Crowdfunding was popularized by platforms like GoFundMe and Kickstarter, which allow individual donors to make small donations towards a cause. Equity crowdfunding takes this concept one step further, allowing anyone to invest in private companies.
Equity crowdfunding is a relatively new way for businesses to raise funds from a large group of investors. The first US-based equity crowdfunding platform was ProFounder, which launched in 2011, but later shut down due to regulatory issues. It wasn’t until the JOBS Act was passed in 2012 that equity crowdfunding became viable.
But what’s the difference between equity crowdfunding and venture capital? While the two concepts are similar in many regards, there are key differences to keep in mind.
Equity Crowdfunding Has Lower Odds of Success
A Chicago Booth report highlights that out of a sample of 367 equity crowdfunding offerings, only a single one (0.2%) exited—with a mere 2.5X return. In comparison, an analysis of over 1,000 startups funded by venture capitalists found that 22 percent exited, and 1 percent reached valuations of over $1 billion.
In other words, venture capital has a far higher success rate than equity crowdfunding. The main reason for this is that equity crowdfunding platforms are often the last resort for businesses that can’t get VC funding. That’s a red flag because it means the company likely doesn’t have the financials or potential for success to convince venture capitalists.
The data backs this up, with the same Chicago Booth report highlighting that firms that sought crowdfunding were less profitable and carried more debt than those that got venture capital.
Another difference is that venture capitalists are experienced professionals who make well-informed decisions about which companies to invest in. They do extensive due diligence on a company before investing and have the resources to provide support if needed.
In contrast, equity crowdfunding investors often have limited knowledge or experience in assessing investments, making it more likely that their decisions will not result in success.
Crowdfunding Has a Greater Risk of Fraud
An analysis of crowdfunding fraud published by the Association of Certified Financial Crime Specialists (ACFCS) highlights that fraudsters often use crowdfunding platforms to launder money and defraud investors.
Since crowdfunding is open to more people, it’s easier for scammers to slip under the radar and solicit investments without going through the same rigorous due diligence process as venture capitalists.
Venture capitalists use a thorough process to screen investments, making it more difficult for fraudsters to get their money. This does not mean that venture capitalists are immune from investing in fraudulent businesses, but their process makes it much less likely.
Equity Crowdfunding Is Used By Retail Investors
Accredited investors have many avenues today to invest in private companies. These investments are reserved for high-net-worth, high-earning, or well-educated individuals who have been deemed to have the financial sophistication or experience to understand the risks associated with investing.
In contrast, retail investors make up the majority of equity crowdfunding investors. They are typically not required to meet any criteria and are allowed to invest regardless of their education, income, or net worth. Equity crowdfunding is a more accessible way for everyday investors to get involved in private investments.
That said, retail investors get paired with businesses that are likely less successful and riskier than those receiving venture capital.
Takeaways
Equity crowdfunding and venture capital have similar goals—to finance businesses in exchange for a share of their profits. However, they differ in terms of their risk profiles, the types of investors involved, and the success rates of their investments.
Venture capital has a higher success rate, is often used by experienced investors, and involves a rigorous due diligence process. Equity crowdfunding is more accessible to retail investors, carries a higher risk of fraud, and has much lower odds of achieving successful exits.