European Crowdfunding Framework Oct 2012

7/30/2019 European Crowdfunding Framework Oct 2012

1/401A FRAMEWORK FOR EUROPEAN CROWDFUNDING | Kristof De Buysere, Oliver Gajda, Ronald Kleverlaan, Dan Marom | 2012

www.crowdundingramework.eu

A Framework for

European Crowdfunding

Kristof De Buysere

Oliver Gajda

Ronald Kleverlaan

Dan Marom

With a foreword by

Matthias Klaes

2012www.crowdundingramework.eu



www.crowdfundingframework.eu

Authors

Kristo De Buysere

Oliver Gajda

Ronald Kleverlaan

Dan Marom

ForewordMatthias Klaes, Proessor o Commerce, Keele University

ContributorsAlain Renaud (France)

Alexis Wochenmarkt (Belgium)

Alex Raguet (France)

Bart Becks (Belgium)

Clas Beese (Germany)

Christian Saublens (Belgium)

Emma Fau (Belgium)

Eva Serlachius (Finland)Fabien Risterucci (France)

Frederic Baud (France)

Guillaume Descle (Belgium)

Iwona Mertin (Belgium)

Jamie Hartzell (Great Britain)

Karol Krl (Poland)

Katelijn Tailly (Belgium)

Korstiaan Zandvliet (The Netherlands)

Liam Collins (Great Britain)

Lionel Slusny (France)

Pascal De Keyser (Belgium)

Paulo Silva Pereira (Portugal)

Reinhard Willort (Austria)

Rhydian Lewis (Great Britain)

Robert van Meer (The Netherlands)

Simone Dean-Johns (Great Britain)

Thierry Merquiol (France)

Tim Meuleman (The Netherlands)

Yann Le Jeune (France)

Yannis Pierrakis (Great Britain)

A Framework for





A Framework for


Supporters

Impressum

A Framework or European Crowdunding, 1st ed., 2012

Kristo De Buysere, Oliver Gajda, Ronald Kleverlaan and Dan Marom,

with a oreword by Matthias Klaes

This work is licensed under a Creative Commons

Attribution-NonCommercial-ShareAlike 3.0 Unported License.

ISBN 978-3-00-040193-0

Layout: www.runtinx.de

Illustrations: Astrid Bckermann

Institut fr Kommunikation

in sozialen Medien

kosom

EUcapital

ppl.com.pt

in association with

Zur Frderung der Innovationskultur




Contents

Contents 3

Foreword 4

Executive Summary 6

Statement o Purpose 8

What is Crowdunding? 9

How Crowdunding Works 12

Challenges With Crowdunding 15

Benets or Entrepreneurs and SMEs 18

The European Crowdunding Market 21

Benets or the Internal Market 23

Policy Discussion in Europe 25

European Regulation and Legislation 28The Pillars o a Crowdunding Framework 33

Implementing an Operational Framework or European Crowdunding 35

Further Reading 38

About the Authors 40




It is more than ve years ago now that the rst ripples o the current nancial crisis started sprea-ding across the globe. What initially looked like a problem largely conned to the North American

sub-prime mortgage sector soon aected most advanced economies in the Western hemisphere. In

Europe in particular, uncertainties resulting rom a general squeeze on retail credit have been acer-

bated by recurring threats o systemic disruption in the nancial and monetary spheres.

Virtually overnight, small and medium sized enterprises have thus ound themselves at the sharp end o di-

minished access to credit. They are joined in their plight by all those organisations and initiatives in the cul-

tural sector who experience a period o almost unprecedented nancial restraint, while private households

even in good nancial standing may struggle to gain access to reasonably priced loans.

The economist Joseph Schumpeter spoke in a similar context o the gales o creative destruction unleas-

hed during an economic crisis. New orms o economic activity may gain oothold and begin to disrupt

established ways o doing business. Crowdunding is arguably the most visible instance at present o such a

reshaping being under way. As a phenomenon, it prompts us to revise our understanding o and approaches

to small to medium scale undraising across most economic activity.

This report is thus very timely indeed. As the authors describe in comprehensive detail, crowdunding may

take many orms. But it is clear rom their survey that we are witness to the rise o a new kind o investor,

a new kind o entrepreneur, and a new kind o intermediary, who are all coming together in novel ways o

channelling unds to innovative projects and SMEs.

The authors also do not hesitate to point out that crowdunding, as a disruptive technology o nancial

intermediation, comes with a set o challenges that policy makers cannot aord to ignore. In its manyorms, crowdunding oten straddles boundaries between dierent regulatory approaches and rameworks

to nancial intermediation and investing. This is particularly true in a European context where common

regulatory approaches to nancial intermediation have displayed a marked tendency to lag behind the es-

tablishment o the common market itsel. Questions have also been raised regarding consumer and investor

protection in this context.

As we are gaining a deeper conceptual and empirical understanding o the issues involved, the ramework

presented here not only seeks to move the discussion along with a number o concrete policy proposals, it

also seeks deeper engagement with the various stakeholders. A call or urther research is thus one o its

key pillars, alongside joined up regulatory thinking and targeted educational initiatives.

In this light, I commend A Framework or European Crowdunding to your attention. It deserves the widest

possible readership and debate, and should acilitate a step-change in approach and coordinated response

to what clearly has the potential o turning into a lasting reconguration o an increasingly important

dimension o nancial intermediation in Europe and beyond.

Matthias Klaes

Proessor o Commerce, Keele University

Author (with N. Wilkinson) oAn Introduction to Behavioral Economics

Foreword




Executive Summary

While all our ancient belies are tottering anddisappearing, while the old pillars o society are

giving way one by one, the power o the crowd is

the only orce that nothing menaces, and o which the pres-

tige is continually on the increace. The age we are about to

enter will in truth be the era o crowds.

Gustave Le Bon

This paper is structured to give a concise overview o the state o crowdunding in Europe, with the

aim o establishing policy and a distinct ramework or the European crowdunding industry, eorts

which we believe will aid in the economic recovery o Europe.

Research shows the majority o job creation comes rom small and medium sized businesses, which

account or 99% o all businesses in Europe. The vast majority o these have ten or ewer employees.

These are also the businesses that have been most impacted by the economic crisis, and as such, need better

access to capital in order to do what they do best: innovate, create jobs, and restore stability.

One o the most promising solutions or restoring capital to entrepreneurs and SME is crowdunding, de-

ned as the collective eort o individuals who network and pool their resources, usually via the Internet, to

support eorts initiated by other people or organizations.

In its various orms, crowdunding allows entrepreneurs and SME to solicit capital rom unders, using

social networks and crowdunding platorms to nance their businesses and projects.

There is currently no established policy in Europe or crowdunding and we believe it is o the utmost im-

portance to create crowdunding legislation to remain competitive in a global market.

Last year, Europe raised around 300 million or one third o the world market, considering all types o

crowdunding. At the end o 2011, there were around 200 crowdunding platorms active in Europe. Their

number is expected to increase by 50% by the end o 2012.

For SMEs and entrepreneurs, not only can crowdunding provide start-up capital, it espouses several non-

nancial benets: validation o product eatures, market segmentation, price and demand, pre-sales and

customer eedback as well as word-o-mouth marketing and a stable, committed shareholding structure.

The European Commission stated its aim to support the business environment or SMEs and promote suc-

cessul entrepreneurship; we believe crowdunding should be integrated into that aim in the near uture.




