The advantages of crowdfunding for companies and investors

Innovative SMEs with promising projects, but with little financial history, often have difficulty in attracting bank funding to launch and consolidate their projects. Strict financial requirements make traditional bank funding accessible only to a limited number of SMEs with enough resources to guarantee these banking operations. However, in recent years a wide range of new private finance services have emerged, whose operation and business models based on the use of new technologies, which have expanded the financial resources available to many more SMEs. These are the so-called participatory funding platforms, also known as crowdfunding.

What types of participatory funding are there for companies?

There are several types of platforms for micro-funding or equity funding of companies: reward, investment, loan, and sale of invoices.

1. Reward crowdfunding

Participatory reward funding (also known as reward crowdfunding) enables companies not only to obtain funding but also to validate new products on the market before undertaking investments for the large-scale production and marketing of a prototype. In the reward platform, the company sets itself the market and the funding targets and will only go ahead with the new product if it achieves them in the crowdfunding campaign. It is a way of ensuring that there is a market for this product and avoiding the risk of e-commerce (producing and then not selling). On the other hand, the micro-mecenas that invest in the new product receive this new product as a reward in exchange, for the first time and under more favourable conditions. Reward crowdfunding is particularly useful for products aimed at the end consumer (B2C).

2. Investment crowdfunding

Investment crowdfunding consists of the online sale, to micro investors, of shares of a company that is not on the Stock Exchange. Somehow it is like ‘democratizing’ the investment market. To do this, the company sets a valuation that must be fair or not exorbitant, endorsed by the crowdfunding platform that makes its own valuation of the company, and from there the company sets the percentage that it wants to give or sell to micro investors.

3. Loan crowdfunding

In crowdlending, these are ‘microlenders’ who agree with the company and amortization and interest on the loan granted.

4. Crowdfunding of sale of invoices

The micro-funding of invoices is like a participative factoring, which provides liquidity to the company that sells its invoice in exchange for a discount on the amount of the invoice.

In the different phases of growth and expansion of a company, the logic of participatory funding starts with the reward crowdfunding to validate the product by the market, continues with the investment crowdfunding, since in the initial stages the borrowing capacity of a company is usually limited, and is completed in later stages with the loan crowdfunding.

In Spain there are around twenty participative funding platforms authorised, registered and supervised by the CNMV, and legislation (law 5/2015 on the promotion of business funding) that regulates participative funding platforms, and protects micro investors with maximum investment ceilings (3,000 euros per company and 10,000 euros per year, for non-accredited small investors), which reduces investment risk.

UK Success Story

The United Kingdom is the European country where participatory funding platforms are most consolidated. As a reference, in 2016 British companies achieved an aggregate amount of around £3.3 billion (€3.8 billion) through equity funding platforms.

What are the advantages of crowdfunding for companies?

Participatory funding platforms have several advantages for SMEs. The main one is that they help them diversify their sources of funding, and access private funding not always accessible through traditional bank funding. According to Spanish legislation, a business project can attract between 2 and 5 million participative funding in one year, depending on whether it is accredited investors or small investors.

In investment crowdfunding, micro-investors also often act as ‘ambassadors’ for the financed company, unofficially creating a chain of prescription or commercial promotion of the products of the investee company.

For a newly created company, it is more attractive to seek equity crowdfunding rather than business angels or venture capital. With the latter, the investment decision processes are longer, and the SME barely has negotiating power, especially if its turnover is still incipient. In the investment platforms, the times are the most marked by the company seeking funding.

For their part, micro investors can more easily diversify their investments in the platforms, and thus minimize the risk through that diversification. Investors also benefit from the risk analysis made by the platforms on the business projects that come to them.

Webinar: “How to use equity crowdfunding for funding innovative SMEs”.

On 13 June, at 11:30 a.m., the Altfinator initiative, promoted by the European Commission to stimulate alternative funding, and in particular crowdfunding for innovative SMEs, will hold the webinar “How to use equity crowdfunding for funding innovative SMEs” with the participation of two experts from an investment platform and an SME that has successfully financed its business project through these platforms. If you want more information and register in the webinar, click on this link.