Crowdfunding: is it the right time for banks?

On an almost daily basis the press talk of diverse projects funded by participatory finance: television productions, video games, NGOs, wind energy, medical companies, biotech products, political campaigns, poultry farming and recently the creation of an outdoor pool on the River Thames in London...

Everyone finds their niche whether it be the "contributor" who is involved in the output of a project and receives a reward or "the project leader" who finances and publicises it, or the "platform" itself which receives commission for services provided by bringing together the contributors and project sponsors.

[Source: Les Echos/Massolution]

In short, participatory funding or crowdfunding is an alternative method of funding that originated in the United States around ten years ago and is experiencing a significant new explosion in interest. Its growth is rapid, its volumes more than double every year.

The amounts collected grew from $6 billion in 2013 to $16.2 billion in 2014, an increase of 167%, and Massolution, a research company specialising in the subject, estimates that these sums are expected to reach $34.4 billion in 2015.^[1] Some even, like Forbes magazine, do not hesitate to predict a market of nearly 1 trillion dollars in 2020!^[2]

SUCCESS FOR MANY REASONS

Crowdfunding allows funding of new projects, new businesses, start-ups, or a simple need for working capital, where traditional banking channels provide only partial and imperfect solutions - or provide no solutions at all. Private individuals wishing to support a project (and/or invest their savings) give meaning to their money with values of membership, proximity, confidence and even passion. Crowdfunding thus meets a need and echoes strong societal trends such as collaborative, transparent and horizontal consumption. It draws on the extraordinary influence and power of the Internet and social networks. Its operating costs are limited. It is simple.

A SUPER SIMPLE MECHANISM

A project is "posted" (as a widget or insert) for a limited time on a "master" site, which provides the tools needed for its communication and monitoring. It is supported on partner sites, blogs and social networks. Amongst the information provided can be a video, a pitch with photos, a target amount to reach and a list of incentives to achieve, depending on contributions made (as well as possible tax benefits). The amounts collected are queued in an electronic wallet or a payment account. Once the deadline and/or financial objectives are achieved, the money is paid into the account of the project leader. If they have opted for the version "All or Nothing", however, they will only receive the money collected if the set minimum is achieved. Some platforms also offer the option "Keep it All" which allows the project manager to keep the money received, even if the objective has not been reached.

The choice of platform will depend on various criteria, including its location, the amounts to be collected and the target market; but also the way in which project leaders wish to reach their goals. In general there are four models: the donation, the donation with rewards, the participatory loan and the equity-based funding.

​A LEGAL FRAMEWORK

However the crowdfunding models, based mainly on the loan or profit participation raise the question concerning regulatory compliance. In most countries, loans and public offers of investment instruments are strictly controlled by the authorities. Accompanied by specific obligations, they are usually the prerogative of banks and authorised financial institutions. Public offers of investment instruments, a category under which crowdfunding projects with a profit stake fall, involve for example relatively heavy obligations such as receiving the approval of regulators and publishing a prospectus detailing the operation. These obligations contradict the core principles underlying the concept of crowdfunding itself: flexibility and simplicity.

Nationally and internationally, American and European legislators have therefore become interested in the issue. In the US, the SEC recently approved new rules to ease the burdens on crowdfunding companies.

In Europe, the European Commission launched a public consultation on the subject in 2013 and established the "European Crowdfunding Stakeholder Forum (ECSF)" in 2014.^[3]

Community legislation, however, is not on the agenda for the time being. Some Member States have therefore moved forward independently on the subject. And, in this respect, diversity of solutions seems to be the rule.^[4] France, with a law on 1 October 2014, attached itself to the framework of platforms by establishing new statutes for investment service providers and advisors in equity investment. It also established the possibility of raising up to 1 million euros in unconstrained equity. But above all, by giving everyone the opportunity to participate in a participatory finance operation without limitation on wealth or income, it breaks the banks' monopoly.

