THE FINANCIAL CROWDFUNDING WITH DIVERSE BUSINESS MODELS
Sandeep Sharma1 Aj. Dr. Nilubol Lertnuwat[2]
1 Author, Postgraduate Student, LL.M (Business Law), Chulalongkorn University, Bangkok, TH. Email: sandeep24886@gmail.com.
2 Co Author, Assistant Professor, Faculty of Law, Thammasat
University, Bangkok, TH. Email: lnilubol@tu.ac.th
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ABSTRACT |
Keywords: Financial; Crowdfunding; Diverse; Business Models; |
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The Alternative Finance
Industry of “Crowdfunding” is to collect relatively small contribution from
large number of people in order to support the small and medium enterprises
and startups. The financial market shows a significant growth in Asia volume grow by 320% to 3.4 billion. The
financial model consist of Equity or
Debt (peer to peer lending) based crowdfunding. The financial model basic
feature of financial return on investment. The diversification in business
model with the distinct approach
of implement the financial model depend on their regulatory systems to
encourage the crowd for invest in alternative financial industry and
furthermore, these model ensure its financial return on high risk investment.
The business model offered “Nominee and Non Nominee” structure in equity
based crowdfunding where as in debt based crowdfunding business model are
“Client Segregated Account,
Fixed Loan, Notary and “Guaranteed” Return consist of (Offline Guaranteed Return or
Automated Guaranteed Return)”. The principle aim of article is to analyses
the diverse business models in terms of its rational, benefits and drawbacks.
Subsequently to find out whether these models are able to eliminate the risk
of investment. In last part article summed up with appropriate conclusion and
suggestion. Publisher All rights reserved. |
INTRODUCTION
The alternative finance industry come
into force after 2008 crisis early stage finance problem faced by the artists, entrepreneur and
start-ups because banks or financial institutions recognized as a traditional
financial sources are unwilling to lend money or charge with an high interest
rates. That give birth to the new financial market called as “Crowdfunding”.
The financial crisis (introduction of Basel III) norms and technological
innovation is the two major factors for the growth of crowdfunding.
Currently crowdfunding market is $16 billion in 2014, with 2015 to grow to over $34
billion. Whereas venture capitalist the VC industry invests an average of $30
billion each year. Within the
ASEAN countries Malaysia is the 1st
country to issue regulations on equity crowdfunding later on Securities and
Exchange Commission of Thailand issue regulations on equity crowdfunding subsequently, Singapore also issued
consultation paper on crowdfunding. There are some risk factors that still
associated with the crowdfunding market. But companies are using differential
approach apart from the regulation to eliminate the risk. These business models
are widely famous in the United States (US) and
United Kingdom (UK). Some of these business model are widely popular and
are able to attract the investors at large. Currently, “crowdfunding” gain wide
attraction across the Asia. The Asian crowdfunding volumes grew up by 320%, to
$3.4 billion raised. While as compare to the UK market only equity crowdfunding market doubled in
size last year and is now worth over £50 million in 2015. The UK alternative
finance market will grow to around £4.4 billion in 2015. Whereas overall
financial market growth rate of 161% in 2014.
The
concept of crowdfunding emerge as the global phenomena to achieve
economic growth and creating alternative financial market to support SME and Start up. This article helps to
understand the business models and their drawbacks from the UK, US and some
other countries. The regulation pertaining to the crowdfunding markets are developing investors friendly
approach whereas firms business models
also working on a measures to attract investors by putting extra efforts to
secure investors interest. But still there are some drawback with these
business models. This article benefits the Asian investors may be in future
investors have to deals with such business models. At appropriate places, this
article also prefer to discuss cases, practices and experience from other
countries.
CROWDFUNDING
Defining
“Crowdfunding”
As an alternative financial industry in
order to support the small and medium scale enterprises and start up.
Crowdfunding defined as a “an open call, essentially through the Internet, for
the provision of financial resources either in form of donation or in exchange
for some form of reward and/or voting rights in order to support initiatives
for specific purposes.” The process of crowdfunding explained in (figure 1) with all three
major player of crowdfunding.
Crowdfunding V.
Crowdsourcing
The Internet based crowdfunding is a merger
of two distinct antecedents called as crowdsourcing and microfinance. The
crowdsourcing enables a firm to outsource specific tasks essential for the
making or sale of its product to the general public (the crowd) with the aid of
an open call over the internet. Consumers “volunteer” to contribute to
production processes and create value. Crowdfunding, describes as a collective
cooperation, attention, and trust by people who network and pool their money
together, usually via the Internet, in order to support efforts initiated by
other people or organizations.
