Crowdfunding is enjoying a sharp increase. Banks are therefore giving the financing method close attention. But do they see this as competition or as a potential partner?
We put this question to Aymeric Olibet, Senior Advisor Business Development at BNP Paribas Fortis.
Does crowdfunding represent a threat or an opportunity?
Aymeric Olibet (AO):
"I see it primarily as a great opportunity for the economy and the banking sector. The financial landscape and the relationship between bank, entrepreneur and individual saver are developing at lightning speed so we need to adapt.
The emergence of the collaborative economy provides us with an excellent opportunity to be close to our clients and bring them closer to us at the same time. New technologies will enable us to identify their exact needs and propose suitable solutions proactively. I am convinced that this will lead to us banking in a completely different way by 2020 with customers in a position to ask for, select and compile made to measure services."
Do you see crowdfunding as a supplementary source of financing?
"Absolutely, because the crowd operates different investment criteria to the model within which we work at present. Traditionally banks mainly finance 'bankable business': investments with an acceptable risk and a reasonable yield. This is logical as financing requires the use of savings which the bank must manage prudently.
This does, however, also mean that a number of initiatives have difficulties getting financed. Projects which provide a social benefit rather than a financial one for example. Or innovative projects where the chances of success are hard to judge and thus involve a high risk and possible loss. Participative financing, where the risk is spread over a large group of moneylenders, is the ideal solution for projects of this nature."
A solution which the economy desperately needs?
"Exactly. Participative financing attaches importance to other criteria like passion, solidarity and a sense of responsibility towards future generations. That makes it easier to join in with innovative projects which may be deemed risky according to the traditional yardstick. The European economy needs this if it is to grow further. A particular feature about crowdfunding is also the fact that these risks do not pass via the balance sheet of a financial institution. There is therefore no systemic risk. The concrete risk for the backer is also limited because he makes a small contribution, knows exactly what his money is used for and is completely behind the investment decision."
How do you envisage the phenomenon developing further?
"Participative financing will continue to grow in popularity thanks to a more flexible regulatory framework and the growing number of investors. The government is also aware of the potential for growth and the interest of the public at large in this form of financing. This means that the threshold for which publication of a prospectus is necessary, for equity and lending based crowdfunding, has increased. In France this has gone up from 100,000 euros to 1 million euros for example. In Belgium as well this ceiling will soon rise from 100,000 to 300,000 euros.
Banks will play an important role in this revolution with their extended networks and financing expertise. The parties involved in crowdfunding are aware of this – just think of Hello crowd!”
Crowdfunding: financing with extras
Are you looking to finance a new project which has some risk attached to it? Present your plans to the crowd and discover how quickly small acorns can become mighty oaks.
Crowdfunding or participative financing involves looking for a (large) number of potential moneylenders. These may be professional investors or co-entrepreneurs or equally your clients or the general public. They will finance your project or company on a quid pro quo basis.
This specific form of crowdsourcing is centuries old. Just think about the construction of the Sagrada Família (Gaudi cathedral) in Barcelona or the plinth for the Statue of Liberty in New York. The way in which it happens is rather different today: via online payment or online platforms, often with lots of publicity on social media. The emergence of social media is undoubtedly one of the reasons for the increasing popularity of crowdfunding, together with the search for alternative sources of financing as a result of the crisis.
Much more than just a source of financing
While crowdfunding focused on cultural or humanitarian initiatives for a long time, its emphasis has recently shifted to commercial projects and even the financing of start-ups and small and medium sized companies. The advantages are clear:
- companies can meet the cost of – mainly innovative – projects which are less suitable for (complete) financing via a bank loan, business angels or a private equity partner. This may be because they have considerable risk attached or demonstrate too little concrete potential for growth, the required amount is too low or the company does not want to have an external party join in with the company capital.
- Financing is just one part of the story; creating sufficient 'buzz' and a community around your project will make you much more visible. Simultaneously, you carry out market research. Is there a call for your product or service? Is the design suitable? And are you bringing it onto the market in the right way? Thanks to this interaction you can also make adjustments to the product during the design phase, thereby reducing the risk of an unsuccessful launch.
- By taking the input of the crowd into consideration you will create a much closer bond with your target market, with clients developing into co-designers, fans and ambassadors.
The many forms of crowdfunding
There are several types of crowdfunding and each has its own way of working, providers and regulations.
Generally speaking we can see four different major types which each attract a different type of funder.
Reward based: crowdfunding with reward system
This formula is the quickest growing crowdfunding segment and it is specifically focused on creative projects by private individuals or small companies. It often involves a form of advanced sale whereby a producer or designer tries to gather the necessary funds to bring a new product onto the market. In exchange for their contribution, funders are entitled to rewards which mainly increase as more capital is collected. These rewards may be additional or exclusive options or perhaps signed copies, a more attractive price or even delivery of the product months before it becomes available to non-participants. Tangible or not, all these rewards have one common feature: they add value for the funder. The big players in this market are American platforms such as Kickstarter and IndieGogo or Hello crowd!Ulule.
