In my last post, I wrote about how differences in legislation between the United States and Europe could create totally different playing fields for crowdfinancing initiatives, in where crowdfunding is applied as a technique for raising investment money, that aims to gain value by interest, dividend payments or share-value.
Now that the JOBS act has almost passed in the US, development in this area has enabled many initiatives to have their platform operational in a legal way. With the US as a leading market in platform development and long lasting success stories in crowd-donating and peer-to-peer lending platforms, this should be a huge boost to crowdfinancing, and hence, an even larger boost to the possibilities for SME's and startups to attract capital without using any classic forms: banks and investment companies.
In general, 2 models of crowdfinancing can be distinguished:
1. Equity (or quasi-equity) investing and 2. lending models in risk-bearing, low-rated debt. I am very curious about which one of these models could become the most adopted.
Looking at the number of platforms, equity investing has seen more adoption, but this might change over time, as (due to the financial commitment) there are long term advantages and disadvantages on investing, that we cannot yet measure.
Let's have a look at the most important advantages and disadvantages for both types of platforms, not only on the entrepreneur side, but also on the investor side:
Equity investing appeals to the big dream of investing: taking a small, double digit amount stake in 'the new google' and making big money out of it. Also, on the involvement side, it is relatively cheap to get well involved in a startup business, which is very interesting for lots of enthusiasts. Those are major investor upsides.
On the downside for investors, the involvement will probably comprise no more than a hearer position, as the micro-stakes leave the individual in the crowd with low influence. Some platforms have very interesting democratic crowd-tools to counter this, however.
On the financial side, and perhaps most importantly, there is no guarantee that they will ever gain, or see their money back. There is no fixed repayment, and a company could die slowly or end up re-investing all gains for a long time and taking big risks without any significant pressure to payback.
The upside for entrepreneurs is that they can share risk to a maximum extent. In no event, will they will have any liability to their crowd, which could be quite a burden, as crowds can contain thousands of individuals.
The Entrepreneur's downside is the crowd of people trying to exert influence on the company. One could argue that the costs (both in time and financial) of stakeholder management could be disproportionate for a small company.
Crowdfinancing models based on debt, however, have the exact opposite of these issues, turning the upsides in downsides and vice-versa. Upsides turned into downsides: Investors have only limited gaining potential and very limited involvement. Downside into upside: a more solid repayment guarantee and knowing better what to expect.
For the entrepreneur, the upside of maximum risk sharing has been turned into the downside of a more solid liability, and the downside of the burden of influence is now gone.
Those differences are striking and of high influence on what model will prevail in the end.
Factors such as the crowd's appetite for risk , and the degree of commitment and success that entrepreneurs can provide will be determining the choice of investment model and platform.
Cultural factors -which differ across the world- will also be of influence, as well as past success rates (return rates) of concepts.
The new playing field promises some very interesting times.
What do you think? Which model do you think will prevail? Let us know in the comments.