people looking to be part of something promising and potentially profitable.
2. Angel investors
Angel investors are wealthy individuals who help startups by investing money in exchange for ownership. They’re like business mentors, offering advice and using their experience to guide startups to success.
Angels often invest smaller amounts than big investment firms but play a crucial role in supporting early-stage companies.
Their involvement can provide startups not just with money but also with valuable connections and expertise to navigate the challenging startup journey.
3. Institutional investors
Institutional investors like pension funds and foundations, often big organizations with significant financial resources, also take part in equity crowdfunding. They might join in later stages or larger funding rounds.
These investors look for opportunities to diversify their investment portfolios, potentially earn returns, and support innovative companies.
Their participation adds credibility and stability to crowdfunding campaigns, attracting other investors and helping startups secure the capital they need to grow.
4. Venture capital firms
Venture Capital Firms are like professional investment teams. They collect money from rich people and big companies to invest in startups with big potential. They look for businesses that can grow fast and become very successful.
Sometimes, these firms join equity crowdfunding to find new startups early and spread out their investments to lower risks.
How does equity crowdfunding work?
Equity crowdfunding operates as a digital platform where startups seeking funding can pitch their business ideas to a wide audience of potential investors. This is often done through online platforms. Now, let’s explore how this process unfolds step by step.
1. Selection of platform
Equity crowdfunding starts with choosing a crowdfunding website or platform. These platforms act like online hubs where startups and investors come together.
Startups seeking funding create profiles on these platforms, while investors looking to invest browse through the available campaigns.
The platform manages the entire investment process, from connecting startups with investors to handling the transfer of funds and equity shares.
2. Startup campaign creation
Startups join the equity crowdfunding platform and create profiles showcasing their business plans and funding needs. They share information about their goals and how much money they require to achieve them.
Additionally, they may include videos or other materials to attract potential investors and explain why their venture is worth supporting.
3. Investor participation
Investors explore startup profiles on the platform. They read about each startup’s goals and funding needs. Based on this information, investors decide whether they want to invest in the startup.
If interested, they can proceed to contribute funds to support the startup’s growth in exchange for a share of its ownership.
4. Funding goals
Startups on the platform set targets for the amount of money they need and the time frame to reach it. If enough investors commit to funding the startup within this period and meet the target, the startup receives the invested funds.
This ensures clarity for investors and motivates startups to achieve their financial objectives within a specified timeline.
5. Equity distribution
After reaching the funding goal, the startup distributes ownership shares (equity) to the investors based on their contributions.
Each investor receives a portion of the company’s ownership corresponding to the amount they invested. This process ensures that investors become stakeholders in the startup and are vested in its success and growth.
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Conclusion
Equity crowdfunding is revolutionising investment opportunities by providing a pathway for everyone to support and benefit from promising startups. As this method gains attraction, it’s clear that its impact on modern finance is profound, and it will make an impact on equity crowdfunding statistics and inclusivity in the investment landscape. However, note that this is not legal in India. To learn more financial concepts, read StockGro blogs.
