Unit 4- Crowfunding
Mention some fraud cases in crowdfunding campaigns
*Kobe red case
Equity Crowdfunding
•A large number of small investors bid shares of firms listed on a web platform, in exchange for a return on their investment. •Equity crowdfunding differs from reward based crowdfunding in terms of: -the nature of its proponents (company vs individuals) -the size of the deals (monetary value of a campaign is higher). • Equity crowdfunding attracts investors who are not necessarily BAs (but do not exclude them) • The provision of extra financial services by equity crowdinvestors, which may: -provide valuable feedback -become " create market awareness and visibility.
When do the capital infusions by professional investors take place?
•Capital infusions from BAs and VCs may take place during or after the closing of the crowdfunding campaign.
What about the risk estimation?
•Crowdfunded firms may also fail soon after the campaign because of the risky nature of the projects or the overconfidence of their proponents •Companies are required to provide a "Financial Snapshot: most companies exhibit optimistic estimates and promise high returns: -difficult to meet such targets unless there is a new injection of capital.
Mention the Key players in a crowdfunding campaign
*Fundraisers *Crowdfunders/Backers *Crowdfunding platforms
Crowdfunding and information asymmetry problems
--->Equity crowdfunding markets are less equipped to overcome information asymmetry problems: *lack of third party certification mechanisms *one time event for entrepreneurs: their reputational incentive to behave correctly is low --->Crowdfunding community systematically underinvests in due diligence: •low quality projects will be pooled with high quality ones. •potential for fraud.
Mention the fundraisers' characteristics (II)
--->Female vs. male •Women are less likely to start projects and be serial fundraisers. But, individual female fundraisers and groups with at least a woman are more likely to succeed. •Female fundraisers attract more female crowdfunders , especially in technological projects: -Activist choice homophily : in sectors where women are under represented, female crowdfunders fund female fundraisers to make them relatively more successful. •Fundraisers' social capital: Both external and internal social capital boost the Success.
Mention the fundraisers' characteristics (I)
--->Single vs. group: Groups of individuals succeed more than individual fundraisers. --->Profit vs. non profit Non profit organizations are usually more successful than for-profit ones: •Projects are of broader interest or could affect a larger share of society •More oriented to quality , rather than merely collecting money • Easier to achieve the target, but with less crowdfunders and lower amount of capital.
What about the Equity crowdfunding in UK? (II)
--->Tax incentives: • The Enterprise Investment Scheme (EIS) provides a tax deduction of 30 percent of the cost of shares purchased in qualifying private companies with a maximum tax benefit of £300,000. •The Seed Enterprise Investment Scheme (SEIS) provides additional incentives by exempting shares up £150,000 in value from capital gains taxes. • EIS and SEIS are subject to a three year minimum holding period, with the relief being clawed back if shares are disposed earlier. -Incentive to postpone exit from crowdfunded firms.
Mention the main equity platforms in UK
-Crowd Cube (largest equity platform in UK) -Syndicate Room -Seedrs -Venture Founders
Mention some of the benefits of Crowdfunding
-Raise additional funds from outside sources after the campaign. -Develop a customer base from those who contributed -Bring press attention to a project. -Change the original view on the demand for a project. -Find business partners or allies.
What kinds of Crowdfunding exist?
1. Equity 2. Peer-to-peer lending 3. Reward-based 4. Patronage/Charity (Donation based)
Mention the determinants of success of a crowdfunding campaign
As empirically demonstrated, the success of a CF campaign may be determined by: •The characteristics of the campaign •The characteristics of the fundraiser/s •The contribution of crowdfunders •The proximity between fundraiser/s and crowdfunders
Mention the benefits and risks for the crowdinvestors
BENEFITS • Opportunity to invest in a wide variety of businesses at an early stage • Risk can be spread across a diversified portfolio • due diligence is crowdsourced • Returns on the equity platforms have the potential to greatly exceed those on the debt platforms and also on the public equity capital markets. RISKS • Investments are high risk. • Levels of due diligence may be unclear and not guaranteed. • Many of the businesses are unlikely to provide an exit for the investors within an acceptable time • The investment is highly illiquid and the investor is unlikely to see any dividends for the short to medium term • There is no formal secondary market for the shares • As minority shareholders, investors will have no influence on the management of the company and very little protection.