Three Main Player
of Crowdfunding
Creator
The person who create or initiate
the project in equity crowdfunding it will be referred as the issuer. The
people or group entrepreneurs, artists, and others who initiate projects or
ventures are labeled as “creators”. Creator is the person who are able to raise
capital and demonstrate demand through
financial or non financial
crowdfunding.
Funder
The Funders can be called as Crowdfunders or Investors. The people who
invest their money in crowdfunding platforms support the ideas or innovations
of creators projects they fund in a philanthropic way or on financial return or
on pre purchase basis. The crowdfunders
generally fund in smaller amounts than, say, angel investors, more investors
are required to raise a given amount of capital.
Platform
Platform is a place where both
funder or creator come together or it can be called an interfaces between
founders and funders. Crowdfunding platforms are a novel place for fundraising
activities, functioning as online intermediaries between entrepreneurs with
ideas and the public with money and expertise. Platform is a place where both
funder or creator come together or it can be called an interfaces between
founders and funders.
Figure 1 The process of crowdfunding.
CATEGORIES OF CROWDFUNDING
There are four
main categories of crowdfunding: Equity crowdfunding, Debt or Peer to Peer
lending based crowdfunding, Reward based crowdfunding and Donation based
crowdfunding . In which two are financial model and others are non financial
model as shown in (figure 2).
Figure 2:
Financial and Non Financial Model.
Source: IOSCO Research Department
Financial model
Financial model define
in terms of financial return on investment includes Equity crowdfunding and
Debt based crowdfunding.
a. Equity crowdfunding sites offers a share of the profits of the business they are funding and
funders receive equity instruments or profit sharing arrangements.
b. Debt or Peer to Peer Lending based crowdfunding can be defined as the use of an online platform that
matches lenders/investors with borrowers/issuers in order to provide unsecured
loans.
Non Financial
model
Non financial
model are define in terms of return are only rewards or other benefit that includes
Reward based crowdfunding and Donation based crowdfunding.
a. Reward based crowdfunding is the “pre-selling” of products to early customers is a common feature of
those crowdfunding projects. The platforms
facilitate a hybrid approach and allow creators may be able to lower their cost
of capital by “selling” goods that are otherwise difficult to trade in
traditional markets for early-stage capital.
b. Donation based crowdfunding contributions on donation sites are, as the name would indicate,
donations. Investors receive nothing in return for their contribution, not even
the eventual return of the amount they contributed. However, although the
contributor's motive is charitable, the recipient's need not be donations can
fund for-profit enterprises.
FINANCIAL BUSINESS MODELS
There is the
different sets of business models that platforms or firms are implementing as a
tool to attract the investors interest
by showcasing the investor protection with there business models.
Equity
crowdfunding business models
The platform offer equity
crowdfunding are more flexible to update its operations and adapt its marketing
and design quickly to an evolving business model there are few platforms have offered their services
internationally. Under the equity crowdfunding there are two famous business
model called as Nominee structure or Non Nominee model. There are
very few equity crowdfunding platforms due to the strict regulatory
requirements that are in place to regulate public equity offerings. By law,
most platforms can offer this type capital raising to sophisticated investors only under defined
jurisdiction or to a limited number of individual investors for example, in China
an equity raising made to less than 200 individuals does not need to fulfill
the public equity raising requirements as set out by the China Securities
Regulatory Commission and in Singapore also there is a cap of 150 investors (but that by passed by using nominee model) under
the Thai and Malaysian regulations there are no such cap on the investors. The
Types of Investors are defined by the regulatory authorities of but most of the investors are classified as a
retail investors which also includes individual investors.
A. Nominee structure model
Under this model nominee company collects a funds and issue
shares in itself to the investors and that nominee company then invests in the
company seeking finance, which in turn issue shares to the nominee. That platform
is the legal shareholder in the relevant company’s shareholder register, but
platform hold those shares on behalf of the various individuals who had
invested in the company through that particular platform. The effect of this
structure is that while platform holds the shares, the full economic interest
including the benefits or individual tax reliefs are passed through to the
underlying investors. This arrangement is very similar to a trustee
relationship, as well as to the structures used by stockbrokers and other types
of intermediary platform. This model is basically called as the Seedrs nominee
structure model of investment explain in (Flow Chart 1).
