Financing start-ups: when crowdfunding invests with business angels

Crowdfunding (CF) is growing in popularity. Since its inception in 2009, US market leader Kickstarter has raised over $2.4 billion for a total of nearly 106,000 projects. In France, figures published by the Financement participatif France association bear witness 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 held in Toulouse on May 26 and 27, 2016 on the theme "The impact of management science research".
Several forms of CF exist, including those that invest in the equity of start-ups: equitycrowdfunding (ECF) or crowdequity. Since the decree of October 2014, companies can raise up to one million euros in ECF as long as the platform is CIP-approved (this amount could rise to 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 mere seed phase of projects, and is a means of financing used both by companies in the start-up phase and by those who have already validated their product on the market and are seeking funds for their commercial or R&D development. At the same time, ECF platforms have become more professional. As a result, the scale of the deals on offer is increasing in terms of the amount of funds raised.
Overall, we can observe a new structuring of the seed capital financing offer, generated by the entire crowdfunding chain. As a result, start-ups are able to obtain initial validation of their project by setting up a reward-based crowdfunding operation. The success of the operation can be a significant first signal about the emerging entrepreneurial project. In a second phase, these same companies may 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 (BAs). These new financing structures modify start-up management and governance procedures, mainly by bringing in additional cognitive resources.

Resources brought to the fundraising

ECF and BA provide the resources needed to implement an entrepreneurial project. These resources are financial, but above all cognitive. Their contributions are different. The ECF brings visibility and notoriety, and is a test of how the project is perceived by the "crowd".
The fund-raising period is marked by intense exchanges between crowdfunders and the entrepreneur (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 scope of the feedback that can be conveyed by the crowd. By joining the ECF platform, the entrepreneur submits his or her vision of the market and the project's ability to develop to the crowd for validation.
There are many potential resources to be acquired, one of the main ones being the expectations of crowdfunders as future consumers or prescribers of the project. Thanks to the involvement of the crowd, the company can partly solve one of the major difficulties facing an entrepreneurial project: time to market.
Like the crowdfunder, the business angel is a natural person who invests part of his or her personal assets directly in a young company. The BA frequently makes his or her skills, experience and personal network available to the company. An important difference with the crowd is the nature of the exchanges. These are private (whereas they are public in ECF) and can therefore deal with confidential issues. In the start-up selection and evaluation phase, the BAs act as expert evaluators alongside the platform. They rely on in-depth interviews with the entrepreneur. They bring a different level of credibility to the project than the crowd.

Organizing long-term relationships with start-ups

ECF is a form of crowdfunding that involves a long-term relationship with the company, since the crowdfunder becomes a shareholder. Organizing this long-term relationship between the company and its shareholders involves new forms of governance.
The BAs and the ECF also play a rather complementary role here, although we still lack hindsight on these long-term relationships given the recent development of crowdfunding. The BAs appear to be leaders in governance design, as shown by several of the case studies we have carried out. They have experience of this mentoring relationship, and also of exits (the resale of shares), which represent a decisive milestone in the way a start-up is "mentored".
The BA is often close to the company, not only geographically, but also culturally and cognitively (through its knowledge of the business sector, for example). What's more, the BAs have greater means of intervention (preferred shares in particular, whereas the ECF intervenes with ordinary shares, at least within the current legislative framework).
The ECF also integrates this governance function, notably through the representation of crowdfunders 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 type of structuring, and take charge of 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 highly promising development in terms of the solutions it brings to funded start-ups. This type of financing brings considerable resources to the company, both because the funds raised can be greater, and because the cognitive contributions are complementary. Financing by these two players sends out a very positive double signal about the quality of the project.
Véronique BessièreProfessor, Management Sciences, IAE Montpellier, University of Montpellier and Éric StéphanyDirector of IAE HDR Senior Lecturer, IAE Montpellier, University of Montpellier
Visit original version of this article was published on The Conversation.