Germany for its part has favoured the route of information obligations for the project leaders; Belgium has framed equity-based funding operations and non-standardised loans by increasing the threshold beyond which a prospectus must be prepared from €100,000 to €300,000 and the limit per person per project from €300 to €1,000 euros. As for Great Britain, it has decided to remain relatively flexible with regard to crowdfunding initiatives while putting in place, in spring 2014, protection for non-professional investors by limiting to 10% of their portfolios the profit sharing they can have in non-listed businesses.^[5]

A PREDICTABLE EVOLUTION OF PLAYERS: PROFESSIONALISATION OF THE SECTOR AND REINFORCEMENT OF ITS SECURITY

While countries are trying to define a legal framework for these funding structures, initiatives are multiplying on the ground, whether they are based on a single model - donation, loan, profit sharing - or several.

Amongst other European platforms there is Crowdcube, Funding Circle, Seedrs in Great Britain, Ulule, KissKissBankBank, Union Loans in France, Symbid, Gambitious in the Netherlands, MyMicroInvest in Belgium, AuxMoney, Companisto, Innovestment in Germany, Derev in Italy, and a newcomer currently focusing on the Luxembourg scene, NUBS, launched in 2014.

After its grass roots origins, we can expect a rapid professionalisation of the sector.

The key success factors of such platforms will no doubt be the quality of their positioning and their services as well as their ability to industrialise their processes and reduce their costs.

Secure payments, the quality of information especially on the risks encountered by a contributor in the case of loans and equity investments, transparency of billing conditions and anti-money laundering policies will also be crucial. An article published in April 2015 in the French magazine Le Nouvel Observateur pinpointed crowdfunding as a new medium for funding terrorism. This article, referring to the conclusion of the latest report from the French Senate,^[6] warned against "the risk of funding terrorist activities through crowdfunding". In this respect, three golden rules need to be respected: know your client, Ensure full traceability of the financial flow and full control of Fund allocation.^[7]​

FOR BANKS, POSITIONING TO INVENT, AN OPPORTUNITY TO SEIZE?

From the outset, banks looked at crowdfunding with a certain condescension. Even today, only a few banks want to see an axis of strategic development in this trend, but is the attitude changing?

Over the last year, we have started to notice changes in their behaviour. Although only a few banks have taken the plunge so far, some have developed partnerships with crowdfunding companies; and more and more are starting to view the phenomenon with interest.

However banks will not be exempt from challenges. Those they will have to address include:

• Their exposure to risk (collective intelligence versus traditional risk analysis);
• Their positioning: How do banks seek to manage their relationship with "the crowd" and the task of sustaining the worst risks and/or the riskiest projects?

Nevertheless banks can no longer ignore participatory finance. Although it seems that at least in the near future Crowdfunding will not represent a significant part of funding in the economy, its rapid development (particularly in lending) should cause concern and force everyone to react one way or another, by positioning themselves not against it, but as Guitry would say, "right up against" it!

Those who finely develop a significant participatory finance activity will find the opportunity to:

• Respond positively to requests to which they are not aware of - or are not in a position to answer today
• Limit customer attrition, as it is likely that a part of savings (especially from young people) will turn to this method of funding;
• Improve the detractors/prescribers ratio;
• Bring banking to additional customers;
• Position themselves close to emerging projects;
• Develop commission-generating activity, with no significant counterparty and non-consumer risk of capital and balance sheet resources;
• Restore confidence for part of the population by creating interdisciplinarity and synergy between trades (retail banking, corporate banking, investment banking).

ENTER THE WORLD OF DIGITAL MARKETING

Banks have the opportunity today to rethink their management practices based on the younger generation of fully connected digital natives. They have a tremendous opportunity to embrace the digital world; but also to boost their innovation capabilities and, in short, reinvent customer relationships.

Positioned at the intersection of finance, banking regulation, strategy consulting and technology, Reply can help in this direction. Through a partnership with MIPISE, it offers secure and easy-to-use crowdfunding solutions.