EQUITY CROWDFUNDING: What it is and its potential for startups and SMEs

EQUITY CROWDFUNDING: What it is and its potential for startups and SMEs

Equity crowdfunding was introduced by Decree-Law no. 179/2012 (becoming a law on December 17, 2012, No. 221) containing “Further urgent measures for the growth of the country”.

The Decree delegated the task of regulating some specific aspects of the phenomenon to Consob. Consob adopted the first regulation on 26 June 2013.

Initially, the opportunity to raise equity crowdfunding was limited to innovative startups only. Only in the following years was an opening up to new types of businesses observed, thanks to new legislative changes and the revision of the Consob regulation, and in particular, the recent expansion in favor of all SMEs.

What is it?

Equity crowdfunding is nothing more than the evolution of traditional crowdfunding, or online fundraising. The logic is a win-win: the company that requests funds in fact collects online financing, and the investor, participating in the collection, receives shares of participation in the company in exchange and consequently administrative and asset rights.

How does it work?

The company that looks for funds is presented on a crowdfunding platform, proposing its objectives and setting an attainable collection target at the end of the campaign.

If the target is successfully reached, the company collects the investments and proceeds with its business plan. In the event of the failure to achieve the target objective, the investments are not finalised and the lender loses nothing.

The Politecnico of Milano has identified 22 platforms for equity crowdfunding authorised against the 100 operating on traditional crowdfunding.

With the new Consob Regulation from 3 January 2019, SMEs can also use online fundraising.

Although it has extended the number of users who can access this service, this has also led to a restriction in the platform management rules.

Among the accepted SMEs are only those that respect the EU criteria: micro-enterprises with less than 10 employees and turnover below 2 million euros; small businesses with less than 50 employees and a turnover under 10 million euros, and medium-sized companies with less than 250 employees and a turnover not exceeding 50 million.

What are the advantages for startups and SMEs?

The advantage of participating in an equity crowdfunding campaign is the ability to secure a more “democratic” financing, based exclusively on the evaluation of the quality of one’s financial documentation (first of all the Business Plan ) as well as an alternative to bank credit and venture capitalists .

Equity crowdfunding is one of the four traditional crowdfunding models, which differ according to the type of reward that financiers offer:

  • Reward. The reward based model offers a reward to the participants, such as a discounted price on a product that has not yet been placed on the market
  • Donation. The donation based model does not offer rewards and is usually launched by non-profit organisations
  • Lending. The lending based model is based on a “borrowed” fundraiser that will be returned with interest to investors once the project is completed.
  • Equity. The last equity based model differs from the other types because those who participate in the investment actually buy shares in the company in question.

The startups enter the campaign outlying the values, mission and the strategy created to reach the goal.

The three main steps are: preparation for the publication of the offer, collection and, finally, closing and post-collection phase.

If the idea is convincing enough, investors decide to pay a portion of their capital to get a share of the company shares and once they reach the end of the campaign, the totals are drawn up.

With equity crowdfunding in particular the startup hopes to:

  • to avoid borrowing;
  • to obtain funds that enter directly into the company’s assets and therefore must not be returned;
  • improve the debt / equity ratio by virtue of the two previous points;
  • avoid negotiating the investment conditions (which happens instead in the case of the use of venture capital);
  • have access to an unlimited pool of potential investors thanks to online collection;
  • get an immediate response from investors that can also serve as a tool to validate the business idea

What are the advantages for investors?

On the investor side, equity crowdfunding also has several advantages:

  • invest relatively small amounts in different projects (risk diversification);
  • possibility of having a capital gain of about 2-3 times the investment made;
  • create a direct relationship with the startup

With access to equity crowdfunding platforms, the investor has the opportunity to become aware of and analyse entrepreneurial projects that they, most likely, would not have had a way to consider otherwise. Furthermore, the process of evaluating an investment through crowdfunding portals by a potential investor is helped by the process that the projects undergo before being published. The platform managers, in fact, analyse and evaluate the entrepreneurial initiative before it is published. Moreover, the investor is always updated through the portal on the progress of the collection.

Certainly, financing an equity crowdfunding startup also has a number of risks ranging from the possibility of capital loss, to the fact that the investment is not liquid and the shares purchased are not easily transferable.

In conclusion, equity crowdfunding is a highly innovative means to ensure that startups and SMEs as well as investors can meet to achieve a common goal.

Team BizPlace

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