To maintain the integrity and proper ethics o crowdunding in Europe, we believe it is essential to create aramework o best practices and suggest a three pillar approach.

The rst pillar is regulation; until legislation is enacted, crowdunding intermediaries should establish

criteria ocusing on the ollowing categories o consumer protection: operational and nancial transparen-

cy practice, nancial control, security o inormation and payments, platorm unctionality, and operatio-

nal procedures. These will assist in raud prevention and detection and will signal credibility to individual

unders.

The second pillar is education; or crowdunding to fourish, we believe a pan-European educational

orum is necessary to educate stakeholders, unders, and entrepreneurs on the benets o the industry, and

the dierent business models o crowdunding. These orums will provide a reasonable and air guide to

protect the nancial interest, exposure and diversication o unders and investees across multiple crowd-

unding business models. This needs to provide guidance around raud, risk explanations and potentially the

testing o unders knowledge.

The third pillar is research; we believe the industry should drive academic and third party research. We

believe crowdunding operators should provide data sets to urther industry research; the industry needs to

nd a transparent and open approach. Public reporting and research will drive competition and innovation

within the industry.

Finally, European, national and local legislators and policy makers should join orces to establish crowdun-

ding-enabling legislation in Europe.

In this paper, we outline a number o potential policies and regulations which we believe oer a good star-

ting point or a broader discussion.

We hope to see many o these thoughts adopted or the benet o the European economy.




Statement of Purpose

People only accept change when they are acedwith necessity, and only recognise necessity

when a crisis is upon them.

Jean Monnet

The 2008 nancial crisis crippled the global economy. For Europe, the recovery has been tenuous,

witnessing the lack o condence in the sustainability o individual nations, and dwindling trust in

the nancial services and banking industry.

While the strategy or economic recovery has ocused on scal policy and the banking system, the

brunt o the nancial burden is placed on small businesses and entrepreneurs. These groups are let

without unding or their businesses, without the security o a bank loan, and without access to

credit lines rom the nancial services industry.

To contextualise the gravity o this problem, we would like to point out that the 23 million small and medi-

um sized enterprises (SMEs) in Europe represent 99% o businesses. Research rom the Kauman Founda-

tion shows or the past 30 years, all net job creation in the USA has taken place in rms less than ve years

old. As such, access to capital or SMEs is critical or sparking job creation in Europe.

The European Commission aims to promote successul entrepreneurship and improve the business envi-

ronment or SMEs. Yet new taxation or banks at the national level and Basel III regulation will likely result

in lower lending to SMEs. Venture capital, a sector dened by an anti-cyclical business model with built-in

protection rom economic crises, is suering rom a serious decline in unds.

Moreover, declining stock prices continue to hinder initial public oerings, ultimately causing venture

capitalists to exit investments through trade sales to large or multinational corporations, acts which inhibit

exponential growth and job-creation within the start-up community.

The broken glass theory espouses that xing the small things will help solve the bigger problems. It is clear

that signicant economic growth and job creation comes rom the myriad o innovating, producing, and

servicing entrepreneurs that enrich our daily lives and disrupt the established markets.

While not every small business is going to be a game changer, we must provide the inrastructure and

access to unding to enable SMEs to succeed. To eliminate the unding gap or SMEs, we must look to the

uture and innovate.

It must be the civil and ethical duty o European politicians and citizens to nd a solution to the economic

crisis. We believe the crisis provides an opportunity or much-needed change. Change, albeit disruptive, i

managed well, is a guarantor or innovation.

Today one o the most promising tools to help enable economic growth, job creation, and innovation is

crowdunding. We believe crowdunding is one o the most viable means o unding new ideas, small busi-ness and job creation across Europe. It is a highly democratic tool that is posed to have a disruptive impact

on community, start-up and consumer nance by allowing value creation on many levels, not just nancial.




What is Crowdfunding?

When patterns are broken, new worlds emerge.Tuli Kupferberg

Crowdunding can be dened as a collective eort o many individuals who network and pool their

resources to support eorts initiated by other people or organizations. This is usually done via or

with the help o the Internet. Individual projects and businesses are nanced with small contribu-

tions rom a large number o individuals, allowing innovators, entrepreneurs and business owners to

utilise their social networks to raise capital.

Common examples o crowdunding include donations to a charitable cause, a band raising money or an

international tour, or even a politician raising money or an election campaign. For example, in 2008, Barack

Obama raised $137 million during his run or the presidency o the United States through an online

campaign that showed signicant similarities to crowdunding.

As an industry, crowdunding is in its inancy. Nearly a decade ago, the rst crowdunding platorms har-

nessed the internet as a tool or community building and distribution. Yet the basic concept o crowdun-

ding is much older and has been utilised across disparate industries or decades. Parallels can be identied

in community and co-op banking, subscription sales, and the opening o the stock market to retail investors.

The rise o the crowdunding industry over the past decade comes rom the advancement in web andmobile-based web applications and services. Entrepreneurs and businesses can utilise the crowd to obtain

ideas, collect money, and solicit input on the product, overall ostering an environment o collective

decision-making and allowing businesses to connect with potential customers.

Crowdunding is used by organisations or market research, nancing and marketing. Depending on the

need o the project, dierent business models can be used. The main advantage o crowdunding is that the

unders are also ambassadors o the project or business they support and that they will help to market and

promote it through their own networks.

In comparison to incumbent nancial services a core dierence lies in the under who participates in

crowdunding. The under in crowdunding is usually a somewhat entrepreneurial person, with a certain ap-petite or excitement, in as much as she or he understands the potential o the project and has the intrinsic

urge to be a part o the group that is going to make it happen.

Oten, the under does not own the relevant resources to nance a project in ull and also does not own the

competencies that may be ound in a venture capitalist or nancial services expert. Yet the under usually

identies with the project, has a mind or change, and is happy to help provide the social proo o concept.

Important here is a perceived emotional rate o return where the value is not only the probability o uture

nancial gains, but also the engagement in a promising project close to the unders interests.

Prot maximisation as a goal is rare in crowdunding, or now. The risk o ailure does not necessarily

translate into risk o loss o capital, because success is or the under usually not dened through nancial

return.




O course, the dierent crowdunding models also correspond to slightly dierent motivations in unders,though they all are to some degree intrinsic motivations. There are basically our types o crowdunding:

donation-based, rewardbased, equity-based, and lending or debt- based:

Donation: a donor contract without existential reward

Reward: purchase contract or some type o product or service

Lending: credit contract, credit is being repaid plus interest

Equity: shareholding contract, shares, equity-like instruments or revenue sharing in the project/business,

potential up-side at exit

Crowdfunding Business ModelsWhile the terminology stated in the main part o this paper is to some degree widely used in the USA and in Europe, we believethat it does not pay tribute to thriving business model innovations that have been created and thus does not take into accountthe potential disruptive nature o crowdunding. We have outlined some o the innovative crowdunding models in use todayseparately here.

We believe crowdunding is transormative in its total o business models, with the biggest potential lying in the combination odierent approaches that will allow unding the whole lie-cycle o a project, product, services or other business innovation. Theollowing is not meant as an inclusive overview but to showcase variety in crowdunding business models.

DonationsNGOs have used this model to attract donations or specic projects or over ten years. Unlike with tradiotional undrasing,donations are collected and ear-marked or a specic project. Because unders know that their money will be used on a veryspecic project, they are more willing to donate higher amounts per person.

