Introduction: what is Crowdfunding?
What do the Pebble watch, the Veronica Mars movie, and the Oculus Rift have in common? Besides being the setup for a bad joke, these products where all the result of a new public financing tool called crowdfunding. Crowdfunding is a public financing tool with which individuals or companies (typically start-ups) can raise money from individuals. The general idea behind crowdfunding is to leverage one’s social network: instead of raising money from a small group (such as professional investors) who will each contribute large sums, smaller sums of money will be raised from a (hopefully) large number of individuals (friends, family, acquaintances, supporters etc…). What makes crowdfunding unique is that its campaigns are ‘all-or-nothing’ affairs. At the start of a crowdfunding campaign the entrepreneur or start-up sets a funding goal. For the duration of the crowdfunding campaign (typically 60 to 70 days) individuals can pledge money with the amount subject to an upper limit defined by the country’s legislative framework. The total amount of money pledged during a campaign is granted to the entrepreneur only if the goal is reached within the pre-arranged time limit.
Launching and managing a crowdfunding campaign is typically done via a publisher who uses a digital platform to keep track of the campaign and the different backers. Note that most (though not all) publishers will perform a due diligence and evaluate the project on its technological and business viability before publishing it on its platform. Whether or not a publisher performs a due diligence differs from publisher to publisher. However the general rule of thumb is that it depends on whether the publisher focusses on non-financial or financial crowdfunding. In essence there are currently four ways, two non-financial and two financial, with which an individual can pledge money to a project via crowdfunding as illustrated by Figure 1.
Figure 1: There are currently two non-financial types of crowdfunding (donation-based, reward-based) and two financial types (lending-based, equity-based). Source: Douw & Koren
1. Donation-based: individuals pledge money without receiving any compensation if the campaign goal is reached.
2. Rewards-based: individuals pledge money and receive non-monetary compensations (e.g. film tickets, early prototypes). In most cases the rewards-based campaign features a tiered compensation structure whereby the reward (or its value) is proportional to the pledged amount.
1. Lending-based: individuals pledge money and if the campaign goal is reached the entrepreneur/startup is required to refund, in monthly installments, the backers over a pre-determined period with interest (commercial lending, bonds) or without (social lending).
2. Equity-based: individuals pledge money and receive a proportional amount of B-shares if the campaign goal is reached. If the crowdfunding campaign is successful, the pledgers are typically assembled in a holding company (in Belgium a CVBA ) without explicit voting rights (i.e. vote of the pledgers’ holding company automatically follows the votes from investors with A-shares). As an example, Figure 2 shows the juridical shareholders structure used in Belgium by Bolero Crowdfunding.
Figure 2: Schematic representation of the juridical shareholder structure used by the Bolero crowdfunding platform in equity-based crowdfunding
For entrepreneurs obtaining financing in the early stages of their undertaking (especially in the Valley of Death before they are revenue positive) is crucial for their survival. The typical financing sequence includes:
1. Pitching competitions/challenges (e.g. Techcrunch Disrupt) and the 3Fs
2. Government grants and subsidies
3. (business) angel investors, accelerators
4. Venture capitalist
5. Bank loan, private equity
6. (later stage) Mergers & acquisitions (or acqui-hires), trade sales, IPO.
At the moment crowdfunding doesn’t have a fixed place in the financing sequence yet (see Figure 3). There are success stories where crowdfunding followed only after commitments from venture capitalists (e.g. Peerby in the Netherlands, Neoscores and Progresso in Belgium) as well as success stories where an early successful crowdfunding campaign was used as leverage for obtaining funding from business angels, a bank loan, and government subsidies.
Whether the crowdfunding campaign precedes or follows the established financing methods, its advantages are clear:
• It’s relatively low cost. Typically the costs consist of:
o Registration fee for publication on a crowdfunding platform, usually in the range €0-500
o Success fee charged by the crowdfunding platform: 3-12% of achieved sum
o Some platforms charge administration/transaction costs of the payments (e.g. bank card, PayPal): typically a 3% success fee and/or 20-25 eurocents per transaction.
• It creates brand awareness, ambassadors, and free publicity: achieving success in a crowdfunding campaign hinges on one’s ability to establish and activate a social network and to convert significant parts of that network to customers within a set time limit. This is only possible with adequate outreach and marketing activities. Whereas before the advent and ubiquitousness of the internet this would have required massive resources only accessible to large companies, today’s multitude of digital social network platforms gives similar capabilities to tech and marketing savvy individuals.
