Startup Funding: When Crowdfunding Teams Up with Business Angels
Crowdfunding (CF) is enjoying growing success. Since its launch in 2009, the crowdfunding (CF) platform Kickstarter, the leader in the U.S. market, has raised over $2.4 billion, funding a total of nearly 106,000 projects. In France, figures published by the association Financement participatif France attest to this success.
Véronique Bessière, University of Montpellier and Éric Stéphany, University of Montpellier
This article, based on a scientific paper, is published as part of the FNEGE–TheConversation France partnership in connection with the États Généraux du Management, which took place in Toulouse on May 26 and 27, 2016, under the theme “The Impact of Management Science Research.”
Several forms of crowdfunding exist, including those that allow investment in the equity of startups: equity crowdfunding (ECF) or crowdequity. Since the October 2014 decree, companies can raise up to one million euros through ECF provided the platform is CIP-approved (this amount could reach 2.5 million, as announced by Minister Emmanuel Macron in March 2016).
This is indeed a new form of seed capital, which is becoming institutionalized and whose importance is now widely recognized. ECF goes beyond the initial seed phase of projects; it is a financing method used not only by startups but also by companies that have already validated their product in the market and are seeking funds for commercial development or R&D. At the same time, ECF platforms have become more professional. Consequently, the transactions offered are of increasing scale in terms of the amount of funds raised.
Overall, we are seeing a restructuring of seed capital financing options, driven by the entire crowdfunding ecosystem. Thus, startups can gain initial validation of their project by launching a reward-based crowdfunding campaign. The success of the campaign can serve as a significant early indicator of the emerging entrepreneurial venture. In a second phase, these same companies can seek a new form of legitimacy by utilizing ECF platforms.
This integration of crowdfunding into funding rounds can also take the form of co-investment with business angels (BA). These new financing structures are changing startup management and governance procedures, primarily through the contribution of complementary cognitive resources.
Funds raised during the fundraising campaign
Crowdfunding platforms and business angels provide the resources needed to launch a startup. These resources are financial, but above all, they are cognitive. Their contributions differ. Crowdfunding platforms offer visibility and brand recognition; they serve as a test of how the project is perceived by the “crowd.”
The fundraising period is marked by intense exchanges between crowdfunders and the entrepreneur (on the ECF platform, or via tweets or blogs), which constitute a genuine cognitive resource for the project. This differs from the support provided by other sources of seed capital in terms of the nature and scope of the informational feedback that can be conveyed by the crowd. By joining the ECF platform, the entrepreneur submits their market vision and the project’s potential for growth to the crowd for validation.
The potential resources to be acquired are numerous; one of the main ones stems from the expectations of crowdfunders as future consumers or future advocates of the project. Thanks to the crowd’s involvement, the company can partially address one of the major challenges of an entrepreneurial project: time to market.
A business angel, much like a crowdfunder, is an individual who invests a portion of their personal wealth directly into a young company. The business angel frequently makes their skills, experience, and personal network available to the company. A key difference from the crowd is the nature of the interactions. These are private (whereas they are public in ECF) and can therefore address confidential matters. During the startup’s selection and evaluation phase, business angels serve as expert evaluators alongside the platform. They rely on in-depth interviews with the entrepreneur. They thus lend the project a different kind of credibility than that provided by the crowd.
Building long-term relationships with startups
ECF is a form of crowdfunding that involves a long-term relationship with the company, as the crowdfunder becomes a shareholder. Establishing this long-term relationship between the company and its shareholders involves new forms of governance.
BA and ECF also play a largely complementary role here, although we still lack sufficient perspective on these long-term relationships given the recent emergence of crowdfunding. BA firms appear to be leaders in governance design, as shown by several case studies we have conducted. They have experience with this mentoring relationship as well as with exits (the resale of shares), which constitute a decisive milestone in how they “mentor” the startup.
The BA is often closely aligned with the company, not only geographically but, more importantly, culturally and in terms of expertise (such as through its knowledge of the industry). Furthermore, BAs have greater leeway to take action (particularly through preferred shares, whereas the ECF operates with common shares, at least under the current legal framework).
ECF also incorporates this governance function, notably through the representation of crowdfunders on the board of directors. These crowdfunders can be formally organized into a holding company that structures their relationship with the startup. Several platforms, including WiSeed, the French leader in ECF, offer this structure and are responsible for managing the holding company and representing it on the company’s board of directors.
The co-investment between BA and ECF therefore appears to be a very promising development given the solutions it offers to the startups it funds. This financing model provides the company with substantial resources, both because the fundraising rounds can be larger and because the intellectual contributions are complementary. Funding from these two entities sends a very positive double signal regarding the quality of the project.
Véronique Bessière, Professor, Management Sciences, IAE Montpellier, University of Montpellier and Eric Stéphany, Director of the IAE, Associate Professor (HDR), IAE Montpellier, University of Montpellier
The original version This article was published on The Conversation.