These types o donors also tend to be more loyal in the long term when the NGO will keep them updated about the progress othe project, ensuring recurring donations. The main motivation or unders is social. It is intrinsic motivation, which is usually agood base or a long term donor relationship.

RewardsThis business model is used by project owners who want to collect donations or a specic project and can give (oten small)non-nancial rewards in return. The rewards are o a symbolic value and provided by the investee. They are usually much lowerthan the donation amount, to ensure there is enough money let or the project.

Nevertheless, the perception o the value can be much higher, or example special VIP tickets as a reward or a higher donation.A reward in this context should not be understood as a token o appreciation. In general, the parties do not consider it a legallybinding obligation to provide the goods and do not classiy it as a sale.

When the dierent reward-levels are chosen wisely, it is possible to receive a much higher average donation than with a pure

donation-based approach.Pre-SalesIt is possible to put a new product or service online and ask unders i they are interested to order and pay in advance. Thisreplaces traditional market research and validates demand while providing working capital, i successul.

Funders that participate in these crowdunding campaigns do it because they want this product or service to be made. Anotherreason is that they will get a discount on the sales price.

LendingWith lending-based crowdunding, a company will borrow money rom a group o people instead o a bank. The role o the plat-orm can be diverse. Some o the platorms will act as a middle-man and will also make the repayments to the lenders, whereother platorms act only as match-makers and the borrower and lenders will be connected when the deal is closed.

Social LendingSome platorms give the possibility to lend to social projects with no interest being oered, or example where businesses indeveloping countries can receive micro-nancing without any interest being paid to the lending party.



Peer-to-Peer LendingAlthough Peer-to-Peer Lending (P2P) is not real crowdunding and is not necessarily based on goodwill, it is an interestingnew nancing model or loans. It has some characteristics o crowdunding lending, but the main dierence is that the lendersand borrowers usually do not know each other.

With P2P lending, the main motivation or the under is a (higher) nancial return. The interest-rates in general are based onthe risk-actor. The risk-actor is calculated based on nancial data and personal securities. These calculations are currently doneby P2P-platorms that show-case the loans or by independent institutes. There are also innovative models in which the risk isborne by provision unds and not the individual lenders.

This model is used by borrowers who are looking or a loan with a lower interest rate than the one they can get rom a bank. Itcan also be used by borrowers who can oer ewer securities. Existing data shows that deault rates or P2P lending on averageare very low, below 1%. This subset o crowdunding is continuously growing and protable. New lending is estimated at wellabove 20 million per month or Europe.

In P2P lending only the money provided by the unders is being lent out. Thereore there is no money creation within the plat-orms unlike with traditional banks. As a result, there is no systemic risk attached to P2P lending.

Peer-to-Business LendingSimilar to P2P lending, there are platorms that provide loans to small and medium sized businesses.

Equity CrowdfundingWhen a company wants to attract an investment rom a group o people, instead o unding by a business angel or anotherprivate investor, this is called equity crowdunding or crowdinvesting.

Some unders are primarily interested in investing in projects that share their own values, that are locally engaging, or thatcreate jobs in their community. Others have a real knowledge o what the market, project, or company is addressing and desiresto bring unds and expertise to the success o the project. This practice is very similar to business angels.

Equity crowdunding also generally includes equity-like arrangements, oering the same payo as equity (shares), and wherethe under is actually merely a creditor who has a contractual right to receive that payo.

Variations on these ModelsNext to the established models which are mentioned above, there are some variations on these models that can be used.

Revenue SharingFunders can also receive a return based on uture revenues o the company via revenue sharing arrangements or instanceor royalty-based nancing. Such rare but nonetheless promising alternative payo structures may be less straightorward tocategorise under the notions above, but contractual reedom may allow oering payo structures that do not resemble equity,equity-like or typical xed loan payos.

In Kind (reward)Independent o the type o business model chosen, organizations can give a payo in kind. This means that based on a moneta-ry input, the under will receive a payo in kind that has substantial worth. The exact amount is not always clear at the start o

the project, and is thus subject to the risk. Normally these are products or services rom that organization.

In Kind (funding)It is also possible to participate in a crowdunding project as a under by oering products or services instead o money. In mostcases, these products or services otherwise need to be purchased by the project and thereore have a real nancial value to theinvestee. For the under, the cost o the investment is restricted to opportunity and operating costs.

Hybrid ModelsCombined models are also possible. Some platorms experiment with a combined model o loans and pre-sales. A percentageo the unding will be put into a loan (and will be repaid with interest) and the other part o the unding will be used to pre-nance the production o the product or service. Also or the entrepreneur there are benets in hybrid models or in approachesto mix crowdunding with other investment orms, or example where crowdunding is used to pre-sell a product, throughwhich market validation and segmentation can be done, to generate revenue and positioning the project or ollow-up orparallel investment rom business angels.



How Crowdfunding Works

In the new economy, inormation, education,and motivation are everything.

William J Clinton

Crowdunding is based on the act that people want to help other people and projects they like and

that are close to them, emotionally or geographically.

Some people are primarily interested in investing in projects that share their own values, that are locally

engaging, or that create jobs in their community. Others have a real knowledge o the market a project or

company is addressing and desire to bring unds and expertise to the success o the project, very similar to

business angels and venture capital unds.

In crowdunding the actors are project owners (entrepreneurs or individuals with a specic goal), unders

(investors, lenders or donors) and the crowdunding platorms as an intermediary.

Motivation of fundersThere are three dierent motivations or people who want to participate in crowdunding: social return,

material return and nancial return.




Social ReturnWith social return, the unders are already satised when they see that a project can be realised, their moti-

vation is intrinsic. Funders do not want anything else in return. This kind o return is normally present with

donation-based crowdunding and is used extensively by non-prot organisations.

Material ReturnWith material return, the unders get a product or service as a reward or their investment. The business

model that is used or this is pre-sales crowdunding. An investor pays the project owner in advance. The

project owner can use the unds as working capital to create the product or service.

Sometimes a under is satised with a return with a (much) lower economic value than the original invest-

ment. This business model is called reward-based crowdunding. The perceived value can be much higher

than the actual economic value, or example, entrance tickets or a concert as a reward or a high donation

or a personal meeting with the musicians when a under gives an even higher donation. Examples are

numerous and not limited to any specic industry.

Sometimes material returns are also given to unders in loan and equity-based business models. Here the

unders get a product or service rom the company they invested in, instead o an interest or dividend

payment.

Financial Return

I a under likes a crowdunding idea, but also wants some nancial return, he can invest via loan or equity-based crowdunding. Here the risk is usually diversied between nancial and emotional motivations.

The project owner can use loans or equity-based crowdunding to collect investments against interest or

dividend payments. In comparison, social lending oers the under a 0% interest-rate on his loan.

Motivation of project ownersBesides raising money, crowdunding allows the project owner to gain eedback on some o the most criti-

cal parts o the product beore its release into the public marketplace.

For example, the project owner is able to gauge pricing inormation, demand or the product, eedback

on how design might be improved, demographic on potential buyers, precise inormation about market

demands, and direct customer interaction. It can also lead to word-o-mouth recommendation and othersocial marketing.

For the project owner, crowdunding establishes a direct link between himsel and the customer. This link is

the rst step towards marketing, customer loyalty, participation, and emotional attachment to the product.

Crowdunding is an incredibly eective way o gauging i their product or idea has a mass appeal. Even

more important is the time in which the project owner is able to make this assessment; a two-month long

crowdunding campaign is a relatively ast turnaround or getting an idea o the ground.

