Access to Finance for the Digital Age

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First published in  Business Agenda, Issue 16, October-November 2013,  Malta Business Bureau.

Crowdfunding is the collective effort of individuals who network and pool resources together to support efforts initiated by entrepreneurs and organisations, usually via the Internet. Projects and businesses are financed withsmall contributions from a large number of persons, allowing innovators, entrepreneurs and business owners to use their social networks to raise capital. DANIEL DEBONO speaks to OLIVER GAJDA, President of the European Crowdfunding Network, on this fast-growing industry and its alternative means of raising finance for SMEs.

The rise of crowdfunding over the past decade is a result of the ongoing digitalisation of processes and communication in our society, with easy access to high speed internet and digital devices. But according to Mr Gajda, “crowdfunding has recently been moved to the forefront in the discussion on access to finance as a result of the economic crisis and the associated market failures of the incumbent financial services industry providing finance to SMEs.”

SMEs are the main contributors to job creation and represent more than 60 per cent of all jobs in Europe, but in the last years they have been less able to access finance for their investment and growth. Mr Gajda refers to statistics that show how the availability of bank loans for SMEs has declined by 23 per cent, while collateral requirements have increased by 34 per cent and interest rates by 54 per cent over the past years.

“This drastic lack of finance for SMEs has a visible impact on Europe’s economy. It is the key reason why today we witness a lively discussion around crowdfunding, which involves political actors of the highest level,” Mr Gajda asserts. However crowdfunding remains largely unregulated and fragmented in the way it operates in different EU member states. Many questions arise whether this can be considered as a positive or negative factor, particularly if it increases the risk factor for investors.

In this respect, Mr Gajda argues that, “the fragmentation of the European Union is a key hurdle for crowdfunding – as it has been for the venture capital industry, too. Although national laws allow for local crowdfunding industries to grow, the markets are limited in size and do not offer room for scale. The different legislations and interpretations of European directives will effectively prohibit a healthy European industry from emerging across border. The fragmentation also concerns a number of other related issues, including e-commerce laws, tax rules and company laws.”

In this light, he continues, “it is alarming for the potential of SME finance that crowdfunding may be regulated on a national basis without a common pan-European principle. So far, national financial services regulators have been slow to reach out to their counterparts in other European countries in order to build a joint position. The European Commission (EC) will not be able to solve this alone. We need cooperation across borders also with regard to politics. Many European investors and entrepreneurs need the possibility to be active across the Union in order to build synergies and scale, while others will be sufficiently happy with a local or regional solution. It is important to address the needs and protect the interests of all.”

This was one main reason behind the setting up of a European Crowdfunding Network two years ago. It intended to launch a public discourse on crowdfunding in Brussels and across Europe. The EC has already made several high level statements in support of crowdfunding, but more importantly is currently discussing across different Directorate Generals a common position on crowdfunding. To this end, (… ) the ongoing public consultation of the EC is paving the way (ed.) ahead of the EC’s presentation of an official opinion in 2014.

Mr Gajda is pleased to note that, “now that we have a political discourse in Europe, we are also going to focus on the aspects of professional conduct and transparency. We believe that crowdfunding has to engage proactively with its customers and stakeholders, unlike traditional financial services firms, with openness and honesty.” He believes that, “this requires professional standards, best behaviours and open data provision, as well as open and ongoing evaluation and monitoring.”

When asked to compare European crowdfunding platforms to the ones in the United States, Mr Gajda believes that there is little difference, especially in view of the donation, social lending or reward-based models. “The difference has to do with the environment in which they operate. The US is a large single market, while Europe is fragmented into many small markets and languages. For US crowdfunding platforms to reach scale is easier than in Europe. In comparison with the typical European (if there is such a person), a US citizen is in general more familiar with stock investing, is more willing to assume financial risks and celebrates risk taking entrepreneurs.”

On whether crowdfunding platforms can take off in smaller economies, particularly when other alternative instruments providing finance such as Venture Capital (VC) and Business Angels (BA) have struggled to succeed, Mr Gajda maintains that “crowdfunding can provide funding for companies with less ambitious growth plans. It can provide debt and equity, or offer pre-sales revenue. Important to the crowdfunding platform is its profit margin. But in contrast to VC and BA, lower margins can be made up for by larger numbers of transactions.” Furthermore he adds that “crowdfunding benefits from the automated online processes, which reduce the operational cost. There are many different models being tried as this is written and there will surely be many innovative approaches changing the way we conduct investment in SMEs for good.”

Crowdfunding has so far been largely successful in the creative industries. Many wonder whether this alternative financial instrument is exclusive to such an industry or whether there is a potential for other sectors too. Mr Gajda admits that crowdfunding has repeatedly been said to be best known for its success in creative industries. However he maintains that “in reality it covers a wide range of areas already for a long time, such as social lending and donations for development projects. And the largest fundraising campaigns, topping million dollar or euro amounts, are most of the time technology-focused products or solutions. Personal credit facilities are also thriving in some countries, as are investments in and loans for businesses and project finance, and citizens engagement for renewable energy.”

In conclusion, what is the potential growth for crowdfunding in Europe? Mr Gajda believes that “for crowdfunding platforms the main problem is the size of the accessible market in order to reach scale. As long as Europe does not offer a de facto single market – and language barriers are a cost factor just as regulation is – the majority of European players will act in national or regional markets, with some exceptions. This is also one of the real growth opportunities, localised platforms, citizens’ engagement, personalised production and collaborative consumption. On top, there will be a number of platforms that will be able to establish a pan European presence. These might also be overseas platforms.”

He is confident that “especially with reward-based and donation based crowdfunding, where regulation is less restrictive, we will see such developments. For financial services, we expect to see banks, VC funds and other intermediaries to enter the crowdfunding space in larger numbers within a short period of time. In the long term, we believe crowdfunding will, in some form or other, become an established aspect of our way of allocation investment, donation or consumption. The market is today estimated to be worth around €1 billion in Europe alone – this is sure to grow significantly, even without enabling policy decisions and regulation.”

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