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What is equity crowdfunding? Why cleaning product and nail polish start-ups ask you to invest

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Last month, eco-friendly cleaning product company Zero Co broke a record. In just 47 minutes, it raised $3m using equity crowdfunding – the fastest raise ever seen in Australia.

Zero Co isn’t the only company who’s been using equity crowdfunding to raise capital. While equity crowdfunding has been open to proprietary companies in Australia since 2018, it’s boomed during the pandemic. You may have seen your favourite retreat, ethical beauty brand or plant-based food company spruiking it as a way to support their mission. The largest crowdfunding intermediary, Birchal, has raised over $70m for over 100 companies since their launch. So what, um, is it?

“It’s asking people – many, many, many people – to invest small amounts of money by buying small amounts of shares in a company,” says associate professor at UNSW Marina Nehme, whose research focuses specifically on equity crowdfunding.

“You know the Statue of Liberty? They built it through crowdfunding … So equity crowdfunding is the same concept, just done online.”

Equity crowdfunding allows companies to sell shares in their business to the public, and package prices can be as low as $50. For companies, it’s a way to raise the capital required to get an idea off the ground or help grow a business and unlike a bank loan, it’s interest-free money that they don’t need to repay.

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It can also be a good marketing tool – a way to spread the word and create loyal customers, because people who are part owners in a business are incentivised to keep supporting it.

For consumers, it’s a chance to invest early for an accessible price tag – and potentially make a profit somewhere down the line. Of course, as with all things investment, there are potential risks. So before you chip in your money, here’s what you need to consider.

The good

Before equity crowdfunding, investing in an early-stage start-up could cost tens of thousands of dollars, as well as requiring a lot of paperwork and a relatively high level of financial literacy. Equity crowdfunding makes early-stage investment relatively easy for anyone with an internet connection, for a more accessible price. Early-stage investments mean jumping on board when a company is small – which means you might enjoy a good financial return, if the business does well.

View image in fullscreen‘Some of these businesses are doing quite interesting and cool things,’ says financial advisor Hamish Landreth. Photograph: lemono/Getty Images

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It’s also a money-where-your-mouth-is way of getting behind the ideas you believe in. Many of the companies who use equity crowdfunding have a strong social mission – Zero Co, for instance, creates products that aim to solve the global single use plastic problem.

“Of course, I think people are going into it hoping that it works out well and that they make money,” says Hamish Landreth, a financial consultant at Prosperity Wealth Advisers. “But the conversations I’m having [with clients], it’s not so much about, oh, I want to make X return on this investment. It’s, ‘I think this is a great idea that could change the world, I want to help this company succeed’.”

There’s a novelty factor too. “Some of these businesses are doing quite interesting and cool things,” Landreth says. “Being a part owner in a brewery is not a bad thing to drop in conversation at a barbecue.”

Landreth believes getting the chance to become a shareholder in a business you already like is “quite a compelling proposition, perhaps more so than something like being a tiny shareholder in a major bank”.

Investors generally aren’t (or shouldn’t be) pouring their life savings into equity crowdfunding ventures. Under Australian legislation, the most an individual can invest per company, per year is $10,000, but typically people spend a lot less than this. With Zero Co, for instance, CEO Mike Smith says that their average parcel investment size was $1700.

There are other safeguards in place as well. The platforms that facilitate equity crowdfunding must do some due diligence on the companies they allow in.

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Matt Vitale, the CEO of Birchal, says they run all companies through a “gatekeeper process” to ensure they are eligible to make a crowdfunding offer. That involves ensuring that “all the directors and senior managers are of good fame and character” and that any disclosable matters are included in the offer document they legally need to produce. After applying to invest, there’s also a five business day cooling-off period.

Nehme says platforms like Birchal have an incentive to keep dubious operators off, “because if they are known as intermediaries who attract dodgy companies, they would lose investors”.

All that being said, “it is a really risky asset class,” cautions Vitale. “That’s just par for the course with early-stage investment.”

The bad

And to that point: equity crowdfunding investors need to be aware that as new businesses, the ventures they are investing in have a high chance of failing.

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“Usually in the first five years a big chunk of them would fail, like at least half,” says Nehme. If a business does go under, any money you’ve put into an equity crowdfunding investment would be lost.

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View image in fullscreenHamish Landreth cautions investors to only put in what they’re prepared to lose. Photograph: Nuthawut Somsuk/Getty Images

That’s what happened with Shebah, a women-only rideshare business that raised $3m through equity crowdfunding in 2019 and this year went into voluntary administration.

Vitale says there are “a couple of companies” who have used equity crowdfunding and gone under, but that “anecdotally, the failure rate hasn’t been as significant as people thought it might be”.

Landreth says the regulatory restrictions around how much you can invest indicate it is viewed as a higher risk style of investment. “That’s there as a protection mechanism … so that people don’t get caught up in putting too much into these things.”

There is no get rich quick scheme in themMarina Nehme, UNSW

Even if the business doesn’t fail, any money put into equity crowdfunding is unlikely to pay off in the short term. You will only get your money (plus any potential return) back after the company you invested in either sells to another corporation, or lists on a stock exchange. That might not happen for many years – if at all. As Nehme warns: “There is no get rich quick scheme in them.”

Crucially, any shares you buy cannot be sold on. “You really will be trapped in these companies,” says Nehme. “If you’re buying those shares, you’re there for the long haul.”

Landreth explains that “buying shares on the stock market is … what’s called a secondary market. There’s someone else there that’s always willing to buy the shares back off you … So you can sell pretty much at any time.” With equity crowdfunding, “you can’t do that”.

Any shares you buy are also at risk of “the dilution effect”. If the company decides to sell more shares through another equity crowdfunding round a year or two down the line, your stake in the business will become smaller, and the value of your shares goes down. “But that’s the same as with [investing in] any company,” Nehme says. “It’s not unique.”

You don’t always know exactly how well the company’s goingHamish Landreth, Prosperity Wealth Advisers

Lastly, companies who use equity crowdfunding are also subject to less disclosure and reporting requirements than traditional shares.

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To raise money on the stock market, a business needs to have what’s called a prospectus, a type of information statement that can easily cost six figures to prepare. That amount of money is prohibitive for the small start-ups, so instead the Australian government requires them to create a much simpler disclosure document – the one reviewed by platforms like Birchal. These documents are less detailed, so offer less information for potential investors.

In addition, these companies aren’t held to the mandatory ongoing reporting requirements of publicly listed companies. This lower transparency means “you don’t always know exactly how well the company’s going,” Landreth says. “That can add some additional risk.”

The bottom line

If you’re interested in equity crowdfunding, the most important thing is to go in with your eyes open.

Nehme says investors “have to pay extra attention and do a little bit more research”, especially as any information in their disclosure document is going to be limited.

Look into the financial health of the business, how long it’s been running for, what sort of profits it has been making and what they plan to use the money they raise using crowdfunding for, says Landreth.

“It’s probably also worth asking the question of, why is the company doing this?” he adds.

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“Why aren’t they borrowing the money from a bank? What’s the benefit in crowdfunding? And that’s not from a sinister point of view. But is it just because it’s a higher risk investment and they can’t get capital elsewhere? Or is it a way for them to market their business at the same time?”

Landreth cautions investors to only put in what they’re prepared to lose. Even if the investment works out, “you’re probably not going to be able to get that money back for potentially a number of years.”

For Nehme, the most important thing is that consumers understand the risks involved. “My concern is, are investors really appreciating what they’re getting into?”

“As long as they know this is a long-term investment and they understand the risk attached to it, then it’s fine because they are making an informed decision.”