Equity crowdfunding, the process of early-stage companies raising funds from a large number of people who invest small amounts, has been a game-changer since the early 2010s. Everyday investors could finally access startup investments and potentially profit from high-growth ventures on platforms like Seedrs (UK), Crowdcube (UK), and StartEngine (US).
In 2023, equity crowdfunding accounted for an estimated 10% of early-stage investments with 240 million Euros raised from the crowd. Although not an insignificant amount and not exactly failing as a source of capital for startups, it’s far behind the expectations of early ‘teens and has faced significant obstacles. What happened, and where is crowdfunding heading? Here’s what we think.
Why crowdfunding matters
There’s a lot that crowdfunding platforms bring to the table, for example:
Access to capital – equity crowdfunding has created a new way for businesses to raise capital, even businesses that may not fit the traditional venture capital mould. Companies can attract investments from a wider pool of investors.
Access to opportunities – retail investors can invest in early-stage startups, which was traditionally the domain of VCs and high-net-worth individuals. This democratizes access to investment opportunities.
Platform and industry growth – platforms like Seedrs, Crowdcube (UK), and StartEngine (US) have raised billions of dollars for startups. Many of those startups have reached subsequent growth or exits, proving the potential of equity crowdfunding.
The unpleasant reality – most startups fail
Equity crowdfunding has allowed thousands of startups to raise capital from small, unaccredited investors. Initially, the excitement and promise are high, but the reality hits hard once the honeymoon ends. The industry data consistently shows that roughly 75% to 90% of startups don’t survive their first few years. This failure rate poses a major challenge for crowdfunding platforms.
Here’s the problem – many small investors, especially newcomers, don’t fully understand the risks of startup investing. They don’t always acknowledge the high failure rate of startups nor understand the usual timeline to a successful exit (hint: it’s much longer than you’d like). Platforms mostly talk about success stories, but inevitably, the majority of companies won’t reach a profitable exit or IPO or get there after a very long and strenuous journey.
As a result, investors might never see returns or sell their positions too early, leading to disappointment and, in some cases, a loss of trust in the platforms themselves. Yet the sustainability of the platforms depends heavily on maintaining investor interest and confidence. It’s crucial to manage investor expectations.
The platforms must balance optimistic marketing with clear communication about risks, educating investors on the realities of startup investing.
The investors must understand that most startup investments won’t yield quick returns and that the likelihood of losses is high. Be prepared for a marathon, not a sprint, and view crowdfunding as a high-risk, high-reward opportunity.
Challenges – transparency, regulations, and evaluations
- High risk and slow returns – startup investments are inherently risky and investors usually don’t generate returns unless there’s an exit (an acquisition or IPO). Most companies fail or take a long time to generate returns. Meanwhile, investors have limited opportunities to cash out, as secondary markets are still developing and gaining traction.
- Regulatory complexity – equity crowdfunding regulations vary widely, especially between the US and the EU. This patchwork of rules can be a headache for companies looking to raise funds across borders. However, efforts like the Global Equity Crowdfunding Alliance (GECA) aim to create a standardized approach to regulations.
- Dilution and oversubscription – some startups raise funds on multiple crowdfunding platforms, leading to highly diluted equity. There’s also concern about startups overvaluing their shares during crowdfunding rounds, presenting optimistic or even unrealistic growth projections.
- Exit challenges – crowdfunding investments lack liquidity since most startups don’t make it to an IPO or a sale. Secondary markets could provide some liquidity, but these markets are often thinly traded and often sell at a discount.
- Lack of oversight – crowdfunding platforms operate under regulatory frameworks, but the companies on those platforms don’t face the same level of scrutiny as publicly listed companies on the stock market. Investors must perform their own due diligence, which can be challenging without in-depth financial or industry knowledge.
What’s next for equity crowdfunding?
More accessibility, transparency, and standardization. Equity crowdfunding platforms have reported a poor fundraising environment for the past few years. But that’s no reason to speculate on the early demise of equity crowdfunding altogether.
The funding landscape has been hard on everyone. We’ve covered both the layoffs of 2022 and the venture capital crunch that started in 2022, and the common denominators boil down to inflation, economic downturn, and global tensions. Investors are hesitant and fewer new members join the investor community altogether.
This means both good and bad news for the investors. While it’s easier to access better deals, there’s also increased risk due to the overall economic strain. The platforms are also taking notice and considering ways to attract more investors. For example, the US platform StartEngine has announced a 20-for-1 stock split to lower share prices and make investments more accessible to a broader audience.
At the same time, platforms like Dacxi Chain called for more trust and transparency in equity crowdfunding at the Euro CrowdCon 2024 conference. There are efforts to harmonize global regulations, to create standardized industry practices. This is seen as key to scaling the industry globally, especially to regions outside Europe with fragmented regulatory frameworks.
The verdict: a market in transition
To sum it all up – equity crowdfunding isn’t failing, but it’s also not yet fulfilling its full potential. While significant risks remain, equity crowdfunding is still the best option we have for democratizing startup investments. It’s a market of high risk but also high potential reward. The success of the platforms depends on how well they can improve liquidity, transparency, and investor access.