For project owners who experienced a successul crowdunding campaign or their rst round o nancing,

the aorementioned benets can be extremely useul or a second round o nancing. Some project ownersmay utilise crowdunding again, where others may resort to more traditional orms o investment, like

venture capital or business angel investing.




When project owners combine dierent approaches they can und the whole lie-cycle o a project,product, services or other business innovation.

Either way, being able to call upon pre-sales inormation, number o unders, amount o money raised in a

specic time period is valuable or project owners seeking a second round o nancing.

How crowdfunding platforms workAn online platorm usually serves as an intermediary between the project owner (entrepreneur or individual)

and under. Below is a simplied sketch o how a typical crowdunding scheme works:

Online platorms receive applications rom project owners who intend to showcase their business idea

or cause on the platorms website. Some platorms make a pre-selection o the ideas based on theirown criteria, while others automatically publish every idea. Platorms that use pre-selection are checking

the background o the project owner and do a quick review on the easibility o the crowdunding plan.

Ater an idea is accepted by the online platorm, the project owner is tasked with creating a unding

goal over a marked period o time and an online pitch (most o the times in the orm o a video), where

the project owner pitches his/her idea to potential unders. Project owners oten utilise social networks

to access potential unders on a larger scale. Funders then und the campaign directly through the

online crowdunding platorm.

During the campaign the project owner will keep his unders/ans updated about the process with

updates on the online platorm.

I the unding goal is reached within the allocated undraising time rame, the project owner receives themoney. I the unding goal is not reached, most o the platorms will reimburse the money to the unders.

In terms o post investment, some unders choose to remain involved in the decision-making and overall

strategy o the business. Some unders receive voting rights in the business. In most cases the

communication between the unders and project owners will continue through the online platorm.




Challenges with

Crowdfunding

We cannot solve our problems with the samethinking we used when we created them.

Albert Einstein

The ollowing is especially pertinent or, but not limited to, equity-based crowdunding. There are

certain disadvantages in the current approach to crowdunding that need to be reconciled in the

near uture. We have outlined below some o the common points o contention below:

FraudFraud is perhaps the most widely-debated issue or critics o crowdunding. Critics point out the potential

or unders to und scams through crowdunding platorms. The risk or raud increases in crowdunding

because unlike venture capital or angel investing, the pool o unders has no personal contact or real know-

ledge o the business idea beyond what is presented on the crowdunding website.

Moreover, the geographical separation between the business/entrepreneur and under can prohibit the un-

der rom physically overseeing the business. However, it can also carry advantages in centralised markets.

Indeed, raud prevention and detection is o utmost importance or maintaining the integrity and ethics o

the industry. We believe there are several methods o preventing raud.

First, it is important to note that social media can be used as a tool o raud prevention. Use o the internet

and social networking allows unders to perorm research on the entrepreneurs beore deciding i they

want to invest.

It is also important to look to the crowdunding platorm to vet against raud. As mentioned beore, most

crowdunding websites already have raud detection mechanisms in place.

Moreover, UK-based independent charity NESTA rightully points out that the emergence o more crowd-

unding platorms will create more competition among platorms, and to remain competitive, raud detec-

tion and vetting services will become even more important.

Setting ValuationsAnother concern with equity crowdunding is setting valuations so the entrepreneurs can decide how much

equity to oer or the amount o capital they want to raise. Current practice establishes that the entrepre-

neur set the value o the business prior to the start o the crowdunding campaign.

This can be problematic, particularly as there are oten parts o the business, such as intellectual property or

estimations on market size and scale that are dicult to estimate or quantiy. As such, the

entrepreneur can either undervalue or overvalue the business, creating signicant problems or the unders.

To circumvent this issue, some crowdunding platorms permit the entrepreneur to be fexible with the

amount o equity oered over the course o the campaign. Another potential solution is allowing the entre-

preneur to set the amount o equity and the number o shares, and then call on the potential unders to bidor the equity or shares. Those unders who pay the most money then win the shares/equity.




Post Investment CommunicationI a crowdunding campaign is successul, many unders will continue to be involved in the business at

the post-investment stage. Post-investment, unders can provide the entrepreneur with advice on issues

ranging rom business strategy to product pricing to design.

However, managing a large number o stakeholders, particularly as they may not all be located in the same

geographical region, can be incredibly dicult to manage. For the platorms which allot voting power

to unders, this can be even more dicult to manage, i not only or purely logistical reasons: imagine

allowing 300 disparate unders to vote!

For equity crowdunding there is also a question about liquidity in the secondary markets, as access to capi-

tal, especially equity, or SMEs remains very limited and the possibilities or urther unding or exits or thecrowd unders are closed. Eorts to combine crowdunding and business angel investing have been made

and are one potential solution, but this will remain a solution or a select ew businesses and projects.

There is a marked tension between investment and guarding the SMEs that needs to be addressed and

resolved in the near uture. In this paper, we will address the need or the creation o a ramework to be

adopted by the crowdunding industry or best practices and to guard against raud.

Data, Analysis And Risk MitigationOne o the main hurdles associated with crowdunding is its open nature, insoar as individual unders

oten times have no ormal training and may not be equipped to assess the nancial risks involved.

Eective risk assessment requires the ollowing three things: reliable data, capacity to analyse, ability to

mitigate risks.

Reliable Data: At this stage, there is no commonly accepted data model used or presenting investment

projects across platorms. While open source accounting data standards do exist, they have not yet been

widely adopted by crowdunding platorms.

There is also no real obligation or ounders to provide any sort o controlled data when pitching an invest-

ment project. A common body o operating standards will greatly assist this prospect and will bring about

the required transparency the crowdunding industry requires.

Capacity to Analyse: Individuals investing in crowdunding platorms oten are not proessional investors

and thereore require metrics o their carried risk when investing in any product. The traditional nancial

industry uses these measures (albeit with mixed success), and crowdunding has the potential to bridge thegap in investor inormation by establishing solid and widely accepted risk measures.

Risk Mitigation: Absolute nancial risk is a convolution o investment time, type o products, economic

context, diversication o investment, and amounts invested compared to total wealth. All these actors

play a complex role in dening whether an investment will be successul or not.

While crowdunding oers opportunities or innite diversication, it currently ares poorly in terms o

controlling products, investment horizon, and the net investment capacity o individuals. The industry

should look to develop a title o qualied investor in crowdunding, that should be complemented by the

obligation o platorms to provide sound and widely accepted risk measures.




Conflicts Of Interest & Operational RisksConficts o interest occur when owners or specic unding providers use privy inormation to generate

systematic superior returns compared to the crowd nancing it.

Some platorms operate on a co-investment model, whereby an investment und completes the investment

o crowds or precedes it in the orm o seed capital. Many o these platorms have already understood the

potential conficts o interest, thereore ollowing a strict 50/50 rule (between own unds and crowdunded

unds) within a single crowdunding campaign.

Although this is mostly true with single crowdunding campaigns, all investors returns have to be compa-

red on the longer term, and there are ew guarantees (or laws) that prevent additional deals to be carriedout ofine (i.e. outside the crowdunding platorms).

There are also parties who might get a better investment opportunity than the crowd initially responsible

or unding. These types o situations must be strictly avoided and rules should be enorced or raising

money online (via the crowdunding platorm) vs. raising money ofine (in private deals).