Explain the relationship between microfinance and crowdsourcing, and crowdfunding.
Crowdfunding is a combination of: -Microfinance •Provisions of relatively small amounts of money •Helping entrepreneurs to acquire financial resources for their projects -Crowdsourcing •Open call through the Internet •Voluntary participation of a distributed network of individuals •Interaction with a community of potential future users and customers •Opportunity of collecting feedback and suggestions from the crowd of the Internet users.
Mention examples of the different types of crowdfunding
Debt: -B2C: Business obtain (unsecured) loans and the crowd becomes a lender using the platform. Ex: Funding circle -Peer-to-peer: Consumer to consumer lending. Ex: Zopa. Equity: -Facilitates subscriptions for new shares and allows the crowd to become shareholders. Ex: CrowdCubeSeedrs. Donations/Rewards: -Used by businesses/individuals/Charities/Social enterprises to raise cash donated by the crowd often in exchange for a reward of some kind, perhaps a "free" version of the product to be developed using the funds raised. Ex: Kickstarter, Indiegogo, Crowdfunder.
What are the main metrics to measure Crowdfunding success?
Different metrics to measure CF campaigns' success: •Meeting the target amount within the project duration •Total amount of capital raised •Total number of backers •Speed of investments "Asuccessful campaign is a start, not an end". The ultimate goal of crowdfunding is to build an enduring business!
How do crowdfunding platforms operate?
Donation and reward crowdfunding platforms can use two different methods of funding: •All or nothing: the project must reach the total goal amount determined before the deadline, in order to be funded. Otherwise no funding is provided. •Keep it all: the creators receive the amount of money reached (especially used in donation based crowdfunding).
Explain the element: "Duration of the campaign" of a crowdfunding campaign
Duration of the campaign: •Opposite findings basing on the country •Longer campaigns have a: -Negative effect in United States -Positive effect in China
Mention some features of Crowdfunding
Features: •Involve little money: between $10k and $100k (e.g. Kickstarter: avg 15 20K$; but 120 projects have raised >500K$ and 58>1ml$; max •Very small individual contribution ( <100$) •Reward for the provider of finance: in kind (discounts on products, experiences, etc. ) or equity stakes. •Be about something more than finance (somewhere between marketing and finance)
What is Crowdfunding?
First attempt: "An open call , essentially through the Internet , for the provision of financial resources either in form of donation or in exchange for some form of reward and/or voting rights in order to support initiatives for specific purposes. General idea: "get small amount of money from many people in order to realize an idea". "Crowdfunding is the act of collecting monetary contributions together with feedback and suggestions from a crowd of voluntary contributors (either in form of donation or in exchange for some forms of reward ) through an open call on enabling web platforms"
What are the main elements of a crowdfunding campaign
Five main features of CF campaigns may affect their success: -Project content -Target capital -Duration of the campaign -Rewards -Information
What is the Home bias phenomenon?
Home bias is the tendency for investors to invest the majority of their portfolio in domestic equities, ignoring the benefits of diversifying into foreign equities. This bias was originally believed to have arisen as a result of the extra difficulties associated with investing in foreign equities, such as legal restrictions and additional transaction costs. Other investors may simply exhibit home bias due to a preference for investing in what they are already familiar with rather than moving into the unknown. The web allows the broad geographic dispersion of investors (the average distance between creators and funders is about 3 000 miles), reducing the home bias phenomenon.
What about fraud in crowdfunding?
In principle, the transparency and traceability granted by the web based structure of crowdfunding can reduce the risk of fraud. However, fraud in crowdfunding is not rare.
Explain the element: "Information" of a crowdfunding campaign
Information made available by the fundraiser to potential crowdfunders •Positive correlation with the probability of success: -Project updates -Links to external webpages -Provision of a video: Have to be short, smart, and targeted to potential crowdfunders and their motivations -Images in the description -Contributions already received -(Medium high number of) comments posted in the project page. Information cascades----> •In crowdfunding platforms , campaigns are presented in order of popularity • Information cascades occur when: *Uncertainty *Sequentiality
What about Equity crowdfunding in Italy?