Flow chart 1:
Source: Replica of Seedrs Nominee model
Investors invest
money in any company though seedrs online platform. The platform collect all
funds together of those investors who like invest in that particular company.
The platform investor representative turned out to be the nominee of all
investors. This representative act like an
single investor or face for other investors.
Advantage for the
investors in administrative efficiency, Nominee takes decisions
for the investors, Rights of the crowd consolidated in the hands of the
nominee, giving the crowd more bargaining power.
Disadvantage for
investors with nominee structure like Loss of unfair prejudice
protection at company level (as the investors are not legal owners of the
shares), Not a party to the shareholders' agreement (at company level) and
Nominee will be able to take certain decisions on behalf of the crowd by way of
majority decision (but the investor may be in the minority).
Advantages for
company are single name (the nominee) on the cap table, The
nominee should able to make decisions more quickly than the crowd, Arguably
more attractive to a VC, and nominee take care of much investment paperwork.
Disadvantages for
company is right of the crowd consolidated in the hands of the
nominee, giving the crowd more bargaining power.
B. Non nominee
structure model
It can be called as a “Non
Nominee Structure” or “Direct Shareholder Structure” where the each investor
becomes a legal individual shareholder of whatever business they choose to
back. All but the largest investors receive “Class B” shares. This model
also allows the fundraisers to tap in to valuable feedback and ideas from the
crowd as they have direct communication with their shareholders. Its an
crowdcube model they argue that it gives individual investors a
greater sense of autonomy and ownership, without any kind of middleman or
intermediary as explained in flow chart 2.
Flow chart 2. Non
nominee structure
Advantage for
company is the (limited) rights of the crowd are not
consolidated in hands of a nominee. Company is able to use the corporate
opportunities for self dealing.
Disadvantages for
company like potentially hundreds of shareholders are on the
cap table and sign the shareholders' agreement and secondly, Company deals with
most of the paperwork (rather than the nominee). The downside is that they have
to deal with hundreds or even thousands of investors in some cases and this is
not a simple task for any small to medium sized enterprise.
Advantage for
investors is each investor is a shareholder in the company
(with very limited minority (unfair prejudice) protections) and each investor
is a party to the shareholders' agreement (if there is one). It gives
individual investors a greater sense of autonomy and ownership, without any
kind of middleman or intermediary and their associated fee.
Disadvantages for
investors like Shares may be non-voting and may lack adequate
(or any) anti-dilution protection. This essentially means that they have no
voting rates when it comes to big company decisions because of the minority
shareholder.
Market Growth of
Equity crowdfunding
In UK the average growth rate of
equity crowdfunding is 410%. Equity based crowdfunding grew by 201% in 2014,
the fastest growing models up by 295% to £332 million raised in 2015. Equity–based crowdfunding, whereby
investors can diversify their portfolio and invest in both early stage (e.g.
pre seed, seed and start up) ventures as well as growth–stage companies,
continues its rapid expansion with a 201 per cent year on year growth rate and
facilitated £84 million in predicted total transaction volume for
2014. As per the Research Firm
Massolution Growth rate in equity-based crowdfunding grew 182% to $1.1 billion
in 2014. Almost 95 percent of the funded UK equity–based crowdfunding deals
were eligible either for the EIS (Enterprise Investment Scheme) or the SEIS
(Seed Enterprise Investment Scheme) schemes. Almost 62% of Investors are retail
investors with no previous experience of early stage/venture capital
investment.
Debt Based
Crowdfunding Models
Is another model of financial return in crowdfunding category it can also
be classified as a lending based crowdfunding or debt based crowdfunding. There
are some other forms like, Peer to Peer “Business Lending” and Peer to Peer “Consumer
Lending”. Peer to Peer “Business
lending” is a debt–based transactions between individuals and existing
businesses which are mostly Small and Medium Enterprises(SMEs) with many
individual lenders contributing to any one loan whereas, Peer-to-peer “Consumer
Lending” is an individuals using an
online platform to borrow from a number of individual lenders each lending a
small amount; most are unsecured personal loans. Peer-to-peer lending
websites data on the size of the overall industry is sparse, peer-to-peer
lending was estimated to have reached approximately $647 million in 2009 and
was expected to grow to $5.8 billion by 2010.
A.
