Initially, crowdfunding was launched to allow non-profit organizations to communicate and market their causes to a large panel of people and thus to expand their donators basis. Since then, crowdfunding platforms have evolved and to not only serve non-profit organizations, but also to serve entrepreneurs and small & mid-cap enterprises.
The traditional financing model with financial institutions, where it takes several months to prepare a file and then obtain an approval, has thus been streamlined and disrupted by crowdfunding which makes it easier and quicker to obtain funds..
Today, we distinguish 3 types of crowdfunding
- Donation based crowdfunding corresponds to funding with no expected financial returns. This funding has been used mainly by non-profit organizations in order to fund a campaign, a cause or a charity.
- Reward based crowdfunding is mainly used to collect funds in order to launch a new business. In return to the funding, a “reward” is promised to the investor. The reward can be a product made by the company being funded, invitations to special events or launches, a special acknowledgement etc. This type of crowdfunding was specially used to finance independent movies, books, music records etc.
- Equity based funding, as its name indicates, allows a contributor to become owner of the company he funds. The investor has thus access to the capital and can buy or sell the shares he owns.
Not only has crowdfunding liberated the “lending” activity, it also came with many benefits to entrepreneurs, start-ups and even individuals willing to finance a cause or a project they believe in.
Crowdfunding leading to a disruption across industries
In the modern world, crowdfunding platforms were launched in 2008-2009. IndieGoGo and KickStarter were the pioneers and their goal was to help creative entrepreneurs get funding for their projects.
Between 2009 and 2014, the funds raised by crowdfunding platforms in the world increased from 0,5 bln euros to almost 10 bln euros.
This spectacular increase is nowhere to be stopped as studies showed that since 2015, this market is growing by more than 40% every year. Even though regulations are being implemented (most recently in Europe in November 2018), they come in favor to crowdfunding as for example, in Europe, the funding cap has been raised to 8 million euros instead of 1; in Finland, contrary to financial institutions, crowdfunding platforms do not need a MIFID license.
All these evolution of the crowdfunding market are disrupting the traditional lending activities performed by venture capitalists, investment banks, asset managers etc. In fact, the World Bank reports that in 2016, more money was raised from crowdfunding than from Venture Capital. Lower fees, direct access to investors and simplicity of the process are attracting more and more entrepreneurs and start-uppers to privilege these types of platforms instead of resorting to the traditional financial services.
Since many small and mid-cap companies are using crowdfunding to obtain financing, banks have identified this threat and potential loss of earnings and have thus decided to take actions. In France, we have observed recent partnerships between crowdfunding platforms and French retail banks, most significant are the partnership between BNP Paribas and Ulule and the acquisition of KissKissBankBank by la Banque Postale.
These partnerships are beneficial to both parties as with the strong dynamic of the crowdfunding market, competition has become very important (more than 170 platforms in France only) making it more and more difficult for these Fintechs to have a sustainable business model and have positive and strong earnings. It is also known that entrepreneurs start their project with a crowdfunding campaign in order to obtain bank loans. So, from the banking industry point of view, a successful crowdfunding campaign is a strong proof of the viability of a project and makes it easier to study the proposal of the client. For banks, partnering with a crowdfunding platform allows direct access to a fast growing market and a larger panel of clients.
Has crowdfunding built the perfect business model?
Even though the crowdfunding industry seems very attractive, it doesn’t come without risks and limitations for entrepreneurs and platforms.
- For entrepreneurs, two main risks can be discussed: the reimbursement of the funds raised in case of an unsuccessful project and the costs related to the use of the platforms can be relatively high.
- From the fintechs’ point of view, we can also distinguish three main risks: the detection of fraudulent projects, the intensive competition and the change in the interbank rate.
The last two risks are the main reasons why Unilend, a leader in crowdlending for mid-cap companies, was forced to file for bankruptcy after it was no longer able to repay the amounts raised on the platform.
In Europe, lending platforms had become very attractive to companies needing funding after the subprime crisis when interbank rates were very high and lending criteria was very strict compared to what the platforms were offering: lower rates and very easy access to liquidity. Today, the European interbank rate is 1% and financial institutions are lending money more easily (even after long study of the business project) making it cheaper for mid-cap companies to borrow money from traditional institutions rather than from crowdfunding platforms. These low interbank rates coupled with the high competition in lending platforms have participated in the bankruptcy of Unilend. The platform was able to raise 6 to 8 million euros in the first 6 months of 2018 but with fees of 4% (almost the only source of revenues) and millions spent in marketing campaigns, the start-up was no longer able to neither pay salaries for its 16 employees nor honor its financial obligations/commitments.
Unilend’s case is not the only one, crowdfunding platforms are becoming less and less profitable and are taking more risks to try to keep up with their expenses. The start-ups are trying to have as much projects on their platforms but in exchange, they are exposing the investors to a very high risk.
Crowdfunding platforms played a very important role in the liberalization of the lending and/or funding activity opening up possibilities to both investors and entrepreneurs to express and communicate on their projects. But today, these platforms are facing strong difficulties to stay profitable.
Will the solution to keep them alive rely on regulations to boost this industry? Should platforms develop partnerships with banks in order to be sustainable? Or should we wait for a new increase in banks interest rates to relaunch the activity?