Italy is the first country in Europe to have adopted a legislation specifically dedicated to equity crowdfunding The regulation provides that: • The equity crowdfunding is supervised by the The Italian Security and Exchange Commission (CONSOB) • Only the " Innovative Start up and innovative SMEs " can raise venture capital by equity crowdfunding. • The offers can be published through online portals operated by individuals entered in a special register maintained by CONSOB.
What is the origin of the word Crowfunding?
Michael Sullivan gave birth to the term crowdfunding in 2006 on Wired Magazine
Explain the element: "Target capital" of a crowdfunding campaign
Negative impact on projects' success: higher target -Greater number of crowdfunders , but lower amount of capital they pledge -Greater difficulties in getting legitimacy - Lower probability of success
Explain the element: "Rewards" of a crowdfunding campaign
Rewards •Material (e.g., gadgets, gifts, products) or symbolic (i.e., public or private acknowledgement) rewards to the crowdfunders -Favor success -Symbolic rewards are valuable only if no material reward is offered.
Describe the Direct structure in equity crowdfunding
The crowd invest directly into the company which in return issues new shares. COMPANY -Advantages: the (limited) rights of the crowd are not consolidated in hands of a nominee. -Disadvantages: *Potentially hundreds of shareholders are on the cap table and sign the shareholders' agreement *Company deals with most of the paperwork (rather than nominee) INVESTORS -Advantages: *Each investor is a shareholder in the company (with very limited minority (unfair prejudice) protections) *Each investor is a party to the shareholders' agreement (if there is one). -Disadvantages: *Shares may be non-voting and may lack adequate (or any) anti-dilution protection.
How proximity affects crowdfunding campaigns?
The proximity between fundraisers and crowdfunders affects success: • Geographical proximity Strong geographic component in the flow of contributions -Local crowdfunders contribute earlier and are less focused on the cumulative amount already collected. -More distant crowdfunders contribute with smaller amounts of capital. • Social proximity or homophily -The probability of success increases if fundraisers and crowdfunders have the same occupation and/or educational background.
Mention the main pros & cons for backers
There are several advantages... •Access to more investment opportunities •Early access to new products (reward based) •Formalization of contracts through platforms ...but also some disadvantages. •Creators incompetence •Fraud •High early project risk •High probability of delivery delays.
Mention the main pros & cons for fundraisers
There are several advantages... •Monetary benefits: raising money (at lower cost) •Non monetary benefits: -Access to a basis of customers that allows to test and improve early versions of innovative products -Use it as a marketing means to understand customers' willingness to pay and size the potential demand. ...but also some disadvantages. •Disclosure requirement •Lack of value added by funders.
Describe the Nominee structure in equity crowdfunding
• A nominee company collects the funds and issue shares to the investors. • Then it invests in the company seeking finance, which in turn issues shares to the nominee. COMPANY -Advantages: *Single name (the nominee) on the cap table *The nominee should be able to make decisions more quickly than the crowd. * Arguably more attractive to a VC * Nominee takes care of much of investment paperwork. -Disadvatages: * Rights of the crowd consolidated in the hands of the nominee, giving the crowd more bargaining power. INVESTORS -Advantages: *Administrative efficiency. Nominee takes decisions for the investors. *Rights of the crowd consolidated in the hands of the nominee, gving the crowd more bargaining power. -Disadvantages: *Loss of unfair prejudice protection at company level (as the investors are not legal owners of the shares) *Not a party to the shareholders' agreement (at company level) *Nominee will be able to take certain decisions on behalf of the crowd by way of majority decision (but the investor may be in the minority).
What is the role of backers?
• Crowdfunders are a critical element in determining success both during and after the CF campaign • Early crowdfunders work as a predictor that reduces the uncertainty and facilitates the attraction of further contributions • Observational learning • Extensive feedback that fundraisers may use to align the project to audience's needs
What about Dispersed ownership?
