Running an equity crowdfunding business is a lot like operating a private equity firm, but on a mass scale. Private equity (PE) firms work with accredited and corporate investors as well as corporate fundraisers or startups. In contrast, a crowdfunding platform focuses on retail and high net worth investors and startups.
A PE firm rarely works with high net worth investors, not speaking about the retail investors with low capital. This has opened an opportunity for the crowdfunding platforms to provide opportunities for retail also known as everyday or non-accredited investors to invest in the early-stage startups.
Venture capital (VC) firms are also interested in the early-stage startups, but they are quite picky when it comes to giving away large sums of money to pre-revenue startups. This is the second problem that crowdfunding solves – providing startups access to a large pool of investors.
By leveraging the power of “crowd”, early-stage startups can raise capital faster and more efficiently compared to banks, for example. In this case, crowdfunding is used as proof of concept for the VC firms to convince them to invest in the startup.
The basics of starting a crowdfunding business
Crowdfunding platform is an online business that connects investors with startups who rarely communicate with each other directly. All of the operations are managed by a fund manager who invests in highly-vetted businesses or a portfolio of projects.
To start an equity crowdfunding business you need to define key factors that will determine your business operations. The key factors include:
- Deal size that you’re comfortable working with (the larger the deal, the less online it is)
- Investor type
- Fundraiser type
- Fees structure or platform’s monetisation strategy
- Niche and region of operations
- Regulatory framework in your country including investment and fundraising limits, rules to pay-ins and pay-outs, reporting procedures, etc.
- KYC/AML requirements
- Level of platform’s automation – automated, semi-manual, and manual (in this case, transactions, registrations, updates, offering management, etc.)
The biggest challenges with the equity crowdfunding concern payment processing, KYC/AML verification and regulations.
Payment and repayment processing is not an issue on a private equity crowdfunding platform, however, it’s a big problem with a mass-market-oriented platform. This is because equity repayments are hard to calculate due to multiple factors of business revenue valuation and projection and its dynamics. Because of so many parameters, equity crowdfunding platforms usually focus on private equity deals.
A private equity crowdfunding platform is not open for everyone. Investors have to go through an extensive KYC verification procedure before being allowed to view and invest in offerings. However, platforms like Seedrs or StartEngine operate publicly offering a minimum investment of $ 10 and $ 100 respectively.
Watch for Regulatory Sandbox opportunities in emerging markets
Many countries are in the process of forming the regulatory framework for equity crowdfunding platforms. Every more or less developed or emerging market provides Regulatory Sandbox where you can test your platform on a real audience under strict supervision of the financial regulatory authority.
Entering a market through a regulatory sandbox is not easy because every platform that applies to a sandbox program undergoes a unique process of business verification on a case-by-case basis. However, this is one of the few ways you can enter the Fintech market on the right foot.
Currently, popular equity crowdfunding markets include the UK, USA, and the MENA region.
Pick a particular industry
Every equity crowdfunding platform focuses on providing fundraising opportunities for SMEs as well as investment options in highly-vetted deals. So, this kind of positioning will soon be oversaturated and lose its differentiation characteristics.
Instead, you should watch the dynamics of a particular industry or a group of industries which have shown similar development trajectories and public resonance. Some of the currently trending industries may include:
- Technology (AR, VR, voice, products, etc.)
- Green energy (solar energy, filters, etc.)
- Food & beverage (Glovo, food waste prevention app, etc.)
- Real estate (note: despite being a profitable equity crowdfunding niche, the workflows on the real estate crowdfunding platform will be very different from the SMEs-focused one)
Invest extra into KYC
Usually, crowdfunding platforms do extra due diligence than required by law. Platform managers do so because they are interested to source high-quality deals and offerings because their profit depends on the quality of deals.
Investors with some professional background will never risk their money if they don’t trust the management team or the platform itself. So, when you’re building your platform you should focus on building trust and authority in your niche.
Apart from the KYC/AML verification usually implemented through a third-party service provider, platforms often double-check startups and investors to create a healthy and more or less secure ecosystem.
Decide how you will handle transactions
High-value deals are usually handled through a wire-transfer and not directly online. Managers manually update the records in the investor’s account as well as make changes to the offering funding progress.
In equity crowdfunding, manual payment processing is usually more than enough, and the platform works as an online ledger.
However, some managers may prefer to automate the platform and integrate it with accounting software, CRM, etc. Depending on the complexity of the offerings and size of transactions, the automation level may vary.
To automate payment processing on your platform, you need to find a trusted payment gateway with extensive API documentation and multiple integration opportunities. Some of the well-known payment gateway in the industry include Mangopay, Goji, LemonWay, WePay, and Stripe. Usually, payment gateways provide both KYC and AML verification services, but only if they’ve been authorised by the regulator.
Crowdfunding is a great opportunity for entrepreneurs who want to target a segment of early-stage startups and individual investors and connect the two. Building out the crowdfunding ecosystem is a profitable online business idea, especially as more and more countries are forming their regulations to prevent fraud and streamline the process of financing a business online.
The key things to pay attention to are regulations, transaction management, KYC, and overall business development strategy and its potential scalability. If you have experience in real estate, investment banking or accounting, this business idea is worth researching.