Crowdfunding, the latest revolution in finance?
- By tmourgues
- On 30/01/2013
- Comments (0)
The word "Crowdfunding" is believed to have been created in 2006. In 2013, 3 bn USD in debt could be raised by crowdfunding, a figure that could double in 2014. Such astonishing figures, even in the world of finance where innovations are an everyday phenomenon, are clearly the trademark of a revolution that could drastically change the way corporates get finance. Is this revolution here to stay?
Basically crowdfunding consists in using internet based crowdfunding platforms to collect a number of most commonly small donations to fund projects. While in a way crowdfunding has always existed under the form of approaching family and friends, the development of internet has turned it into an incomparably more powerful instrument. Any compelling funding proposal may find at no cost a global audience to support a good project. The original concept consisted in charity donations; in a second stage, the creative industry successfully used the concept: movie, music, and other artistic projects could be financed without the recourse to well-established producing companies. The public was happy just to facilitate innovative products, or possibly to get some reward as concert ticket. Since a couple of years, crowdfunding is commonly met among all sorts of ventures, mostly tech projects but not only and can work as securities. Alternative schemes may also be designed to forego the legal restrictions that prevent the public offer of securities. For example, some firms sell micro-intellectual property rights valid for any sale which takes place in a small geographical area… To sum up, crowdfunding may be used on the model of a charity, of the proposal of a reward, but also of debt and equity, in short fulfill all the financial needs of a start-up.
The fascination for crowdfunding has been fuelled by success stories such as Pebble, a company that provides e-Paper watch for i-Phone and Android: they intended to raise 100 000 USD and eventually collected over 10 million USD. Although this story is clearly more the exception than the rule, a platform such as Kickstarter raised 145 million in 2012, and may have over 700 competitors worldwide.
In view of the boom, public authorities have understood that crowdfunding represents a reservoir that should be exploited, and that unjustified legal restrictions should fall. For example in the US, potential investors to invest in small businesses were required an annual income of over 200 000 USD or a total wealth in excess of 1 million USD. In addition the number of shareholders of a small business was limited and small businesses could not advertise for investors. The JOBS act signed in April 2012 allows small businesses to sell their equity on a crowdfunding platform and investors can invest 10 000 USD or 10% of their income (which is lower) to fund projects. However the legislation requires the SEC to pass the corresponding regulations, which has not been done so far. The EU commission is also planning to enact a Directive by the end of 2013 which will have to be transposed in the respective national laws by the member States within 3 years.
For companies that require small seed capital, typically inferior to 100 000 USD, crowdfunding looks like an attractive option. It may well end up out-crowding venture capitalists. One limitation is that it may create risk of theft of intellectual property, of the ideas being copied, a risk maybe exaggerated by many entrepreneurs developing a certain paranoia with commercial secrecy. In practice, this fear is not likely to be well grounded in many instances. Crowdfunding allows to obtain results extremely quickly, which shorten the implementation delays of a project. This is sufficient to grant a decisive competitive advantage to the company that benefits from being first on the market. Another limitation is that when the company has grown and wishes to raise venture capital or private equity, the presence of a great number of small shareholders may be an obstacle to the attraction of an institutional investor.
On the other hand, the advantages of this new approach to start-up finance are clear. For the entrepreneurs, it is a low cost solution which exposes them to the reality of the market. Investors are very often potential clients which will have a long term relation to the company. In addition this tool demonstrates total flexibility and unrivalled rapidity, which are ideal attributes when you try to launch a new business on fast moving markets – as all modern markets.
We also believe crowdfunding to open new opportunities in developing markets where access to finance is often a bottle neck. Thanks to the power of internet, good projects get immediate access to billion potential investors and bypass the limitation of the local financial intermediaries. Discrimination between the rich and the poor who do not have family and friends to help them, gaps between the well-connected and the lonely genius, all these factors which may limit the development of successful projects may increasingly become something of the past.
Still in its infancy, crowdfunding has to develop all its potential. This will require more legal reforms, consolidation of the platforms, and increased capacity building for entrepreneurs to learn how to use this new tool efficiently. But the way is open and free.