Debt/Lending based: crowdfunding via loans
This type of crowdfunding is primarily intended for start-ups or companies which want to set up a new project. They borrow the necessary funds for this from a number of funders. The precise repayment modalities for the loan areset in conjunction with the financiers. This may occur with monthly sums for example, on one occasion at the end of the term – with annual payment of interest – or via a formula whereby both the capital and the interest are repaid at the end of the term.
Examples of providers include Lending Club (USA), Babyloan (FR) or Belgian platforms such as CroFun and Look&Fin. In Flanders this form of financing can also occur in the form of a Winwinlening (win-win loan) which provides the funder with additional tax benefits.
Equity based: crowdfunding through share participation
Large projects or companies which wish to collect a substantial amount are best advised to make use of this formula. In concrete terms the funders or investors form a cooperative which receives a share in the company concerned. In this way they invest directly in the equity capital of the company and have the prospect of a financial return if the project turns out to be successful.
An additional form is crowdfunding via profit sharing where funders invest a previously stated amount in a new company project. In return they receive a payment which is calculated on the basis of the growth in turnover or profit which the project achieves.
In our country MyMicroInvest and Angel.me provide crowdfunding services of this nature.
Donation based: crowdfunding via gift
With this type of crowdfunding, which is actually a form of philanthropy or patronage, funders do not expect any reward or yield for their contribution. The return is purely an emotional one. The beneficiaries are generally 'good causes' in the broadest sense, ranging from gymnastics clubs looking for sponsorship for new apparatus to initiatives for socially vulnerable groups. The Belgian organisation SoCrowd is an example of a donation based platform.
Intermediate forms An innovative form of financing like crowdfunding can of course not be shackled. This is why more and more hybrid types are cropping up. A company can set up a system, for instance, where they contribute 1 euro for each euro which is contributed by private funders. Another intermediate form is an interest free loan to a non-profit making organisation, a sort of combination of donation and loan.
Crowdfunding is also very frequently combined with other forms of financing such as bank loans or contributions by business angels or venture capitalists.
Challenges and risks associated with crowdfunding
Although crowdfunding provides almost inexhaustible possibilities, it also involves a number of challenges and risks. An overview.
1. For the company
You open the company up to the public. This is of huge benefit in terms of marketing and strategy but it also means that everyone has access to the complete financial situation. You must therefore be prepared to be completely open and sometimes share sensitive information.
This new business model turns all traditional models on their heads. The greatest challenge is learning to deal with this and finding a good balance in the area of
- control: how do you divide authority between the company and the crowd? There is no golden rule but research conducted by the University of Toronto suggests that the ideal system has 80% of the project firmly in place with the crowd having a say in the remaining 20% (e.g. choice of colours, technologies, points of sale etc.);
- transparency: to what extent do you wish to share your knowledge, technology and research and development results with others – including potential competitors? How will you protect your copyright and intellectual property in such a case?
A significant risk is of course the fact that you may not achieve the desired funding and the campaign fizzles out. However, this is an advantage in a sense. The campaign helps you assess whether there is a demand for your intended product or service on the market. If this does not appear to be the case, you will at least find out in time and be able to avoid the much higher loss of a failed product launch, both financially and in terms of reputation. You can use the feedback received to instigate changes and make a new attempt later on.
If you add up all the fees and the marketing, time and energy involved in a crowdfunding campaign, the cost of this form of financing can be extremely high. With reward-based funding there are definitely a few flies in the ointment. You must declare the funds collected as taxable income. In addition, a pledge is regarded as a sales transaction which is therefore subject to VAT for companies. Take these factors into account when setting your prices. Otherwise the tax office may bring you an unpleasant surprise...
2. For the investor
For a moneylender the challenge primarily involves finding good projects. There is no shortage of attractive initiatives. Quite the opposite in fact. With reward-based campaigns it can sometimes even be difficult to resist the temptation. But what will your investment yield?
Putting money into a project always remains a bit of a gamble, even if you have analysed it thoroughly and you believe in it. Success is never certain and unforeseen problems may occur at any time. With lending or equity-based formulas your complete investment could then be lost.
The chance of this happening is smaller for the reward-based model, as is the amount invested. There is always the possibility, however, that the initiator will not meet his commitments, will only partially meet them or severely delay meeting them. In very rare cases fraud may be involved with the collectors (and your contribution) disappearing into thin air.
A clear picture
Do you want an objective opinion before joining a Belgian crowdfunding project?
If the project has a prospectus obligation, you can look at it with the FSMA approved prospectus. Among other things this contains further information about the initiator and the legal form of your investment (share, loan etc.). An approval or licence from the FSMA or the National Bank of Belgium does not however mean that these bodies automatically deem the project suitable for investment – it is up to you to weigh up the risks.
