Equity crowdfunding is an alternative finance tool that enables startups and SMEs to raise venture capital from a broad audience of investors without listing on the stock exchange and without turning to investment funds or business angels.

Equity crowdfunding capital raising takes place online and does not require financial intermediaries, only an authorized platform to provide the portal where potential investors are welcomed and the infrastructure for payment. This financing model not only facilitates and democratizes capital raising, but also offers strategic advantages because it functions as a marketing tool that brings visibility to the company, expands its network and fosters the creation of a community around the brand.

In this article we provide a comprehensive guide to equity crowdfunding for startups and SMEs that want to learn how to raise capital independently and alternatively.

What is equity crowdfunding?

Equity crowdfunding is a collective financing mode in which a company raises capital by offering company shares in return. Investors, therefore, become partners in the company.

Unlike reward crowdfunding, where backers receive a product or service in exchange for their contribution, or lending crowdfunding, which involves repayable loans with interest, equity crowdfunding allows investors to acquire a direct stake in the company. 

As we shall see, however, this does not mean that all crowd investors will have a say in company decisions, because a peculiarity of equity crowdfunding is precisely that it allows the company to Keep corporate governance intact In the hands of the original partners.

Origins and development of the phenomenon

The concept of crowdfunding originated centuries ago with the collective financing of creative projects and commercial enterprises, but it experienced a renaissance starting in the 1990s with the growing demand for alternative financial instruments. This is how it has evolved to include more sophisticated models such as equity crowdfunding. 

In Italy, equity crowdfunding regulation was introduced in 2013 by Consob, making that country one of the first in Europe to regulate this sector. As of 2023, all EU member states share a common regulation on crowdfunding, the ECSP Regulation.

To learn more about the origins and development of the phenomenon, you can read our article on the history of crowdfunding.

How Equity Crowdfunding Works

A startup or SME through equity crowdfunding can sell pieces of the company online to raise capital, expanding the shareholder base. The reference model is that of the placement of shares on the stock exchange or the entry of institutional investors-such as investment funds or business angels-into the share capital, with the difference being that equity crowdfunding is a process that is more easily accessible to all companies, much simpler and less costly, and does not involve the transfer of decision-making power.

Let's find out how equity crowdfunding works: a comprehensive guide that looks at all stages of the online capital raising process.

1. Preliminary analysis and fulfillment

In order to launch an equity crowdfunding campaign, a company must meet certain requirements and carry out certain bureaucratic tasks. Specifically:

• Include in the corporate bylaws the possibility of crowdfunding capital raising, if not already present, with relevant clauses.
• Open a capital increase at a notary public.
• Draft an offering document with all relevant information about the transaction for investors (especially minimum and maximum collection target).
• Prepare a business plan or incorporate the prospect of an equity crowdfunding campaign into the existing one.
• Making a pre-money valuation of the company.
• Prepare a budget for the crowdfunding campaign.

2. Choice of crowdfunding platform and selection process

The company must choose an equity crowdfunding platform authorized according to European regulations where to launch their campaign. It can be an Italian platform, but also a foreign one, as long as it has authorization to operate with Italian companies.

The choice of platform can depend on many factors, such as the economic sector of specialization, the success rate of campaigns, the fees imposed, and the support offered.

Admission to a given platform, however, is not automatic: any startup or SME that wants to launch an equity crowdfunding campaign must pass a selection process. The parameters submitted for evaluation mainly concern the company's potential, the credibility of its business plan, team structure, network of contacts, and marketing processes.

Learn with us tips for passing the crowdfunding platform screening.

3. Precrowd phase

The preparation phase of the equity crowdfunding campaign can be called precrowd because, for it to be effective, it must build and field test the marketing and sales strategies and processes that will form the core of the campaign. This is also referred to as "pre marketing." At this stage, it is crucial to already reach the target audience of potential investors and gather expressions of interest in the investment, so as to build a "warm" following, engaged and ready to participate in the campaign from the first minutes after launch.

This phase can last from a few weeks to more than a month and also serves to more accurately establish a realistic collection goal and time (minimum and maximum threshold).

4. The equity crowdfunding campaign

On launch day, the goal is to open the campaign and immediately see the counter go up, thanks to supporters engaged in precrowd, so as to trigger a herd effect. Throughout the campaign, Marketing activities must continue according to a well-defined schedule and processes and must be supported by Sales activities, aimed at making direct contact with potential investors and leading them to the goal.