Similarly, while we know that many nancial institutions do not publicly disclose the identities or demogra-

phics o their shareholders. It is critical to question this practice or the crowdunding industry.

The limited size o many crowdunding platorms starting-up supposes a high concentration o ownership

within the operating companies. This means the actual operations and development depends on the limited

set o resources o its shareholders. Size and shareholder capability are thereore a signicant issue or

many (growing) crowdunding platorms.




Benefits for Entrepreneurs

and SMEs

Benefts should be conerred gradually.And in that way they will taste better.

Niccolo Machiavelli

Crowdunding can oer unique support or budding and existing entrepreneurs on multiple levels.

No other investment orm, be it debt or equity, can provide the benets o pre-sales, market re-

search, word-o-mouth promotion, and crowd wisdom without additional cost.

Donation-based crowdunding helps not-or prot organisations to und projects and core costs, but it can

also help to und creative activities and common purpose activities. Both debt-based crowdunding and

peer-to-peer unding help smooth consumption and income fuctuations, and can provide SMEs unds or

business expansion, production, and other activities. This is a compelling alternative to traditional lending

products.

Reward-based crowdunding is requently used or creative businesses or smaller consumer products, whe-

re basic pre-nancing or production is linked to an initial demand-test. I a sucient number o people

enter into a unding agreement, the entrepreneur has market validation as well as the pre-nancing or his

activities.

And nally, equity-based crowdunding oers an additional route to raise equity or any business venture,

with all associated risks. Due to inormation asymmetries and lack o publicly available data in the tra-

ditional sense, the investment risk appears higher. However, through the nature o peer review and peer

recommendation, as well as instant eedback and the publication o all necessary project details to a large

group o potential unders, some o this risk can be mitigated.




Crowdunding denotes space or co-creation and the involvement o the end-user in the product denition,a greater pool o innovative ideas and a ree word-o-mouth marketing channel. It is also an investment

channel or collective wisdom, replacing investment decisions by individual investors or individual und

managers acting based on their personal understanding o or experience with any given market.

These benets can decrease the cost o product development and pre-marketing, while at the same time

generating revenues beore production, thereore providing, at best, a positive cash-fow rom the start.

Crowdunding, in all its varieties, is an unparalleled source o pre-seed and seed capital, loans, revenue

and donations. Crowdunding has the real opportunity to apply leverage where all other ormal nancial

services ail.

In the very early, pre-seed stages that are usually ully nanced by the entrepreneurs themselves, their a-

milies and their riends, crowdunding can provide risk-diversication to start-up and micro-entrepreneurs

in highly innovative services and products, with a specic local appeal or generic consumer markets.

It can be used beore and as a supplement or government support unds, business angels and bank loans,

whilst enabling entrepreneurs to either grow their business organically or to scale the business ast through

equity investment to make it attractive or early-stage venture capital unds.

Crowdunders are motivated rstly by an emotional engagement and personal interest in a specic project

that seeks unds. The emotional engagement is related to, amongst others, local needs, private preerences,

or brand values that are attached to the project.

These are not emotional reactions on the macro level and thus have no systemic risk attached. This is in

direct contrast to public markets, where uncertainty requently creates ear and leads to signicant but

non-rational value destruction (or creation) as can be seen with the Euro Debt Crisis or with industry stocks

and single stocks ater public announcements.

Emotional engagement with a specic project aligns the crowdunder with the entrepreneur. The under

ultimately takes a risk based on an intrinsic personal conviction o the projects possibilities, oten mixed

with additional expectations o social and nancial return.

Crowdunding combines the emotional engagement and dedication o entrepreneurship with the social and

nancial returns o investment, ultimately aligning the under and investee in the early stages o business

growth.

The users direct infuence and nancial support become key actors in the successul delivery o the nal

oering with regard to value creation the user becomes a co-creator.

In this way, crowdunding changes the way we should see nancial services and the involvement o consu-

mers. Its mechanisms help to de-risk pre-seed to later-stage investments prior to committing unds, while

provide input as to demand, pricing and validity o the business at the same time.




According to the Harvard Law & Policy Review, crowdunding, in its various maniestations, promises todecentralise and generally transorm corporate nance around the world. Where entrepreneurs and SMEs

have diculty accessing unding rom traditional nancial institutions, crowdunding allows unders to

utilise personal networks to und their businesses and create jobs.

Studies rom the Advanced Human Resource Studies Center at Cornell University show that remote work

is oten more productive than work in an oce. The results o this are twoold: rst, many companies are

shiting towards a remote workorce, and second, workers are beginning to live outside o major urban

centres.

This trend is inherently problematic or the entrepreneur seeking unding, as studies rom Harvard Business

School show that the entrepreneurs proximity to an urban hub (where venture capital companies are usu-

ally located) is connected to the decision o the venture capital company to provide unding. The research

suggests that the arther away an entrepreneur lives rom an urban hub, the less likely he/she is to secure

venture capital unding.

However, or now especially projects with a regional or niche ocus are able to attract support rom the

relevant communities, as they can develop a close connection to the project, and oten meet ace to ace

with the people behind the project. Fragmentation through language, tax and legal issues and regulation

across Europe will contribute to this.

While we believe that this works well with relevant projects, we do not believe it adequate or more am-

bitions, scalable projects and their potential impact on society. Governments need to decentralise unding

networks by providing crowdunding investing rameworks, which allow unders to und projects romanywhere on the globe. A crowdunding ramework both makes capital more available and more ecient,

ultimately leading to higher GDP and more job creation.




The European

Crowdfunding Market

In today already walks tomorrow.Friedrich von Schiller

At this juncture, there is no trade body surveying the industry. Private research rms have gathered

market data and academics are conducting research and gathering data.

Unortunately, comparative data is dicult to collect because o the regional nature and variation

in crowdunding business models. As a result, as with all non-public trades, the data presented heremust be read with care and should be viewed as indicative rather than absolute.

We estimate 2.2 billion will be raised globally by crowdunding platorms in 2012, up 80% rom1.2

billion in 2011 and 400 million in 2009 (own estimates based on market interviews and research rom

Massolution 2012). The research states that worldwide there are over 450 crowdunding platorms.

In line with this, the number o crowdunding platorms active across Europe at the beginning o 2012 can

be estimated at around 200, representing all types o platorms, slightly less than in North America. Their

number is expected to rise another 50% by the end o 2012.

With the US JOBS act and its potentially liberating eects on the crowdunding market in the USA, one

can expect a signicant increase in crowdunding platorms in the United States o America and a spillover eect to Europe. A number o large American crowdunding platorms have already started their rst

ventures in Europe, hoping to establish a market presence against European platorms.

In 2011, considering all types o crowdunding, Europe raised around more than 300 million, one third o

the world market, through hundreds o thousands o crowdunding campaigns. For 2012, the estimate is

that 2.2 billion will be raised globally by crowdunding platorms, up 80% rom 1.2 billion in 2011 and

400 million in 2009.

Again, this number refects eorts by the various types o crowdunding platorms. We believe it is impor-

tant to stress that we do not raise one business model above the other, but that we think all o them have

an equal place in the modern economy.

In Europe, the split between the dierent crowdunding types shows nearly hal o all activity rom reward

based approaches, with ewer than one quarter or platorms rom donation based approaches, as well as

equity based approaches. Lending or debt based approaches make up or the remainder.

In comparison, in the USA donation based approaches dominate while equity based approaches reach only

a symbolic percentage due to legal constraints.

