Introduction
Equity crowdfunding deal types opens up startup and private company investment, once exclusive to wealthy angel investors and venture capital firms, to everyday retail investors. It allows providing seed capital to emerging ventures in exchange for partial business ownership and potential returns.
However, not all equity offered is the same. Beyond straightforward stock, companies structure creative types aligning risks and rewards for founders and investors both. As an investor scrutinizing crowdfunding offerings, having clarity on these instruments is essential.
Equity Crowdfunding Deal types
Common Stock
The most basic and frequently used equity structure offered to crowdfunding backers is common stock. It represents formal partial business ownership, granting investors rights and privileges like:
Voting Rights – Stockholders can vote on company matters like appointing directors or fundamental decisions at shareholder meetings based on percentage holdings.
Dividends Rights – If and when a startup becomes profitable and issues dividends from earnings, common stock investors have a right to receive payouts.
Equity Value Growth – As the valuation of the startup goes up in future funding rounds or via an acquisition, common stock appreciates.
Liquidation Rights – In case of sale or shutdown, assets get distributed to all shareholders including common stockowners after debt repayment.
So common stock puts investors literally on equal faction with founders in both financial risks and rewards. Of course, the entrepreneur founding team often continues holding majority ownership control.
While most transparent and flexible, pure common share deals face the highest risk of losing entire value should the startup fail. But the unlimited upside in growth ventures makes it most attractive.
Preferred Stock Deals
Many equity crowdfunding deals issue some form of preferred rather than pure common stock to balance risks. Key features include:
Preferred Dividends – Investors earn first rights to dividends before common stock payouts if and when declared. However, this income not guaranteed.
Liquidation Preference – In case of businesses winding down, preferred shareholders get paid before common holders from asset sales up to the amount invested.
Conversion Rights – Terms often allow investors to convert preferred into common stock later at predefined rates.
Superior Voting Rights – Depends on agreement, but preferred stock can carry veto rights over certain decisions like selling the company even without majority ownership.
So preferred shares reduce the downside risk by adding priority recovery provisions. But upside potential also gets capped by limiting equity value participation. Most sophisticated angel investors and VCs backing startups opt for preferred terms.
Convertible Note Deals
Startups can also structure equity crowdfunding raises using convertible notes rather than direct stock issuance. These are essentially short-term debt instruments carrying the right or option to convert into equity shares later under preagreed terms.
Typical convertible note features include:
Maturity Period – Duration ranging from 6 months to 4 years before note expires or gets converted.
Interest/Returns – Notes may carry small interest rates around 5-8% or not. The conversion share benefit is the main investor appeal.
Conversion Discount – Investors gain the right to become shareholders at reduced rates of up to 20% compared to future outside investors. This positions notes to provide higher equity upside.
Convertible notes allow founders to immediately raise funding without complicated equity valuations or diluting control rights. The conversion feature also incentivizes early financing partners once successful growth materializes. Convertible structures usually suit pre-seed to seed stage fundraising or bridge financing needs rather than large equity raises.
SAFE Agreements
‘Safe’ stands for Simple Agreement for Future Equity. SAFE instruments bear similarity to convertible notes by allowing investors to make a defined capital contribution today in exchange for the right to gain future equity at predetermined conversion rates. But SAFEs contain fewer clauses and zero debt or credit components.
Key SAFE terms cover:
Valuation Cap – Sets ceiling for company value used for conversion share calculations, protecting investor upside.
Discount Rates – Guarantee conversion prices at discounts between 10-30% below price per share paid by next funding round investors.
Other flexible components can include pro-rata rights to invest in future rounds and clauses around liquidity events like acquisitions.
With no maturity date pressures and fewer negotiated terms, SAFE instruments allow expedited fundraising. But they offer limited rights or certainty before actual equity conversion down the line.
Revenue-Share Agreements
A relatively newer investment structure emerging in crowdfunding campaigns involves offering revenue-based financing or shared revenue agreements with investors.
In such deals, backers provide capital in exchange for rights to receive a fixed percentage share of the startup’s gross future revenue until the contributed amount gets repaid, plus any additional return multiple also predefined. Payout timelines usually range 3-5 years.
Typical revenue sharing agreement features encompass:
Revenue Percentage – Usually 0.5-2.0% of total gross monthly revenue.
Payback Cap – Repayment amount capped at 2-3X original investment.
Payback Schedule – 3-5 years to return capital plus gains.
Monthly/Quarterly Payments – Revenue share tranches flowed to investors accordingly.
The main appeal of such capital-as-a-service structures is providing investment exposure without diluting founder ownership or board control compared to traditional equity deals. Investors also avoid risky valuations. But revenue uncertainty still carries risks unless businesses scale successfully.
Conclusion
Equity crowdfunding democratizes access to private funding rounds for retail investors globally. But assessing offerings goes beyond headline fundraising amounts. The type of security issued - common or preferred stock, convertible notes, SAFE instruments and other structured agreements - shapes risk, return, rights and liquidity in each case.
Doing due diligence to analyze deal terms allows investors to anchor expectations and align involvement with personal preferences. For entrepreneurs, innovating beyond one-size-fits-all equity through tailored capital raising instruments also helps attract diversity in funding partners. Understanding these emerging models offers mutual advantages to participants on both sides of private online financing platforms.