Crowdfunding: the birth of a new industry in the global financial intermediation landscape – Part 2 –
Summary:
– Crowdfunding is a booming industry that raised more than $5 billion worldwide in 2013, nearly two-thirds of which was in the United States, and is expected to reach $10 billion by the end of 2014.
– In France, this market is growing rapidly, exceeding €150 million raised in 2014, compared to less than €10 million before 2011.
– This young industry is taking shape and carving out a place for itself in the financing landscape, alongside banks and traditional players in personal and business financing.
– France is one of the most advanced countries, both in terms of regulation and the ecosystem that has developed in recent years, and has all the assets to become a key player in crowdfunding worldwide in the future.
Crowdfunding is a young industry that aims to carve out a place for itself in the financing landscape in France and around the world. It is based on principles that are both effective and innovative in order to bridge the famous financing gap.
Crowdfunding is an industry that is taking shape. Today, it comprises four main activities: donations without rewards, donations with rewards, loans to individuals or businesses, and equity investments in companies. Nevertheless, there are characteristics common to crowdfunding as a whole.
Crowdfunding platforms are accessible on the internet. A crowdfunding platform’s website is its showcase, through which it reveals the characteristics of projects currently being funded or already funded. It is on this dedicated space that those seeking financing (companies, associations, entrepreneurs, or individuals) will meet those wishing to invest, save, or donate their financing capacities in ways other than the traditional channels represented by bank accounts, investment vehicles, or public interest organizations.
1 – General principles
1.1 – Crowdfunding stakeholders
The actors seeking funding are the project leaders. They use the platform directly to have their financing plan validated. Generally, platforms support project leaders before submitting their projects to internet users. These new intermediaries present the platform’s philosophy and how it works, identify the project leader’s needs, and assess the project’s viability and seriousness before publishing it on a dedicated interface. The showcase generally contains a description of the project, the profile of the project leader(s), the amount needed to carry out the project, and details of the expenses anticipated if the fundraising is successful. It also specifies, if necessary, the time allowed for fundraising, which is stipulated before the launch.
Once the project has been submitted to the platform, it becomes accessible to the public. Anyone can access the project page, subject to prior registration on certain platforms, and can choose to invest any amount of money they wish. Once the contributor (also known as a backer) has made their contribution, they can interact with the project leaders to make comments or offer their expertise. The backer also has access to all the news and information that the project leaders wish to share with the community thus created.
The platform acts as a financial intermediary. It is remunerated by commissions, which are generally a fraction of the amount raised by the project leader. They may also be partly fixed, i.e., independent of the amount raised.
1.2 – Principles of fundraising
There are two main fundraising principles:
– AON (All or Nothing) fundraising, which is widely used in the crowdfunding world, consists of releasing funds only if the target set by the project leaders is at least reached by the end of the fundraising period.
– KIA (Keep it all) fundraising, which involves releasing the funds raised regardless of the initial target.
AON fundraising has become the norm for artistic, entrepreneurial, and corporate projects, but KIA fundraising is still used in certain cases (solidarity projects, social projects, etc.).
2 – Donations without compensation
2.1 – Scope and specific features
Donation-based crowdfunding platforms are mainly used for charitable projects. There is no financial or in-kind return on investments made through this type of platform. The targets of this type of platform are projects led by associations or citizen initiatives. They rely on raising public awareness of social, ethical, or humanitarian issues in order to collect donations from individuals who wish to contribute financially to their cause. Backers become patrons, supporting projects to which they have a particular attachment. These platforms emerged at the dawn of crowdfunding and have helped develop a new source of funding for non-governmental organizations (NGOs), which can now finance specific projects rather than just their day-to-day expenses.
They also enable individuals to publicize personal projects around which they can build a community in order to find the financial means to bring them to fruition. Project leaders then rely on the generosity and altruism of backers, thus broadening the scope of possibilities for this type of financing, which is generally based on family and friends.
2.2 – Main players in France and around the world
The main players in this segment of crowdfunding are generally generalist platforms or donation platforms that collect funds with and without rewards. There are also, mainly across the Atlantic, peer-to-peer financing platforms dedicated to donations without rewards. In France, this segment concerns platforms for donations to associations.
