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: 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.
Banks and crowdfunding: an impossible marriage?
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 in practice: Ulule
Ulule is a platform of French origin which facilitates the participatory financing of creative, innovative, or community-minded projects thanks to the participation of Internet users.
In other words, Ulule offers any interested person the opportunity to turn a good idea into reality, whether the owner of the idea is a company, an organisation or a private individual. An approach which is undoubtedly attractive and which fits in easily with the existing financing chain: shareholders' equity, debt, grants, sponsorships etc. An interview with Arnaud Burgot, CEO of Ulule.
What is the model used by Ulule?
Arnaud Burgot (AB):
“Technically, we would refer to it as a "Reward-based" model, or participatory financing with rewards. The principle is simple: an entrepreneur posts his project on the Ulule website. He details the budget to be reached in order to realise his project, the term of the fundraising and the exclusive rewards he is offering in return for the support of Internet users. For example: a copy of the product or a dvd with the short film made with the help of the Internet users who agreed to be involved in the financing.
At the end of the collection period, if the target has been reached, the project owner receives the funds, completes the project and sends the agreed rewards to the counterparties. If the initial capital has not been reached the Internet users who have participated in the financing of the project are reimbursed without charge.”
Who is this type of financing aimed at? What advantages does it have?
“It is a method of financing which suits B2C projects, since the potential funders are Internet users. For the investor who is looking for capital, it is first and foremost a very flexible method of financing which creates a direct link with the public. This allows him not only to raise the capital but also to assess the reaction of the public to his project. In some ways it is a real-life test.
From a financial perspective, one of the important advantages is that the financing is non-dilutive: the project owner retains the entire intellectual and capital property of his project.For the Internet user passion and charm are the prime motivators. As financial rewards are prohibited, profit does not enter into the equation. It is rather the pleasure of helping to turn an attractive idea into reality, whether that idea is creative, innovative, unusual or community-minded.”
What are the risks?
“For participants, they are very small. Historically, the number of projects on Ulule which have reached their targets and not granted their promised rewards can be counted on the fingers of one hand. Since a participant never invests a significant amount, the main issue is the loss of trust towards the project owner, who will be overlooked in future.
There will be little point in him hoping to appeal for crowdfunding at a later date if he does not respect his obligations. For the project owner there is the risk of time being wasted if the crowdfunding campaign does not work. That is a relative risk, because we have a success rate of 67%. We always provide support for projects before they are posted online so that their chances of success are maximised.”
Do you operate on a national or international level?
“Both. Ulule operates in 6 languages – French, English, German, Spanish, Italian and Portuguese –, which means that we can offer projects with an international dimension on the same platform, covering the various target countries. The Benelux countries represent one of our priority markets to develop: we opened an office in Belgium in 2015, and The Netherlands will be next.”
Has legislation evolved to allow this type of financing?
“Because the Ulule platform is located in France we are subject to French law. French legislation is evolving rapidly in order to facilitate participatory financing via an equity holding in a company's capital and in the form of a loan. This is good news for crowdfunding in general, even if it does not affect Ulule directly since we do not offer this type of service. But it is definitely a positive sign.”
In what sense is there a partnership with the banking world?
“Ulule is very much a service which complements the type of financing offered by the banks. Participatory financing with rewards can intervene very early in the entrepreneurial process. It facilitates all or part of the launch of the project, tests it relevance and publicises it. Put another way, it gives a leg-up. But, from then on, it is the role of the banks to support the entrepreneurs. Ulule is not a substitute for a relationship with the bank, that is not its role.”
What advice would you give to candidates?
“There's plenty! The most important advice: rely on your direct personal network in order to find the initial financers and, in particular, the first ambassadors for the project. Crowdfunding is a method of financing which has a snowball effect. If one person relays your project to his personal network, this leverages the level of communication about your activity and makes the search for financing much easier.
Ultimately it's all about attracting and sharing. Your dream has to become the dream of others if you are hoping to see them help you make it a reality. You have to put yourself forward and tell your story, both about yourself as the architect of your project and about the project itself. As Ulule is web-based you should capitalise on the advantages of the Internet in terms of images and videos. You should definitely make the most of quality visuals to illustrate your project and attract people to it.”