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What is the State of Equity Crowdfunding Heading into Q4 of 2018?

 

Equity crowdfunding is digitalising the capital raising industry.

In case you aren’t familiar with the term, in a nutshell, equity crowdfunding is digitalising the capital raising industry. Many industries have already been hit by the digitalisation wave, but now it is the fundraising industry’s turn to go digital. In this blog post, I will attempt to reflect on the current state of equity crowdfunding as we head deeper into the fourth quarter of 2018.

Reputation Check

Equity crowdfunding is a young industry. It’s fair to say that the market started in its current form in 2011 and 2012. Early years were experimental with young growth companies testing a new option to raising capital. Crowdfunding platforms were also experimenting their business models and learning from their various mistakes.

As the existing market found a new challenger, it was expected that the traditional players were feeling threatened and some of them did their fair share of spreading negativity about the new disrupting industry. During every disruptive change, there will be proper, but also improper players entering the market and some of the industry-critical comments from the traditional players have been well deserved. 

All in all, equity crowdfunding has managed to uphold a good reputation thanks in part by sufficient regulatory oversight. There is still work to do and hearts to win over, especially among some cynical bankers, but as an industry we are heading in the right direction.

The Investor Base Continues to Evolve: More VC Syndication and Institutionals

Business angels and retail investors have always been the backbone of the equity crowdfunding investor base. As researched by Anna Lukkarinen of Aalto University based on Invesdor’s data, the average equity crowdfunding investor is a highly educated, 43-year-old male, who has an investment portfolio of listed shares and mutual funds.

Furthermore, the potential in the ‘long tail’ (investors who only invest a couple hundred euros once or twice during their lifecycle) is absolutely immense. As more and more companies, especially consumer-facing brands, organize crowdfunding rounds, more and more long tail investors are introduced to equity crowdfunding. This crowd is likely to be the source of long term growth in the market.

But the investor base is evolving beyond private individual investors. Last year we started to see VC funds and even institutional investors entering the digital fundraising market, which takes equity crowdfunding again one step closer to becoming the ultimate syndication tool.

In 2018 we have started to see more VC funds bringing their portfolio companies to equity crowdfunding services to diversify the risks and to get marketing visibility for the target companies. In a usual case the VC fund negotiates the valuation and makes an anchor investment into the company through the platform, after which new shares are offered publicly with same investment terms to everyone.

Recently, even American VC’s have started expressing interest towards leveraging equity crowdfunding. They’re a bit late to the market compared to European VC’s. This is largely due to long-winded uncertainty in the regulatory framework of equity crowdfunding in the US.

In addition to the VC funds, we have started to see experimental institutional investors to use equity crowdfunding platforms, but the lack of a secondary market is still a major hurdle to some traditional institutional investors. However, some of the more advanced platforms have already organised IPOs to their target companies, which provides the liquidity required by the institutional investors. This enables them to use digital platforms along with the other types of investors who don’t have the same strict mandates and rules as institutionals.

Regulation Creates Demand in Digitalization of Traditional Players

Given the tighter regulatory environment, such as MiFID II, the traditional small investment firms, such as various types of brokerages, corporate finance boutiques and wealth managers, are feeling the squeeze. They may no longer be able to work without adopting proper investor authentication and KYC processes, as many of them have been in the past.

Licensed equity crowdfunding platforms are the most recent newcomers in the regulated financial industry and thus have the most modern solutions to regulatory matters. Traditional players wishing to adopt the practices will likely look to the fintechs for help. This is an area where I predict we will soon see more cooperation with traditional players and the fully-licensed equity crowdfunding platforms with their digital MiFID-compliant KYC processes.

Growth Continues Strong, Much Untapped Potential in Non-Digital Equity Capital Raising Market

According to the University of Cambridge European Alternative Finance report, the European online alternative finance market was 7.67bn euros in 2016. The UK represents an absolutely dominant share of this market due to the generous tax incentives for investors. But if we exclude the UK, the continental European business funding market adds up to 1.12bn Euros in 2016 with a growth rate of 110% compared to last year. Equity-based crowdfunding, totaling 304m euros in 2016, represents approximately 30% of business funding included in the report.

These volumes are still small compared to the fundraising market as a whole. According to unofficial estimates 5-15% of the current equity fundraising market has been digitalised. Given the large growth potential and the current growth rates, the equity crowdfunding market will be experiencing very interesting times ahead.

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(Image source: Shutterstock)

Tagged: Points of view, Invesdor Insider, Investment-based crowdfunding

Lasse Mäkelä

Written by Lasse Mäkelä

An investment banker and CFO by experience, Lasse heads Invesdor as its CEO and co-founder.