• Dispersed ownership is expected to increase agency costs and as a result harm firm performance due to less efficient monitoring. • High ownership dispersion is also associated with higher coordination costs. • The complexity of managing a dispersed set of shareholders may further: -hinder follow on financing from professional investors. -put a significant burden on entrepreneurs' available time to manage the business because much of their time gets consumed by dealing with diverse shareholders, groups and communities. -reduce flexibility and responsiveness key success factors for innovation in turbulent environments, because of the difficulty to achieve interest alignment.
What about Equity crowdfunding in US?
• Equity crowdfunding was opened to the public in the U.S on September 2013, under the JOBS Act. But, it was restricted to 'accredited investors only'. • In 2015 JOBS Act has widen the classes of investor who could use an equity platform (beyond the existing class of 'accredited investor'). • In the months and years following the passage of the JOBS Act, numerous equity crowdfunding platform have arisen: such as Wefunder and Localstake • They complemented existing platforms (AngelList and EquityNet both preceded the JOBS Act).
Mention the Federal Trade Commission (FTC) enforcements in Crowdfunding
• Securities laws in the U.S. have several antifraud provisions that allow investors and the SEC to bring legal actions. • These provisions apply in the context of a purchase or sale of a security. •Reward based crowdfunding does not include offering securities-SEC has no jurisdiction over fraudulent activities in reward based crowdfunding. • However, fraudsters are still subject to prosecutions by Federal Trade Commission (FTC) or state attorneys general.
What are the types of shareholders structures in crowdfunding
• Some platforms use a unified nominee structure: -the platforms themselves remain the representative of their investors: Seedrs and VentureFounders •Some platforms use a direct structure: possibility to place both A class and B class shares directly to small investors. Ex: Crowdcube.
Different operational modes of crowdfunding platforms
• Some platforms use the ' wisdom of crowds' theory.. •Some crowdfunding platforms are branching out into other areas, alongside their core activities.
Corporate governance in equity crowdfunding
• Unique to the equity crowdfunding markets , companies can set an investment threshold under which no voting rights are granted. --->the issuance of A class (carrying voting rights) vs B class shares (not carrying voting rights) depend on each investor's decision.
Explain the Equity-based crowfunding
•Funders invest money in a company and receive shares in that company. • It allows to become part owners and it enables contributors to receive financial return on their investment such as dividends.
Explain the lending-based crowfunding
•Funders provide money by way of a loan with a requirement that the loan is repaid with interest • Rate of interest is usually lower than the rate provided by credit institutions.
Explain the Reward-based crowfunding
•Funders provide money to a company in exchange for some sort of reward. •The reward is usually correlated to the developing project such as an early prototype of the product •Popular Portals Kickstarter and Indiegogo. • Give money, get a reward. • Largely unregulated • Most established
What about the crowdfunding platforms?
•More than 1 250 platforms work worldwide. •Different platforms are correlated to different types of crowdfunding. • Platforms are profit oriented requiring a percentage fee (from 5 to 30 computed on the total amount of the investment provided.
How important are different shareholder structures for equity crowdfunding firm performance?
•Ownership type and structure can have a significant impact on firm performance. •Not all equity crowdfunding is the same and different platforms use fundamentally different shareholder structures •Entrepreneurship studies often "lack of recognition of the different ownership structures and goals which may affect the structure and processes of governance.
What about the market of equity crowdfunding?
•Shares of firms listed on crowdfunding platforms are not easy to trade • The development of a secondary market is prevented by: -the small size of the potential free float -serious concerns about investor protection -The JOBS Act, for instance, prohibits a secondary market during the first year of issuance.
What about the Equity crowdfunding in UK?
•The United Kingdom has the most developed pure equity crowdfunding market, both in terms of number and size of the offerings. •The regulation of equity crowdfunding is the main ingredient of its development •Three types of investors are allowed to trade on crowdfunding platforms: -high net worth individuals ( annual income of at least £100,000 or net assets of at least £250,000 ) -Professional investors (BA, VC..) -Restricted investors.
Explain the Donation-based crowdfunding
•The funders have philanthropic intentions. •The donation based model is tightly linked to the non profit organizations. •Support a person or a cause •Growing very quickly (GoFundMe; Patreon)