You can also use the FSMA website to check whether the internet platform and/or the initiator are under special supervision by the FSMA or the National Bank of Belgium.
Crowdfunding in practice: MyMicroInvest
MyMicroInvest, created in 2012, is a crowdfunding platform that provides financing to companies by raising funds from both professional investors and the crowd.
Guillaume Desclée, platform manager at MyMicroInvest, explains the rationale behind this unique combination.
Why was MyMicroInvest created?
Guillaume Desclée (GD):
“We detected a double need: on the one hand, the Belgian productive economy needs financing, while on the other hand investors are on the lookout for attractive yields. MyMicroInvest was launched to channel the available savings of Belgians to value-creating companies.
Our basic assumption was simple: over 70% of added value and job creation in Europe comes from small and medium-sized companies. Nevertheless, these companies find it difficult to raise capital to finance their growth. This is the issue we are tackling, by offering individuals the option to invest in the form of acquisition of equity capital or lending to expanding companies.”
How does MyMicroInvest work?
“MyMicroInvest is a crowdfunding platform enabling the public to finance innovative companies in the form of lending or equity capital investment. We combine two methods of financing: crowdfunding – i.e. involving the general public – and professional investment via investment funds and/or business angels partners. Put concretely, the general public is involved in the process of selection, analysis, investment and support of the professionals. They work together to increase the chances of success of their investments.”
How does this happen in practice?
“We apply a three-step process. During the first stage, applications for financing are preselected by the general public. In this way, the market validates the potential of the concepts proposed by the companies applying for financing. Analysis is then conducted by an experienced investor, who will concentrate on financial validation of the applicant. If all lights are green, the company can launch the procedure of raising funds on our platform.
During the selection phase, each company wanting to raise funds provides us with a set of legal and accounts documents. Once this due diligence process is complete, the company fills out a form providing our teams with all information necessary for drafting the investment memorandum or the issue prospectus accompanying this transaction.
Next, we come to the actual investment phase. As I mentioned before, companies working with MyMicroInvest are financed by external investors and by the crowd. This external financing can come in before or after the crowdfunding transaction but the condition is that this is done based on the same financial conditions as the crowd
The third phase, when a multitude of investors turns into a network of ambassadors, is where the magic of crowdfunding comes in! Everyone becomes a stakeholder in the success of the company and mobilises to support it and help it grow. Exchanges between the company and its community of investors are organised online on our platform, in a secure space reserved specifically for them. Periodically, the company sends news to its investors. The community's contribution comes through strategic advice, sharing the network and highlighting the product or service sold by the company.”
Do you focus on a certain type of company
“The objective of MyMicroInvest is to respond to the financing requirements of all companies wishing to enjoy the benefits of crowdfunding, regardless of their size, whether in the form of lending, known as crowd-lending, for the more mature companies, or in the form of acquisition of equity, crowd-equity, for younger companies or in the case of a major increase in capital operation. Since our visibility is still relatively limited, our capacity for raising funds per project is limited to a few hundred thousand euros per company. This limits the size of the companies that can be financed.
Apart from the traditional exclusion criteria, we do not have any specific criteria in terms of sectors. We do follow the logic of co-investment between the crowd and the professional investors, which is our trademark.That is why out of the 17 companies that have used MyMicroInvest to raise funds, we finds university spin-offs and companies active in health, IT food processing, media, nuclear medicine, etc.”
Does your model present less risk than a "traditional" venture capital investment?
“We model our procedure of selection, analysis, investment and support on the procedure for traditional risk capital funds, except we add in involvement by the general public, because we believe it will make it possible to improve the chances of success of the companies being financed.
Another factor to be considered is that the risk and potential return on investments made on MyMicroInvest are linked to the company chosen by the internet user, unlike investment funds where the risk is spread over a portfolio. It is therefore up to the investor to diversify their investments on MyMicroInvest, according to the size of the companies, the sectors of activity and the type of investment – lending or equity capital.”
How long do investors have to keep their shares in the company?
“The liquidity and the return on the investment depend on the type of investment made. If the crowd invests in the form of lending to more mature companies, this will yield a fixed and recurrent return. If they opt to acquire equity capital, however, the return will be uncertain, as it depends on the future resale of the equity.
As a general rule, resale is carried out within a period of 3 to 6 years, depending on the size of the company. Nevertheless, an investor has the right to sell his share to a third party before this maturity if he wishes – even if MyMicroInvest has not organised a secondary market on that date.
From a legal point of view, MyMicroInvest Finance S.A., the separate structure bringing all the crowd investors together, requires inclusion of a tag/drag-along clause – if this is not yet the case – in the company's shareholders' agreement. As a result, the resale of the equity held by MyMicroInvest on behalf of the general public can be completed at the same time and under the same conditions as the resale of an external investor's equity.”