Donations without rewards currently represent less than 1% of the funds raised in Europe since 2012. Over the same period in France, this industry represents nearly 4% of the amounts raised. According to the latest crowdfunding barometer, the funds raised in France reached €4.7 million, a 2.6-fold increase on the amounts raised by the industry in 2013. The projects supported were social, environmental, or cultural projects. In France, the promoters of this type of project are almost exclusively associations. The success rate for this type of fundraising in France in 2014 was 99%. This high rate is due to the fact that the main platforms[1]for donations without compensation in France mainly use the KIA fundraising system. Some also accept recurring donations to associations, without a prior fundraising target.
3 – Donations with rewards
3.1 – Scope and specific features
Reward-based crowdfunding is the segment of the industry best known to the general public. It consists of calling for donations for projects for which donors receive a reward, which generally does not reflect the actual price paid. These rewards may be the delivery of a good or service, but may also be more symbolic in nature, such as thanks from the project leaders, or recognition as a funder in cultural works (videos, music, films, entertainment videos, etc.). In regulatory terms, this translates into the pre-sale or ordering of goods and services for individuals or businesses. These platforms therefore serve as market tests, where customers can be identified and understood, and where the offer can be adapted to this potential clientele. This type of financing is particularly well suited to artistic and cultural projects.
3.2 – Main players in France and around the world
Donations with rewards are at the heart of the crowdfunding industry’s media coverage. The major crowdfunding platforms that use this method of fundraising are now widely known, and their success stories have had a major impact, both in the specialist media and in the mainstream press. Kickstarter, the world leader in crowdfunding in the form of donations with rewards, has helped finance ambitious projects worth millions of dollars, such as Pebble Time watches and Coolest multifunction coolers. It currently has more than 80,000 funded projects, totaling nearly $1.6 billion. In France, platforms such as MyMajorCompany, Ulule, and KissKissBankBank are currently leaders in this market.
3.3 – France/World weight
In continental Europe, this market accounts for 20% of the amounts raised through crowdfunding. In England, nearly €66 million has been raised since 2012 through crowdfunding with rewards, close to the €61 million raised by French platforms, representing 24% of the national market.
The success rate for fundraising was 57% in 2014. This relatively low rate can be explained by the difficulty platforms have in assessing the viability or accurately predicting the funding potential of certain projects. Indeed, the majority of projects proposed are cultural in nature, the scope of which is difficult to predict and will depend on their presentation, but also on the ability of project leaders to form a community. Thus, the success of a fundraising campaign will depend on the communication skills of the project leader and the community that will be stimulated, particularly through social networks. For example, the French platform Ulule raised more than €680,000 for a project that required €35,000, thanks to the loyalty of a community of nearly 12,000 contributors who supported and propelled the project to record levels.
In 2014, 73% of projects funded in France were cultural projects, but reward-based crowdfunding platforms are also used for commercial or solidarity projects.
4 – Interest-bearing or social loans
4.1 – Scope and specific features
Lending platforms, or debt crowdfunding or P2P [2]lending crowdfunding, are the most structured segment of the crowdfunding industry. They originated from microcredit, which consists of granting small loans to entrepreneurs, artisans, or small businesses that cannot access traditional bank credit. Those seeking financing can then turn to the crowd, who agree to lend them money in exchange for interest and repayment of the principal at maturity. There are two forms of financing granted by lending platforms:
– Unpaid loans, which function as zero-interest micro-loans for which lenders are repaid once the project is completed, but do not receive any financial return on their loan. Like donation platforms, unpaid loans rely on the ability to create a community that is concerned about the issues at stake and that can take pride in having contributed to a project.
– Interest-bearing loans, where the crowd replaces banking intermediaries and is willing to take on a risk that banks would not bear. The interest rate is set via the platforms, which assess the viability and intrinsic risk of the project and present their conclusions on each project to lenders. Lenders are then paid regularly based on the interest rate set in advance and the gradual or final repayment of the principal.
4.2 – Main players in France and worldwide
Anglo-Saxon economies are well ahead of other economies. The best-known P2P lending platform is Lending Club, an American platform founded in 2006 and listed on the NYSE in December 2014. It has raised $7.6 billion since its creation and is the first publicly traded crowdfunding platform. In the United Kingdom, an ecosystem around interest-bearing loans has been created. FundingCircle, Zopa, and other P2P lending platforms are members of an association[3]that promotes the activity and self-regulates the industry by promoting best practices. In France, there are a multitude of crowdfunding lenders. The best known is Babyloan, founded in 2008, which is a solidarity-based lending platform, and Prêt d’Union, the leading peer-to-peer lending platform in France. In 2014, business loans increased significantly, and platforms such as Unilend and Lendopolis are now key players in French crowdfunding.