5. Post-campaign

If the minimum goal, also known as the unbreakable threshold, is met or exceeded by the predetermined deadline, the campaign is successfully closed. Until this time, the capital contributed by investors remains locked in an escrow account opened specifically by the company. After the investors are registered in the company's Chamber of Commerce registration, the funds are released. The company share held by each investor is determined on the basis of the paid-up capital, the company's pre-money valuation, and the post-money valuation that results as a result of the crowdfunding campaign.

At this point it is very important to maintain a transparent relationship with investors, communicating regular updates on the company's progress and use of capital and involving them in subsequent projects.

The role of the crowdfunding platform

Equity crowdfunding platforms act as intermediaries between companies and investors. Their role is crucial because they enable capital raisings to take place in a way that is transparent, supported, regulated and safe for both companies and investors. For this reason, it is crucial to turn only to equity crowdfunding platforms authorized by Consob and the Bank of Italy under the European ECSP regulation.

The crowdfunding platform selects companies, supports them in creating the page for the campaign and provides marketing suggestions, takes care of the technical aspects of the payment infrastructure for investments, monitors the progress of the campaign, and provides assistance to users. After the campaign closes, the platform sees to it that the paperwork is done correctly and the funds are released-which it never holds directly-and provides reporting to investors on the company's progress. But its role ends there.

It is important to note that the platforms do not deal directly with the marketing of individual campaigns, but are limited to providing generic support and sending newsletters to their user database with information on all ongoing campaigns. By law, platforms cannot do targeted marketing for individual campaigns or participate in campaigns-these constraints were introduced to avoid conflicts of interest and ensure impartiality in the fundraising process. Successful capital raising, therefore, depends on the crowdfunding communication strategy adopted by the company to reach and persuade potential investors.

Who are equity crowdfunding investors?

In equity crowdfunding, the typical investor is neither an institutional entity nor a serial investor constantly looking for new opportunities online. On the contrary, the vast majority of crowd investors are clients, or potential clients, of the same companies that promote the campaigns. This fact is confirmed every year by the numbers in the report of the Crowdinvesting Observatory of the Politecnico di Milano: about 75 percent of investors usually participate in only one campaign, and just over 1 percent invest in ten or more campaigns.

These data suggest that investors do not arrive casually on the platform, but are already interested in the project even before they encounter the online campaign page. And often that interest stems from an existing direct or potential relationship with the sponsoring company.

The beating heart of a successful equity crowdfunding campaign is, therefore, people who already know and like the company's product or service. These are current or potential customers, people who have a vested interest in the company growing and thriving.

Engaging this target audience offers numerous advantages:

• It starts with an existing database of contacts.

• Communication is simpler and more effective because the interlocutor is already familiar with the brand or the type of product or service offered or even just the need it proposes to address.

• A twofold result is achieved: investor/customer acquisition and customer retention.

• An organic word-of-mouth effect is generated.

But why should a client also become an investor? The reasons are not only emotional. The potential financial return plays a role, but since these are high-risk, long-maturing investments, it is not enough. That is where rewards come in, immediate rewards for those who participate in the campaign, which make the investment more attractive and tangible already in the short term. We will explore this element in more detail later.

Advantages of equity crowdfunding for startups and SMEs

Equity crowdfunding offers startups and SMEs a real opportunity not only to raise capital, but also to gain strategic benefits that go far beyond the financial aspect. This is why we talk about "smart money".

Here are all the benefits of doing a proficient equity crowdfunding campaign.

• Access to alternative capital: The first obvious and immediate benefit is the ability to access sources of capital other than traditional ones, such as bank loans or investments from funds.
• Built-in marketing: Each campaign is, in fact, a massive action of visibility, exposure and corporate storytelling on a multiplicity of communication channels. While raising capital you are also doing marketing, so it is an efficient activity. In practice, every euro spent on the campaign is not only an investment in fundraising, but also in marketing for the company itself. Compared to the company's normal marketing activities, moreover, crowdfunding is unique and distinctive from competitors, because it is hardly similar to something that others are also doing at the same time. That is why even established companies use crowdfunding to strengthen their brand and position themselves distinctively in the market.
• Customer retention and acquisition: Crowdfunding makes it possible to turn customers into investors and vice versa. Those who buy a product and are satisfied with it will be more likely to support the company financially as well, and those who invest will tend to become loyal customers. This dual connection improves the customer retention and expands customer base.
• Creating a community: A well-structured campaign enables the creation of a community of investors and supporters directly involved in the company's activities. Direct involvement of the target audience creates a group of "ambassadors" who not only invest and buy, but also talk about the project, promote and advocate for it. This generates a solid base of support for future campaigns and initiatives.
• Networking opporunities: Equity crowdfunding makes it possible to reach people with knowledge, skills and connections that can come in handy for the company in the operation of the business and give additional support for growth beyond the financial one.