The number o crowdunding campaigns is driven by donation based approaches, as the unding targets

involved are generally much smaller than, or example, equity based unding targets.




However, an increase in campaigns can be seen or all our dierent approaches, with campaigns in rewardbased approaches increasing more than ve times over, compared to a doubling in number o equity based

campaigns and increases o around 50% or donation and three quarters or lending and debt based cam-

paigns.

We estimate European averages per campaign are around 500 or donations, 3,000 or reward, 4,500

or lending and debt and 50,000 or equity based campaigns, though or the latter there are already a

signicant number that reach the maximum o100,000 through the use o co-investments rom proes-

sional investors. We estimate that averages will double or triple within a short period o time, especially or

lending.

Naturally, an enabling regulatory ramework could smooth the development signicantly and help econo-

mic growth through resulting innovation and entrepreneurial activities.

There are signicant dierences in the various crowdunding models described earlier and the market data

conrms these. While donation and reward based approaches are targeting smaller campaigns, they are also

ocused more on societal, health and environmental issues as well as on education, community and religion.

Reward based approaches are also used requently or product nance o creative projects, especially within

lm and music, but also or technology products. Lending and debt based approaches are usually peer-to-

peer platorms, where individuals can lend each other money or specic purposes at better lending rates

than banks oer.

Equity based approaches are still rare. They ocus on equity in start-up companies or small and mediumsized companies, where equity stakes in the tens o thousands o Euros makes economic sense. This is espe-

cially true or sotware and internet businesses, but also in computer and telecommunications related areas,

in consumer products, media and the environment. In the USA, equity crowdunding is only anticipated to

be possible with the implementation o the JOBS Act.

The average crowdunding campaign takes just under three weeks to raise the rst quarter o the unds

sought, though lending based campaigns hit their goals aster, in about hal the time o equity campaigns.

In general, crowdunding campaigns run anywhere rom ve to ten weeks, with lending campaigns comple-

ting within ve weeks, equity in around eight weeks, and lending and donations in around ten weeks.

According to research (Massolution 2012), the average unders o crowdunding platorms are involved in

one or two projects, and 10% o unders have participated in multiple projects. Nearly 70% o undraisers o

crowdunding have started one or two campaigns, and only a little more than 30% have started more than

two.

This data indicates that while crowdunding is already attracting many people, it has not yet reached ma-

turity to rival incumbent nancial services. There is a healthy respect or the risks among the early adopters

and existing users, which allows crowdunding platorms to careully improve their client protection and

education eorts.




Benefits for the Internal

Market

There is the greatest practical beneft in making aew ailures early in lie.

Thomas Huxley

System ResilienceWe hope the crowdunding industry evolves into a structure where market share is signicantly less con-

centrated than in incumbent nancial services. Numbers show that the banking industry is run by a selectew organisations who widely dominate the entire market. This situation can create the too big to ail -

nancing model, where the largest institutions bear the risk o making the whole system collapse on deault.

Regulators and the public should stand or building a crowdunding industry where no single player can

possess overall market share, both in volume and in numbers o projects unded. With more than 200 plat-

orms present in Europe today, there should be ample room to achieve a higher level o diversication and

resilience o this industry.

Systemic risks recently encountered by the nancial system would be lowered by the intrinsic nature o the

crowdunding industry to operate as highly inter-connected networks.

Better market rates discoveryBecause rates are dened by the demand o the crowd, leading crowdunding platorms will enable true

return and price discovery or many nancial aggregates that are nowadays controlled by a handul o

nancial institutions.

It is known that the basis o interest rates used within the global nancial industry can be manipulated by

very ew individuals or organisations. They thereore bear the risk o not being relevant or the economy.

Crowdunding possesses the ability to generate real market prices and real interest rates, in the sense

that they would be per denition highly accepted and thus generating opportunities or continuous high

liquidity.

Funding diversificationSMEs nd it hard to both secure long-term nancing and nd sources o revenue outside investment

banking.

While crowdunding oers new investment opportunities to individuals and corporate investors, it also

oers recipients o unding the ability to diversiy their sources o unding. This lowers their unding risk

and creates value or the system as a whole, again making the business less prone to unding shortages,

thereore allowing them to better able to pool resources on signicant business opportunities.

This eature has the potential to make entire industries competitive on a global scale.




Financial stabilityHistorically, a crisis has oten been caused by a sudden drop in unding fows (velocity), a subsequent public

spending re-balancing, and by unsustainable decits experiencing contraction.

While crowdunding does not annihilate the risk o signicant drops in unding fows, it still generates new

nancial ties and opportunities or existing unds to be re-invested in tangible projects that bear a return

to investors. Thereore, money is less likely to stop fowing when investment opportunities still exist and are

readily available.

This represents a signicant alternative to money creation or economic crisis management and also redu-

ces the risk o over infation caused by articial infows o investment into the economy.

Alternative financing channelsThe inherent ability to generate data and accurately describe projects enables governments to better target

key areas o investment. In the short term, governments and public bodies will nd opportunities to leve-

rage a highly interconnected network o unding channels that will create better visibility o actual unding

needs within the economy.

Where public unds are now pushed to certain areas and investment segments with a long investment

cycle, with crowdunding these can now be operating with pull dynamics, where certain public unding

envelopes are used only i the actual demand or unds is actually there. In the long term, it could also deci-

de to avour certain investment channels and industries (e.g. with tax incentives). All these can be operated

through crowdunding platorms.




Policy Discussion in Europe

A policy is a temporary creed liable to bechanged, but while it holds good it has to be

pursued with apostolic zeal.

Mahatma Gandhi

Many o Europes challenges come rom the act that its overall legal and regulatory ramework

leaves too much opportunity or ragmentation through varying national interpretations. The samegoes or access to nance or Small and Medium Sized Enterprises (SMEs).

In 2011 the European Commission issued an action plan to improve access to nance or SMEs. It

outlines the key obstacles with regard to access to nance SMEs in areas such as loans, venture

capital and capital markets. The plan describes measures taken since 2007 to oster access to nance

or SMEs, including the Competitiveness and Innovation Programme (CIP), the European Investment

Bank allocation or SME loans, cohesion policy unds and the Risk Sharing instrument in the Euro-

pean Commissions Framework Programme 7.

In order to build on these the European Commission identied urther measures aimed at improving access

to nancing or SMEs, such as regulatory measures, nancial measures to improve lending and venture

capital across the European Union and measures to improve the environment or SMEs.

The action plan did thus discuss a number o highly important issues in order to improve entrepreneurship

in Europe, it however did not include crowdunding as an highly innovative option or seed and early-stage

equity unding, debt and lending instruments or a highly ecient tool to pre-validate business ideas and

products in the market.

Also in 2011, the participants o the Agorada 2011+ Conerence, an international summit in Bielsko-Biala,

co-authored a paper now known as the Bielsko Biala Declaration - Maximising the Opportunities oered by

Crowdunding. The declaration consists o six small paragraphs addressing the EU administration, Member

States, and Regional Authorities.

The declaration argues that the underlying aim o crowdunding is to provide entrepreneurial and innova-

tive projects the nancial means to execute. Public authorities should have an interest in supporting the

development o crowdunding in order to remove barriers to entrepreneurship and to acilitate a avourable

legal ramework, while maintaining the minimum o proessionalism and regulation.

The declaration continues that crowdunding needs to be better understood, and to this end, relevant data

collection should be encouraged and data should be benchmarked. To help smooth the ragmented Euro-

pean market, crowdunding should be welcomed and promoted at a European, national, and regional level.