4.3 – France’s share of the global market
In Europe, the United Kingdom is the undisputed leader in loan-based crowdfunding. With more than €2.6 billion raised between 2012 and 2014, this industry alone accounts for more than 55% of participatory finance in Europe. The United Kingdom has developed this industry in two areas:peer-to-peer business lending, which raised nearly €1 billion in 2014, and peer-to-peerconsumer lending.
In continental Europe, P2P lending accounts for nearly 60% of the amounts raised through participatory finance. In France, crowdfunding in the form of loans is the most developed segment, with nearly €90 million raised in 2014, representing 60% of all crowdfunding in France. These funds are mainly raised in the form of interest-bearing loans. This is because these loans are often used for projects that require more funds than non-interest-bearing loans. Sixty percent of the funds raised go to businesses and 36% to individuals, and are used for projects mainly related to the trade and services sectors. The success rate of crowdfunding platforms is close to 100%. The repayment capacities assessed by the platforms and the interest rates set according to the projects allow the demand and supply of financing for this type of project to be adapted, although fundraising is mainly based on the AON fundraising system.
5 – Equity Crowdfundingor capital investment
5.1 – Scope and specific features
Equity crowdfunding, or direct investment in company capital, is the youngest segment of the industry, but also the one that holds the future of business financing and a potentially viable response tothe equity gap issue. This type of financing consists of a public call for funding as part of a capital increase. Entrepreneurs in need of financing define their capital requirements and set a percentage that they open up for subscription by the crowd. Backers then hold ownership rights in the company they are financing, which leads to the dilution of the company’s existing shareholders, usually the founder(s). In practice, entrepreneurs submit their financing applications to platforms, which assess the viability and quality of the application. They then set the price of the company’s shares before the potential capital increase (pre-money pricing). Funds are always raised in the form of AON and may exceed the amount requested. This is referred to asoverfunding. The valuation of the company is therefore final at the end of the fundraising on theequity crowdfunding platform( post-money pricing). The securities are released at the end of the fundraising, once the share price has been set. Backers then act as partners in the company, with or without decision-making power depending on whether or not the shares carry voting rights.
This type of crowdfunding raises legal questions, and regulations currently vary widely depending on the country in which the platforms are based. In the United States, for example, anyone who is not accredited as an investor, i.e., who does not have a certain level of financial stability that enables them to absorb the capital losses associated with this type of risky investment, is prohibited from participating. In France, regulations are more flexible and allow individuals to invest in equity crowdfunding without any income requirements.
5.2 – Main players in France and worldwide
As in all other segments of crowdfunding, and despite restrictive regulations, the United States is the global leader inequity crowdfunding. The main platforms in the US are Crowdfunders and Seedinvest, currently the market leader in the US.
In the United Kingdom,equity crowdfunding is thefourth largest segment of the industry behind the two forms of P2P lending crowdfunding andinvoice trading (which can be translated as online factoring). The main British platforms today are CrowdCube and Seedrs.
In France, Wiseed is the leadingequity crowdfunding platform. It recently announced its intention to raise a venture capital fund in order to diversify its business and clearly position itself in a new financing segment, between love money and private equity.
5.3 – France/World weight
Equity crowdfunding is still in its infancy. To date, it accounts for 14% of the amounts raised by crowdfunding between 2012 and 2014. In the United Kingdom, these amounts represent 4% of the total industry.Equity-based crowdfunding currently benefits from more favorable or less restrictive legislation in Europe than in other countries, even Anglo-Saxon ones.
In France, €25.4 million was raised in 2014, a 2.5-fold increase on the amounts raised in 2013. This type of fundraising for businesses concerns the trade and services, health and environment, and technology sectors. A new movement seems to be underway in capital financing. This involves real estate investment and the development of an alternative to SCPIs[5]. In 2014, 6% of projects financed byequity crowdfunding were real estate projects.
Conclusion
Crowdfunding is taking shape in France and around the world, but has not yet reached critical mass. The growth dynamics of crowdfunding are characteristic of young industries, and the structure, regulation, and ecosystem that will accompany this growth will play a crucial role in the pace of growth of this new financing method and will influence the long-term viability of the concept.
[2] Peer-to-peer
[3] P2PFA (Peer to Peer Finance Association)
[4]The equity gap, or financing gap, refers to the inaccessibility of financing faced by private companies with informal capital because their demand for capital is too high but too low to benefit from funding from institutional financing players.
[5]Real Estate Investment Trusts