Client segregated account model
This is an individual lender is
matched to an individual borrower through an intermediary platform, and a
contract is set up between the individuals with little participation by the
intermediary platform. As shown in (flow chart 3).
Flow chart 3:
Client segregated account model
Source: IOSCO Research Department
All funds from
lenders and borrowers are separated from the platform balance sheet and go
through a legally segregated client account, over which the platform has no
claim on the event of the platform collapse.
The platform use these fund to match borrowers with lenders, allowing
the lenders some choice as to whom they finance or with bidding option. The
platform then handles the administration of the loan and repayments. As it is a
trust, it is legally distanced from the platform itself thereby preventing loss
to the investors if the platform were to fail. An example of this business
model would be Afluenta, based in Argentina.
Advantage for
investors there is no middle man direct benefit or profit to
investors. Investor able to get refund even if platform fail. That’s help the
investors in terms of protection that he can deal directly with the borrower on
event of failure.
Disadvantage for
investors On the event of default lender have go through the
traditional process of law. Auctions tie up with the investors funds because
auctions typically last 7 or 14 days. During this time your money is not
earning any interest and your bid may be knocked out by a lower rate. This
means that investors may bid multiple times during an auction, with no
guarantee their bid will be successful. Confusing and complex to understand
auctions can be confusing and unattractive, especially for new investors.
Unattractive to borrowers many business owners are put off by the lack of
certainty around the cost of their loan.
B. Fixed interest lending model
Under this model loans will be
issued with an interest rate assigned by a risk band and loan term. Sensible
states its long-term object is to pre-approve loans even before they hit the
screen. There is no option of variation in interest rates on particular loan
because interest rate is decided on basis on creditworthiness and the term of
loan. The platform also determine the grade level for borrower on the basis
of creditworthiness as shown in (figure
2).
Figure 2: Grade
level for borrowers
Source: Funding circle fixed interest rate model.
This particular model introduce by the Funding
circle in September 2015. The similar fixed interest model is
adopted by Sensible Lender on February 2016, a UK peer to peer lending
platform, has made the jump from auctioned interest rates to fixed rates set by
the online lender.
Advantage for
investors the lenders will be presented with fixed interest
rates based on borrower risk and can choose which companies to invest in on a
first-come, first-serve basis. Its simple and easy to understand, the
creditworthiness is the deciding factors for rate of interest or if borrower
interested to reduce the interest rate he has to maintain the creditworthiness
for a long time.
Disadvantage for
investors the interest rate is based according to
the risk of the loan, rather than the availability of investor funds. The Rates
will be set according to the risk band and the length of the business loan.
There are still missing guidelines on what basis the risk of the loan is
determine whether it was on the credit history or the risk about the project.
If it was the credit history of the borrower so the risk can be determine but
if the risk about the project. So what the factors or the basis of determining
the risk about the project is still unclear and excessive platform
interference.
C. Notary model
Under this model platform acts as
an intermediary between the lender and the borrower, matching them to each
other. The lender then bids on the loans they want in their portfolio once the
amount of money required is reached the loan is originated. However, instead of
originating the loan themselves, a bank originates the loan. The platform then
issues a note (the name “notary” stems from the issuance of notes instead of
contracts) to the lender for the value of their contribution to the loan. This
note is considered as a security in many jurisdictions. The investor has made an investment in a note,
not an actual loan, and hopes that the borrower will repay so that the note
will be paid by the platform. This model is popular in the US,
particularly with platforms such as Prosper and Lending Club as shown in (flow
chart 4).
Flow chart 4:
Notary Model
Source: IOSCO Research Department
Advantage for
investors shifts the risk of loan non-payment to the lenders themselves and
away from the bank originating the loan, Investor are able to invest in big
projects or able to project finance.
Disadvantage for
investors Investors do not make loans directly to borrowers,
excessive power is in the hands of banks or platform (middle man), Lender have
to rely on the platform about the credit ratings of the borrower, lenders don’t
have the ability to determine interest rates instead, the site sets an interest
rate based on borrower performance, On the event of default lender have to wait
up till the platform or the bank start proceedings.
D. “Guaranteed” return model
Under this model allows
lenders to invest in peer-to-peer loans through the intermediary platform at a
set rate of return on the investment guaranteed by the intermediary platform
but there are two other models called as a Offline Guaranteed Return Model or
Automated Guaranteed Return Model as shown in (flow chart 5).