These six high level statements point in the right direction, but in the authors opinion, leave room or im-

provement. We believe that the crowdunding industry has a vital role to play in dening best practices oroperations, customer protection, data collection, stakeholder education, and regulation.




We also believe that European, national and regional regulators and legislators may be interested in recei-ving input about crowdunding rom the industry so they can produce ample guidelines in turn.

We thereore welcome the initiative o Start-up Exemption in the United States o America. Ater more

than a year, the USA was rewarded or their eorts in drawing up a regulatory exemption ramework that

positively enables crowdunding to become a driver or job creation and economic growth.

The ramework has, in adapted versions, passed the US House o Representatives as the Entrepreneur Access

to Capital Act with 407 votes against 17 on 3rd November 2011. It is also the oundation or Democratizati-

on o Capital Act submitted in the Senate. It has been reerenced by President Obama in the American JOBS

Act.

The exemption ramework consists o just a ew bullet points, but unlike the European call or support, it

lists actual exemptions to be implemented by the legislators. It addresses denitions o share structures and

amounts or small business unding, investment limits or unsophisticated or unaccredited investors, risk

disclosure, number o investors, and ling and reporting requirements.

While the exemption ramework or crowdunding developed in the USA is ar more practical than the

Bielsko Biala Declaration, the USA ramework is impractical or the ragmented European market. However,

i crowdunding is to succeed in bringing about economic growth, job creation, and nancial stability, it is

critical that the European discourse is held on both levels.

While we are mindul that ocial legislation and regulation may not happen overnight, it is crucial that we

move orward with urgency. The passing o the JOBS Act in the United States has accelerated the growth

and signicance o crowdunding in the American economy.

A competitive edge or America will create adverse circumstances or the European crowdunding industry,

investors and entrepreneurs, but may also hinder economic growth and job creation. Crowdunding legisla-

tion and policy will ensure balanced global economic power distribution.

We are aware that crowdunding is being discussed seriously within the European institutions as an alter-

native or SME nancing, especially with view on the Europe 2020 strategy. We also believe that proposed

regulation that will introduce new pan-European banking regulation will present an opportunity or crowd-

unding.

Earlier in 2012, an expert group or the Directorate-General or Enterprise and Industry at the European

Commission working on cross border matching o innovative rms with suitable investors, called or the

European Commission to monitor the emergence o new sources o unding that employ social media.

The working group argued that the ragmented European regulatory environment along national lines or

cross border platorms are among the emerging challenges which pose issues or entrepreneurs, platorm

providers and investors alike.

The expert group stated that crowdunding may indeed have the potential to become an important source

o SME unding at the seed stage or equity capital. In conclusion, the expert group called to encourage

crowdunding in Europe without over- regulation, but with adequate investor and entrepreneur protection.

A recommendation went to the European Commission to set up a specialist expert group to review thesubject o crowdunding, drawing on existing experiences in Member States and elsewhere internationally.

The European crowdunding industry and the European Crowdunding Network would be well suited to join

such dialogue.




In September 2012, the opinion o the European Economic and Social Committee (EESC) on the communi-cation rom the Commission to the Council, to the European Parliament, to the Committee o the Regions,

and to the European Economic and Social Committee, created an action plan to improve access to nancing

or SMEs.

The opinion, issued in 2011, was made public. A public hearing at the EESC was held June 2012 at which re-

presentatives o the crowdunding industry were present. The crowdunding industry was invited to provide

a public intervention via the European Crowdunding Network. The thorough review o SME nancing op-

tions concludes that Europes economic recovery can only be achieved i SME policy is high on the agenda

o European policy-makers.

The EESC supports the eorts o the European Commission and other institutions to increase the resilience

o the nancial system in order to create an instrument at the disposal o the real economy.

The opinion also concludes that crowdunding is a good example to mention and participative banking

could be another option to take into consideration alongside all other proposed actions to improve access

to nance or SMEs. In addition, the EESC opinion stresses that crowdunding can be supportive to equity

investment and urges the European Commission to look at innovative approaches to venture unding.

Together, the European crowdunding industry and the European legislators and regulators must collabo-

ratively enable economic growth and job creation rom the bottom up. Should Europe decide to encourage

the crowdunding industry and nd itsel in a position to compete with non-European uture global players

(especially those with signicant access to growth capital rom the Americas and Asia), we will need to

establish a European ramework and ecosystem or best practices.

Innovation comes rom changing the way we think about and work with nancial services. We ask the

European crowdunding industry to work on open sel-regulation and transparency, customer protection

and data collection, and the European legislators and regulators to proactively develop an understanding o

crowdunding and to support the crowdunding industry by providing relevant exemptions and guidance.

By working together to ensure crowdunding as a sustainable and sae nancial service oering to entre-

preneurs and unders alike, we will be in a position to mobilise billions o Euros or the purpose o invest-

ment in customer-approved innovation and entrepreneurship.




European Regulation and

Legislation

Virtue is more to be eared than vice, because itsexcesses are not subject to the regulation o

conscience.

Adam Smith

Financial regulation and legislation has the duty to stimulate ecient and transparent markets

while ensuring investor protection. This should also include the possibility o creating crowdun-

ding venues or platorms. Currently, ecient and transparent markets cannot arise in the eld oequity and loan based crowdunding because investor protection regimes are designed or incumbent

investment settings which exclude a large number o crowd unders.

This heavily restricts investment choices or European citizens and unders that want to express their

support or economic or social initiatives. Legislation should not obstruct access to assets where

users want to und value creation - or both, nancial and non-nancial reasons.

Regulations impacting the promotion of Campaigns (2003/71/EC)Based on current experience, crowdunding will generally remain below the 5m threshold, where the Pros-

pectus Directive (2003/71/EC, amended by 2010/73/EC) oers reedom to national lawmakers to implement

a country-specic promotion regime. This reedom has resulted in many dierent national regimes rangingrom ull prospectus regimes to complete exemptions.

Although the Prospectus Directive also contains a harmonised exemption that even pre-empts national re-

gimes, namely or campaigns that do not exceed100,000, this does not create a Europe-wide level playing

eld because many campaigns may exceed the 100,000 threshold.

The Prospectus Directive can be improved to include harmonised pan-European rules or exemptions in the

sub-5 million region to reduce the compliance cost or pan-European crowdunding initiatives, and to

prevent the situation where disproportionate compliance costs would deprive start-ups in some countries

rom cross-border undraisings above 100,000.

Although current exemptions in the Prospectus Directive theoretically only apply to the obligation to

publish a prospectus, it would be advisable to extend this to the preparation and approval procedure or

such prospectus or prospectus-grade document. This is a guarantee against additional potential national

regulatory layers o undraising promotions rules.

Finally, an additional exemption which is based on an investment cap per investor or per campaign

might be suitable or crowdunding in order to provide protection or investors.

We ask the European Commission to create a pan-European harmonised regime or sub-5 million

oerings - instead o excluding sub-5 million oerings rom the ull harmonization regime o the

Prospectus Directive (see article 1, 2 (h) o the Prospectus Directive). Such a harmonised regime

may, or instance, take the orm o a ull exemption below a certain threshold and a light regulatoryregime above that threshold but below 5 million. In the event o a light regulatory regime, above a

certain threshold, it could also include a European Passport or the promotion.




