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Equity Crowdfunding: what is it and how does it work?

Equity crowdfunding has emerged as an innovative and accessible financing alternative for startups and emerging companies. This model connects entrepreneurs with a wide network of investors through online platforms, allowing companies to raise capital without resorting to traditional funding sources, such as banks or private investors. In return, investors acquire a stake in the company, which means they become shareholders entitled to potential future profits.

What is Equity Crowdfunding?

Equity crowdfunding is a form of crowdfunding in which multiple investors contribute small amounts of capital in exchange for shares or equity in a company. Unlike other types of crowdfunding, in equity crowdfunding investors acquire ownership rights in the company, with the expectation of a financial return if the business is successful.

This model has gained popularity because it democratises access to capital, allowing anyone to invest in start-ups with growth potential. In addition, companies can raise funds without the need to significantly dilute control, as is the case with other forms of investment, such as venture capital.

How does Equity Crowdfunding work?

The equity crowdfunding process follows a relatively simple structure, but must comply with certain specific regulations, such as the supervision of the Comisión Nacional del Mercado de Valores (CNMV) in Spain.

  1. Campaign creation: The startup sets up a campaign on a licensed equity crowdfunding platform. In this campaign, the business proposal is presented, including details about the business model, the team, the amount of capital to be raised and how the funds will be used. Once the campaign is ready, it is launched on the equity crowdfunding platform, where investors can review it and decide whether they wish to participate. This step is crucial to attract investors.
  2. Investor analysis: Interested investors evaluate the campaigns available on the platform. This analysis involves reviewing key factors such as project viability, founding team, market growth potential and associated risks. Equity crowdfunding platforms typically provide detailed information about each project, but investors must supplement this information with their own research and analysis.
  3. Capital contribution: Investors contribute capital according to their interest and economic capacity, thus acquiring a stake in the company. Each investor receives a percentage of shares proportional to their investment.
  4. Use of funds: The startup uses the capital raised to finance its growth, which may include product development, expansion into new markets or strengthening the team. It is essential that startups keep investors informed about the use of the money and the progress of the business.
  5. Potential returns for investors: Investors expect a return if the company is successful, either through dividends or by selling their shares when the company grows or is acquired.

Advantages of Equity Crowdfunding

Equity crowdfunding offers benefits for both entrepreneurs and investors, making it an attractive funding option for startups:

  • Access to capital: Enables companies to raise funds from a large number of small investors, which would otherwise be difficult to reach.
  • Market validation: A successful campaign not only attracts funding, but also validates the market’s interest in the startup’s product or service.
  • Investment diversification: For investors, equity crowdfunding allows them to diversify their investments, reducing risk by investing in multiple projects.
  • Maintaining control: Unlike venture capital investments, startups can maintain greater control over the direction of the company, as crowdfunding investors tend to have less direct influence on decision-making.
  • Flexibility in terms: Startups can set investment terms that are tailored to their specific needs, such as the valuation of the company or the rights attached to the shares.

Disadvantages of Equity Crowdfunding

Despite its advantages, equity crowdfunding is not without risks and challenges:

  • High risk for investors: Investing in startups is inherently risky, and investors may lose some or all of their investment if the company does not succeed.
  • Dilution of control: Issuing new shares dilutes the ownership of the founders and can affect strategic decision-making.
  • Regulatory complexity: Equity crowdfunding platforms and startups must comply with strict financial regulations, which can increase the complexity and costs of the process.
  • Lack of liquidity: Unlike shares in listed companies, shares acquired through equity crowdfunding are often illiquid. Investors may find it difficult to sell their shares until the company is acquired or goes public.

Equity Crowdfunding Platforms

Equity crowdfunding platforms play a key role in the process. Some of the most popular ones, such as Seedrs, Crowdcube, AngelList and OurCrowd, not only connect entrepreneurs with investors, but also provide tools and resources for entrepreneurs to effectively prepare and manage their funding campaigns. In addition, many of these platforms offer complementary services, such as legal and financial advice, to help startups meet the challenges of funding.

Final Considerations

Equity crowdfunding is a powerful tool that can help startups raise the capital needed to scale their business and validate their proposition in the market. However, both entrepreneurs and investors must be aware of the risks involved. For entrepreneurs, it is essential to structure attractive, transparent and clear campaigns, while investors must do their due diligence before committing their capital.

This type of crowdfunding represents a significant change in the way startups raise resources, fostering innovation and opening up new opportunities for those looking to be part of a company’s early stage success.

This publication does not constitute legal advice.

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