Flow chart 5:
Automated guarantee return model
Source: IOSCO Research Department
Under Offline mode
the use of direct channels and through face to face sales techniques in the
locality of the borrowers. The borrower is then manually assessed for
creditworthiness. After this, the loan is listed on the online platform and
lenders can choose to invest in the loan. This is the most popular model in China, and is the
main model used by CreditEase. Under Automated Guaranteed Return Model, with
the TrustBuddy International AB. The
lender pays into a client account the amount they wish to invest overall. The
platform then automatically lends this money to borrowers it has chosen through
a metric created by the platform itself.
Advantage for
investors Under this model there is a low risk on
investment, fixed return on investment interest on particular, offline model manual
assessed for credit worthiness of the borrowers or direct in touch with
borrowers and no concept of middle men in investment.
Disadvantage for
investors Investors have to rely on platform
assessment about the creditworthiness of the borrower that create significant
doubt whether the platform assessment is done with certain standard. What if
the platform failed like Trustbuddy international. Trustbuddy international
filed for the bankruptcy there is the suspected misconduct that compelled the
platform to shut down operations charges.
The cause of failure are misconduct, lack of liquidity and inability to
operate a regulated operation, TrustBuddy cannot move forward with the
business.
MARKET GROWTH OF DEBT BASED
CROWDFUNDING
The surging alternative finance
market in Europe has reached nearly €3 billion ($3.9 billion) in 2014, a jump
of 144%, and small-business peer-to-peer loan volume in France alone grew
almost 4,000% last year, to reach €8.2 million ($10.6 million), crowdfunding in
Europe is becoming a major factor in the finance sector as shown in figure
3.
Figure 3: Growth
of peer to peer lending from 2010 to 2015.
Source: Last Quarter Peer to Peer FA Data.
The growth of the
peer to peer lending is expected to grow to $150 billion by 2025, according to
accounting firm PwC.
ALTERNATIVE FINANCIAL MARKET GROWTH
The UK alternative
finance grows by 84% to £3.2 Billion in 2015. Online alternative finance grew 84%
to £3.2 billion from £1.74 billion in 2014 as shown in (figure 4). The SMEs
were the biggest beneficiaries as approximately 20,000 raised about £2.2
billion on digital platforms during the year. The total alternative lending hit
£1.82 billion or 3.43% of gross national bank’s lending to SMEs. The lending
still continues as the largest sector by volume. Equity crowdfunding continues to grow rapidly jumping
295% to £332 million from only £84 million in 2015. This segment of crowdfunding now represents
15% of all UK seed and venture funding. The hottest sector is the Real estate.
The combination of debt and equity drove this category to £700 million in 2015.
The Institutional investors are playing a larger role in alternative finance
with 32% of consumer lending and 26% of business lending being driven by big
money.
Figure 4: Raise of
Alternative finance in UK.
Source: Report by crowdinsider
In the UK peer to
peer lending growth rate in business
lending average growth in 2012 -14 is around 210% the major business sectors
includes Manufacturing, Professional and Business Services, Retail and
Construction. In business model the investor range of £1000 - £3000
comprises maximum 30% of the investment and minimum range of investment amount is
below £500. In consumer lending average growth rate in 2012- 14 around 108%
includes Car/Vehicle purchase, Home improvement, Debt consolidation (e.g.
paying off credit cards overdrafts). In consumer lending the investors range of
£5000 - £20000 comprises maximum 31% of the investment amount and minimum range
of investment is below £100.
CONCLUSION
The alternative
financial system is alternate to the traditional financial model like banks,
financial institution etc. The growth of the alternative finance market depend
on the investors friendly and protective approach. There are certain issues
with regard to these market is still unresolved. The private entrepreneurs or
online portals business models are try to establish business model that able to
create more investors friendly approach. The Financial return business models under equity or debt based crowdfunding
facing both advantage and disadvantage. The crowdfunding is under the
developing phase its premature to conclude which business model is best model
for the crowdfunding industry. There issues of credit rating because the credit
rating is the deciding factors for the investors to invest in particular
industry. Its important to maintain certain measures and guideline for
the platform to define credit rating for the borrower. Secondly crowdfunding is on the concept of
free market the interference of the platform operator in managing the funds for
the investors but restricting the interference of the platform operator further
imposed duty on the investors to do due diligence with regard to the project
and must aware of the fact that
investment may get failed.
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