Disadvantages and Risks of Equity Crowdfunding

Knowing the possible disadvantages and risks of equity crowdfunding is essential to avoid them and to know how to deal with the challenges that may be faced by startups and SMEs that decide to engage in this activity.

• Dilution of Ownership: The entry of new shareholders leads to a reduction in the shareholding of founding shareholders and original investors. This can affect decision-making control and governance balance if appropriate bylaws clauses are not in place. Therefore, we have written an article on the simple cautions to maintain governance with equity crowdfunding. The main measure is to differentiate corporate shares into voting A shares and non-voting B shares for crowd investors.
• Increased administrative burden: The company must provide transparency, regular communications, and updates to investors. Poor management can damage the company's reputation and create discontent among shareholders.
• Public exposure and reputational risk: Launching a campaign involves making company data and strategies public, with the risk that they may be exploited by competitors. In addition, campaign failure or inadequate communication can generate damage to corporate image.
• Commitment of economic and human resources: An equity crowdfunding campaign is not a marginal activity that can be conducted in one's spare time and at zero cost. It requires the employment of a team of people who devote specific moments only to this activity and has costs to be incurred, such as online advertising spending and platform fees.

Strategies for a Successful Equity Crowdfunding Campaign

To maximize the likelihood of success of an equity crowdfunding campaign and to avoid the risks described in the previous paragraph, there are some unavoidable strategies to adopt.

• Setting realistic and reasoned goals
• Accurately define the target customers and potential such
• Make an appropriate precrowd phase, during which to collect expressions of interest for 90% of the unbreakable threshold (minimum goal) of the campaign
• Prepare a multichannel communication plan and use CRM software to build timely and effective marketing and sales processes
• Propose attractive rewards that are of value to the target audience
• Constantly monitor the progress of activities and correct where necessary

To learn more about the strategy for successful equity crowdfunding, we refer you to the articles devoted to the individual points in our blog.

We dwell here on the importance of rewards. An immediate reward is an indispensable lever for an investment with an unguaranteed, long-term projected payoff. An effective reward must have three characteristics:

1. Direct connection with the company's product or service.
   
2. Exclusivity - must be accessible only through the campaign (e.g., a simple discount alone is not enough).
3. Time expiration - to generate urgency and incentivize early investment.

The so-called “reward matrix” involves offering more generous rewards to those who express interest during the precrowd and then invest right away at the opening of the campaign, and then gradually leveling off for those who invest later, down to the least juicy rewards for those who make it to the final stages.

Equity crowdfunding: a guide to regulation

Equity crowdfunding is regulated in Italy by a regulatory system that has been able to anticipate European trends. As early as 2013, in fact, Consob introduced specific regulations to allow innovative startups to raise capital through authorized online portals. In subsequent years, it also extended the opportunity to innovative SMEs and finally to all kinds of LLCs. Today, this regulatory framework has been complemented and enhanced by the new European Crowdfunding Regulation (ECSP), which entered into force in November 2021 and is fully operational since November 2023.

Most of the regulations actually concern the platforms, rather than the offering companies. For the latter, the most important aspects are those related to bureaucratic requirements, which we described earlier in this article, the 5-million-euro raising ceiling in one year, and the rules on solicitation of public savings. 

In equity crowdfunding campaign promotion activities, care must be taken to comply with the rules of investment solicitation. Rules in Italy first and foremost provide for maximum transparency about the conditions and risks of the investment, but also prohibit having third parties, such as partners, influencers, etc., directly promote one's crowdfunding campaign. This is why there are strategies such as affiliate and referral marketing.

The most relevant implication of the European crowdfunding regulation for startups and SMEs is the ability to launch crowdfunding campaigns in any EU country on authorized platforms. It is possible, today, to attract foreign investors without regulatory barriers. This Complete guide to equity crowdfunding for startups and SMEs is the basic tool for raising capital anywhere.