• If done well, it samples in a relevant way the market of interest: during the lead up to the actual crowdfunding campaign, efforts are focused on identifying the relevant demographics and establishing and activating within those demographics a large social network of potential pledges. The conversion rate during the campaign (whether it’s successful or not in the end) will be an indicative sample of the way the market might respond to a general launch.
• It can be leveraged for more investing: A successful campaign is an indicator of both how well the entrepreneur can reach out and convert a social network as well as an indicator of the interest (and the potential) of the targeted market.
• It’s fast: crowdfunding campaigns which are well designed, planned and executed can amass amounts similar to those made available by venture capitalists in only in 60 to 70 days.
Figure 3: In currently known success stories, crowdfunding was used in the very early stages of the start-up life cycle [source Bolero].
Crowdfunding: caveat emptor?
In crowdfunding, the individuals pledging/investing money will rarely be financial professionals as opposed to VCs and business angels. This poses, especially for financial crowdfunding, an interesting dichotomy. On the one hand, the crowdfunding phenomenon is part of society’s evolution towards digital democratization and crowdsourcing. Thus, the knowledge/expertise threshold to pledge money should be fairly low in order for crowdfunding to be accessible to the average (lay)person. This, then, poses a problem. How can an individual, who has limited financial knowledge, be expected to make a well thought out, rational investment (let alone setup a diversified portfolio) with his or her money in an early and immature enterprise when this is deemed to be challenging even for professional investors?
At the moment, this thorny issue is only partially addressed. In several countries in the EU, publication of a prospectus by the entrepreneur is mandatory if the goal of the crowdfunding campaign surpasses a certain threshold. This threshold, however, varies wildly from country to country even within the EU. For example, in Belgium the threshold is 300.000 EUR which is significantly lower than in France (1.000.000 EUR), the Netherlands (2.500.000 EUR), and the UK (2.500.000 EUR). Even so, it remains to be seen how much a company’s prospectus or even its business plan are taken into account by individuals when deciding whether or not to pledge money in a campaign. In addition, the total amount of money an individual can pledge also varies wildly. Unsurprisingly, Belgium is again the conservative member of the pack with a current upper limit of 1.000 EUR per campaign (though new legislation should soon change this to 5.000 EUR). This is in stark contrast with the Netherlands (maximum 40.000 EUR per investment in a lending campaign or 80.000 EUR if it’s in an equity campaign), and especially France and the UK which have no upper limit at all.
At the moment there is no official data on the profile of the average crowdfunder in Belgium though a small sample survey by iMinds shows the average financial crowdfunder to be male, between 25 and 35 years old, and highly educated (at least 80% has a BSc or higher). It would be interesting to see if data from the crowdfunding platforms’ website (e.g. what does he/she look at and for how long? How long between first visit and pledge? Etc…) can be correlated with the different crowdfunding profiles.
According to research by Massolution  the worldwide market, in 2015, for crowdfunding encompassed 135 billion USD with the total addressable market to be estimated around 3.300 billion USD. The World Bank expects that if the crowdfunding market holds its current growth rate it might overtake the VC market in 2016 . Figure 4 shows how this market was divided over the major relevant regions (US, China, Europe).
Figure 4: Overview of the worldwide crowdfunding market in 2015 (source: Cambridge University, Douw & Koren).
In volume alone, China is unarguably the front runner with over 70,2% of the crowdfunding market with the US a distant second. Even if the crowdfunding market share is normalized with respect to the GDP of each region, China (0,86%) still comfortably leads the pack over the US (0,2%) and Europe (0,04%). Within Europe, the only countries to come even close to China and the US are Sweden (0,289%) and the UK (0,14%).
At the moment there are no in depth studies explaining as to why there is such a distinct discrepancy between China and the rest of the world (a problem compounded by China’s infamous opaqueness regarding its investment market) though the current hypothesis is that the risk averse Chinese banks are reluctant to invest in young startups thereby creating an institutional gap in the funding cycle which is currently being filled by crowdfunding .
Stefaan HEYVAERT, PhD, R&D Consultant, Leyton Belgium
 Coöperatieve Vennootschap met Beperkte Aansprakelijkheid
 Ellen Lemaire, Omar Mohout, and Bart Vanhaere Crowdfunding in België (Brugge: die Keure, 2016), p.59