Karen E. Wilson

Improving the Role of Equity Crowdfunding in Europe's Capital Markets

SummaryCrowdfunding is a growing phenomenon that encompasses several different models of financing for business or other ventures. Despite the hype, equity crowdfunding is still the smallest part of the crowdfunding market. Because of its legal framework, Europe has been at the forefront of equity crowdfunding market development.Equity crowdfunding is more complex than other forms of crowdfunding and requires proper checks and balances if it is to provide a viable channel for financial intermediation in the seed and early-stage market in Europe. It is important to explore this new channel of funding for young and innovative firms given the critical role these start-ups can play job creation and economic growth in Europe.We assess the potential role of equity crowdfunding in the overall seed and early-stage financing market and highlight the potential risks of equity crowdfunding. We describe the current state of play in this nascent industry, considering both the innovations introduced by market operators and existing regulation. Currently in Europe there is a patchwork of national legal frameworks related to equity crowdfunding and this should be addressed in a harmonised way.IntroductionCrowdfunding is increasingly attracting attention, most recently for its potential to provide equity funding to start-ups. Providing funding to young and innovative firms is particularly relevant given their importance for job creation and economic growth (OECD, 2013; Haltiwangner et al, 2011; Stangler and Litan, 2009). In addition, at a time when banking intermediation is under pressure (Sapir and Wolff, 2013), it is important for European Union policymakers to further explore alternative forms of financial intermediation. But questions remain about the appropriateness of crowdfunding for providing seed and early stage equity finance to new ventures and how this market could be developed and regulated.While there is growing hype around crowdfunding, there are also many wrong perceptions. The bulk of crowdfunding is for philanthropic projects (in the form of donations), consumer products often for creative ventures such as music and film (in the form of pre-funding orders) and lending. Equity crowdfunding, sometimes called crowdinvesting is relatively new and currently comprises the smallest part of the crowdfunding market. However, it is currently more active in Europe than in other regions.Growth of crowdfundingCrowdfunding can be defined as the collection of funds, usually through a web platform, from a large pool of backers to fund an initiative. Two fundamental elements underpin this model and both have been enabled by the development of the internet. First, by substantially reducing transaction costs, the internet makes it possible to collect small sums from a large pool of funders - the crowd. The aggregation of many small contributions can result in considerable amounts of capital. Second, the internet makes it possible to directly connect funders with those seeking funding, without an active intermediary. Crowdfunding platforms assume the role of facilitators of the match.While people tend to talk about crowdfunding in general, the crowdfunding phenomenon encompasses quite heterogeneous financing models. There are four main types -Donation-based, in which funders donate to causes that they want to support with no expected compensation (ie philanthropic or sponsorship-based incentive).Reward-based, in which funders’ objective for funding is to gain a non-financial reward such as a token gift or a product, such as a first edition release.Lending-based (crowd lending), in which funders receive fixed periodic income and expect repayment of the original principal investment.Equity-based (usually defined as crowdinvesting), in which funders receive compensation in the form of fundraiser’s equity-based revenue or profit-share arrangements. In other words, the entrepreneur decides how much money he or she would like to raise in exchange for a percentage of equity and each crowdfunder receives a pro-rata share (usually ordinary shares) of the company depending on the fraction of the target amount they decide to commit. For example, if a start-up is trying to raise €50,000 in exchange for 20 percent of its equity and each crowdfunder provides €500 (1 percent of €50,000), the crowdfunder will receive 0.20 percent (1 percent of 20 percent) of the company’s equity.The four models vary in terms of complexity and level of uncertainty. The donation-based model is the simplest. Legally the transaction takes the form of a donation. The risk is that the project does not achieve its declared goals, but the backer does not expect any material or financial return from the transaction. Equity crowdfunding is the most complex. From a legal standpoint, the funder buys a stake in the company, the value of which must be estimated. Moreover, the level of uncertainty in equity crowdfunding is much greater compared to the other models because it concerns the entrepreneur’s ability to generate equity value in the company, which is extremely difficult to assess.

Policy Lessons from Financing Innovative Firms

There has been increasing global concern from policy makers over the lack of access to finance for young innovative firms. As a result, governments in many OECD countries have sought to address the financing gap and perceived market failures by supporting the seed and early stage market. This paper seeks to summarise the lessons learned in seed and early stage finance based on OECD work focused on policies related to financing high growth firms, including angel investment and venture capital. Growth in seed and early stage finance policies highlights the role that financial development and other policies play in firm dynamics and job creation.

Policies for Seed and Early Stage Finance

This report highlights the growth in support for financial instruments for seed and early stage firms across OECD member countries. These instruments include grants, loans and guarantee schemes, tax incentives and equity funds. This increased support is linked to the recent financial crisis and the growing concern about young firms’ access to finance. The paper notes that framework conditions play an important role in access to finance and must be taken into consideration as a significant part of the policy mix. Demand-side policies to develop entrepreneurial and investment talent and networks are also critical. The role of evaluation and the need to better link policy objectives and outcomes are also discussed.

From Start-Up to Scale-Up: Examining Public Policies for the Financing of High-Growth Ventures

This paper examines the challenge of entrepreneurial companies to go beyond the start-up phase and grow into large successful companies. We examine the long-term financing of these so-called scale-up companies, focusing on the US, Europe and Canada. The paper first provides a conceptual framework for understanding the challenges of financing scale-ups. It then shows some data about the various aspects of financing scale-ups in the US, Europe and Canada. Finally the paper raises the question of long-term public policies for supporting the creation of a better scale-up environment.