Many start-ups face difficulty raising sufficient funds at the early stage of their businesses. Traditionally, entrepreneurs raise capital from friends and family, angel investment, venture capital or bank loans. However, with the development of Internet platforms, alternative finance methods have arisen. Entrepreneurs are starting to look for financial help from crowdfunding platforms, at the same time, more people from the general public with extra money starting to invest on crowdfunding websites.
This research focuses on equity crowdfunding, an emerging entrepreneurial finance alternative. Equity crowdfunding has only existed since 2011 in Europe. There is limited research about equity crowdfunding worldwide, let alone research about crowdfunding in the Netherlands. Based on the “lemon market” theory from Akerlof (1970), information asymmetry would harm the market and lead to market shrink or even failure. This research is intended to reduce information asymmetry in equity crowdfunding ecosystem, in an aim to promote equity crowdfunding in the Netherlands.
There are two types of information asymmetry being mitigated in this research. The information asymmetry between entrepreneurs and investors can be mitigated by an assessment tool. The assessment tool was developed by first compiling 11 success factors of equity crowdfunding from 5 key literature sources. Then a selection of success factors was discussed before a draft assessment tool is developed. This draft assessment tool is validated later by entrepreneurs using a semi-structured interview approach. The assessment tool is meant for entrepreneurs in the Netherlands in the high-tech industry to pre-screen or evaluate them whether equity crowdfunding can be considered as an alternative funding during their seed-stage financing. This assessment tool can present a fast insight to show start-ups how to raise money successfully on an equity crowdfunding campaign. Hence, it helps entrepreneurs make efficient decisions whether equity crowdfunding can be considered as a source of financing. The assessment tool can also pinpoint their weaknesses if they are going to participate in an equity crowdfunding campaign. By raising the awareness of equity crowdfunding among entrepreneurs, it is possible to provide them with one more option (equity crowdfunding) in their seed-stage fundraising strategy.
The information asymmetry between entrepreneurs and platforms can be mitigated by collecting recommendations to platforms. There are two sources of recommendations. One is from entrepreneurs’ point of view by semi-structured interviews. The other one is from second hand information collected to learn from the market leader the UK.
Equity crowdfunding platforms in the UK have evolved with new operations compared to the Netherlands. One is lead investor system whereby the lead investor serves as an experienced investor who can conduct due diligence on behalf of rest of investors from the crowd, but also lead investor attracts followers to invest because of his/her reputation in the field. Under this system, the success rate of campaigns goes up to more than 72%, while platforms without lead investor mechanism is about 55%. Another trend is unified nominee structure, which is the “funds” function by Seedrs. So investors can invest to equity crowdfunding campaigns, convertible loans, or funds. In the earlier two options, investors invest under their own identity to projects, which means entrepreneurs can have hundreds of small investors that they have to manage updates with. However, in the “funds” option, investors put money into a pool under the name of Seedrs. And Seedrs invest to different projects to leverage the risks for investors, acting as a portfolio manager in traditional banking. Also, entrepreneurs do not have to worry about managing hundreds of investors. All investment is under the unified nominee structure, which is under Seedrs name. This structure provides both sides convenience. This innovative trend is definitely worth borrowing by Netherlands platforms. Also, there is a difference of operations on due diligence between the UK platforms and the Netherlands platforms. The Netherlands platform Symbid perform due diligence after the campaign target is reached and before passing to the entrepreneur. While the UK platforms perform due diligence before listing a campaign online. This measurement results a rejection rate of 72% of projects. However, investors can expect better quality projects to invest. As a result, platforms act with more reputation would attract more investors.
To summarise recommendations from entrepreneurs to platforms, they think if the speed of fundraising were faster than formal investors (VC and angels), it would be more appealing to entrepreneurs. So the platform can be attract more entrepreneurs by shortening the fundraising cycle of equity crowdfunding. Also, if the platform can enable functions of “network and knowledge” to be provided by the crowd, it would attract more entrepreneurs, because all interviewees in the research think it is very important. “Network and knowledge” are the most repeated key words when entrepreneurs answering the interview questions regarding their concerns in choosing equity crowdfunding. Not surprisingly, the most attractive part of traditional investors (VC and angels) is the value-added services. They can provide their network to boost the development of start-ups. They can also provide their knowledge or expertise in technical, managerial or strategic levels to help start-ups to expand as fast as possible. If those benefits entrepreneurs can acquire from the crowds on equity crowdfunding campaign, there will be more entrepreneurs to choose equity crowdfunding. One of the reasons why the equity crowdfunding in the UK market is much more developed than the one in the Netherlands market is that the equity crowdfunding platforms have been backed by venture capital or lead investors (angels). The collaboration between equity crowdfunding platforms and venture capital in the UK is the goal for the Netherlands to achieve. However, in the UK, there is more institutional investment money in looking for investment opportunities than the Netherlands. It might be a challenge for Netherlands equity crowdfunding platforms to seek collaboration with venture capitals, but there are advantages from government subsidies that are possible to collaborate with.
The hybrid financial instrument between equity crowdfunding and other sources is possible. Two possible applications are like this. 1) If the entrepreneur has reached the target of equity crowdfunding campaign, the government subsidy would be provided on top of the money raised on equity crowdfunding. So it doubled the investment originally it would acquire only from the crowd. 2) If the entrepreneur has reached the goal of equity crowdfunding, a bank loan under government incentives would be provided on top of this equity crowdfunding funding. In other words, entrepreneurs can exchange less equity for the same amount of money. However, on equity crowdfunding platforms, the innovative projects are limited. Future study can explore the feasibility of this suggestion. In the UK, the collaboration between VC and equity crowdfunding already exists. Venture capital start investing in start-ups via equity crowdfunding platforms. This has proved to be feasible in the UK. It can be possible in the Netherlands in the future as well, since from the regulation part, equity crowdfunding in the UK and in the Netherlands are similar.
With more actors (venture capital, angel investors, government subsidies) involved on equity crowdfunding platforms, not only the crowds, there would be a bigger cash pool to invest in campaigns. In return, it can attract more entrepreneurs to participate in equity crowdfunding platforms.
By reducing information asymmetry between the entrepreneurs and the platforms and the entrepreneurs and the investors, it would be possible to mitigate “lemon market” effect by Akerlof (1970) and lead to a more prosperous equity crowdfunding industry in the Netherlands.
Keywords: Crowdfunding, Crowdsourcing, Equity-based crowdfunding, start-ups, seed-stage financing, entrepreneurial financing, lemon market theory, information asymmetry, information cascade, herding, crowd wisdom, signalling, success factors.