Start-up financing: when crowdfunding invests alongside business angels
Crowdfunding (CF) is enjoying growing success. Since its inception in 2009, the crowdfunding (CF) platform Kickstarter, the US market leader, has raised more than $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 around the États Généraux du Management conference held in Toulouse on May 26 and 27, 2016, on the theme of "The impact of management science research."
There are several forms of CF, including those that allow investment in the equity of start-ups: equity crowdfunding (ECF) or crowdequity. Since the decree of October 2014, companies can raise up to €1 million in ECF as long as 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 start-up phase of projects; it is a means of financing used both by start-ups and by companies that have already validated their product on the market and are seeking funds for commercial development or R&D. At the same time, ECF platforms have become more professional. As a result, the transactions offered are increasing in scale in terms of the amount of funds raised.
Overall, we are seeing a new structure in the provision of seed capital financing, driven by the entire crowdfunding chain. Start-ups can obtain initial validation of their project by setting up a reward-based crowdfunding operation. The success of the operation can be an important first signal about the emerging entrepreneurial project. In a second stage, these same companies can seek a new form of legitimacy through the use of ECF platforms.
This integration of CF into financing rounds can also take the form of co-investment with business angels (BA). These new financing structures are changing the management and governance procedures of start-ups, mainly through the contribution of additional cognitive resources.
The resources provided during the fundraising campaign
ECF and BA provide the resources needed to implement an entrepreneurial project. These resources are financial, but above all cognitive. Their contributions are different. ECF provides visibility and notoriety, acting as a test of how the project is perceived by the "crowd."
The fundraising period is marked by intense exchanges between crowdfunders and the business creator (on the ECF platform, or via tweets or blogs), which constitute a real cognitive resource for the project. It differs from that provided by other sources of seed capital in the nature and extent of the informational feedback that can be conveyed by the crowd. By joining the ECF platform, the entrepreneur submits their vision of the market and the project's capacity for development to the crowd for validation.
There are many potential resources to be acquired, one of the main ones resulting from the expectations of crowdfunders as future consumers or future influencers of the project. Thanks to the involvement of the crowd, the company can partially solve one of the major difficulties of an entrepreneurial project: time to market.
Like crowdfunders, business angels are individuals who invest part of their personal wealth directly in a young company. BAs often make their skills, experience, and personal networks available to the company. An important difference from the crowd is the nature of the exchanges. These are private (whereas they are public in ECFs) and can therefore deal with confidential matters. During the start-up selection and evaluation phase, BAs act as expert evaluators alongside the platform. They rely on in-depth interviews with the entrepreneur. They therefore bring a different kind of credibility to the project than the crowd does.
Organizing long-term relationships with the startup
ECF is a form of crowdfunding that involves a long-term relationship with the company, as the crowdfunder becomes a shareholder. Organizing this long-term relationship between the company and its shareholders involves new forms of governance.
BAs and ECFs also play a complementary role here, although we still lack perspective on these long-term relationships given the recent development of crowdfunding. BAs appear to be leaders in governance design, as shown by several case studies we have conducted. They have experience in mentoring relationships and also in exits (the resale of shares), which are a decisive milestone in how to "mentor" a start-up.
BAs are often close to the company, geographically speaking, but above all culturally and cognitively (through their knowledge of the sector, for example). In addition, BAs have greater means of intervention (preference shares in particular, whereas ECFs intervene with ordinary shares, at least within the current legislative framework).
The ECF also incorporates this governance function, notably through crowdfunders' representation on the board of directors. Crowdfunders can be formally brought together in a holding company that structures their relationship with the start-up. Several platforms, notably WiSeed, the French leader in ECF, offer this structure and are responsible for running the holding company and representing it on the company's board of directors.
Co-investment between BA and ECF therefore appears to be a very promising development due to the solutions it provides to the start-ups it finances. This financing model brings considerable resources to the company, both because the funds raised can be larger and because the cognitive contributions are complementary. Financing by these two players sends a very positive double signal about the quality of the project.
Véronique BessièreProfessor, Management Sciences, IAE Montpellier, University of Montpellier and Eric StéphanyDirector of IAE, Senior Lecturer, IAE Montpellier University of Montpellier
The original version of this article was published on The Conversation.