In case the European lawmaker would ail to come up with a maximum harmonization in thissub-5m domain, then we ask national governments and regulators to coordinate their national

reedom, in order to move away rom country-specic sub-5 million regimes and to coordinate a

common regime in avour o crowdunding.

Corporate law provisions impacting the ability to offer

direct equity to crowd investorsStart-ups typically choose relatively inexpensive corporate entity types. In most countries, this means that

they choose or a closely held company type. However, by choosing such closely held (or oten simplied)

company type, they unintentionally run into limitations to oer equity to new and yet unknown

investors. This may vary rom ormalities (notarial intervention) to outright prohibitions to accept such

new shareholders.

This is obviously an undesirable eature in the inexpensive corporate entity types. Also, it should clearly be

asked i the ormalities that are in many cases involved with equity transaction, are still suitable in the in-

ormation age. Today, even share trading in public companies is entirely organized in a dematerialized way,

by means o bookkeeping entries.

We recommend to harmonize or coordinate company laws, and to oer eatures rom public compa-

ny types (which are not necessarily listed companies!) to the cheaper company types

Regulations impacting arranging and dealing

(for Platforms)There is room or interpretation o European regulation on member state level. As a result, there are die-

rent views in dierent countries regarding acceptable transaction structures. A regulator in one country

may nd one transaction structure more acceptable, and another regulator may potentially nd that the

same structure (or even all structures) unacceptable and may potentially nd yet another transaction struc-

ture acceptable.

For example, crowdunding structures usually ocus on arranging transactions between investors and

investees directly, be it loan, equity or otherwise, but in case o equity crowdunding many platorms actas a central counterparty between the investor and the investee in order to accommodate limitations or

costly ormal steps in company laws to accept new and unknown shareholders. Ultimately, the investor will

then receive equity in an intermediate entity, or he will be a creditor o that intermediate entity through an

equity-like contract.

We ask the European Commission or intervention to avoid a highly investor-unriendly situation

whereby every platorm operates a dierent transaction model, depending on the country where it

is based (thus depending on the type o model that the regulator in that country deems acceptable).

Such intervention should however be immune rom simply avouring or preerring crowdunding

transaction models rom existing platorms. Indeed, some crowdunding platorms already started

operations despite the regulatory burdens, but this may certainly not result in rent-seeking behavi-

our, by seeking approval or their transaction model.




Accepting reclaimable funds(Directives 2006/48/EC & 2009/110/EC)Under European regulation, accepting reclaimable unds rom the public requires a license as a credit

institution. Electronically storing a monetary value to be used or payment transaction (i.e. beore a loan is

arranged between the investor and investee) also requires a license as a credit institution.

Such license requirements may aim to help separate investor unds rom the platorms own unds. Plat-

orms (which are typically unable to meet the license requirements to become a credit institution) may

comply with such requirements by entering into an arrangement with a licensed service provider that will

act as the acceptor o the reclaimable unds.

By oering investors the chance to reclaim unds i a campaign ails or i unds have not been allocated

to campaigns, platorms oer customer protection. The crowdunding platorms do not use the unds to

pursue money creating activities. Yet by doing this, they ace the highest regulatory burden and the highest

cost, either by having to obtain an expensive license as credit institution, or by having to cooperate with a

licensed third party, as possible under the e-Money Directives, to accept the money rom investors.

We ask the European Commission to oer an exemption or light license to e-commerce operators

(in this case crowdunding platorms) that accept reclaimable unds or unds that will be used to

electronically store and represent money in accounts (thereby potentially alling under directives

2006/48/EC & 2009/110/EC), as long as mechanisms are used whereby unds are separated rom the

platorms unds in case o bankruptcy and as long as no money creation takes place.

Collective Investment UndertakingsSome platorms that act as a central counterparty between investor and investee, and at the same time opt

to deal in equities, all outside the harmonised scope o the Undertakings or the Collective Investment in

Transerable Securities (UCITS) directives, and the Alternative Investment Fund Managers (AIFM) directives.

Otherwise, such regimes would be prohibitively costly.

Instead, they are subject to country-specic regimes (both in terms o operations as in terms o marketing

o the stakes), which hinders the possibility to operate a pan-European transaction model based on inter-

mediate counterparties between investors and investees.

This hinders the emergence o a market with strong network eects. This lack o EU-wide level playing eld

or non-UCITS and non-AIFM collective investment undertakings has already been highlighted in other con-

texts, or instance by the investment und industry as a reaction to the Commission Green Paper on Asset

Management rom 2005.




In case specic considerations would be made or crowdunding platorms, then it should be noted thatmany platorms under this transaction structure do not manage the stakes on a discretionary basis.

We ask the European Commission to harmonise collective investment activities that are currently

not harmonised under Undertakings or Collective Investment in Transerable Securities (UCITS) or

Alternative Investment Fund Managers (AIFM) directives, and that may be suitable or crowdunding

platorms that pool amounts o money that do not represent the same type o systematic risks that

are normally associated by the much more substantial amounts in case o UCITS or AIFM activities.

In case the European lawmaker would ail to come up with a maximum harmonization, then national

governments and regulators should coordinate collective investment undertaking regimes that arecurrently below the harmonization thresholds o the AIFM directive, or outside the scope o UCITS

directives.

MiFID Impacting the conduct of business of platform operators

Some activities regulated by the Markets in Financial Instruments Directive (MiFID) may ace dierent nati-

onal interpretations as to whether a platorm transaction structure classies as such an activity or not. This

is especially true or the placing o nancial instruments, execution o orders on behal o clients, reception

and transmission o orders in relation to one or more nancial instruments, operating a multilateral trading

acility, operating an organised trading acility (under MiFID II) and services related to underwriting.

Platorms can nd very strong arguments against such qualications, depending on their transaction

model, including

That loans or equities will not always qualiy as nancial instruments (thus no reception and transmissi

on o orders, and not placing o nancial instruments),

That the platorm will not act as an agent or the campaigner (thus no placing o nancial instruments) or

That there will be no multilateral mechanism where multiple participants compete or the best price

(thus no multilateral trading acility).

Nonetheless, there is a substantial risk to be qualied as such a regulated activity by any given national

regulator. The MiFID directive does not oresee the issuance o a legally binding opinion rom a regulator or

a no-action letter, which creates substantial operational uncertainty or crowdunding platorms, especially

those operating in multiple member states.

It is likely that the proposed regulated activity o operating an organised trading acility will also apply to

crowdunding platorm operators. It may not be illogical to qualiy under some sort o regulation, but the

regime should be proportional and manageable rom an organizational point o view. This may require an

exemption.




Platorms can adapt the MiFID regime now under prohibitively high cost, perhaps in order to enjoy the legalcertainty to operate cross border under the European passport or one (or more) o the relevant activi-

ties. This may create a user unriendly situation where clients have to be categorised according to MiFID

requirements. In addition, treating both investees and investors as clients may create problems under the

inducement rule, which orces regulated rms to operate in the best interest o their clients (which conficts

in this case).

We ask the European Commission to clearly dene activities that are mentioned in the annex o the

Markets in Financial Instruments Directive (MiFID) directive, to avoid any dierent interpretations

and legal uncertainty as to whether a specic crowdunding platorm setup alls within the scope o

such an activity or not. Also, i this would eventually lead to a classication as a regulated activity,

then some exemptions might be suitable. For instance, to prevent that qualication as Organised

Trading Facilities (in upcoming MiFID amendments) would result in organisational burdens or start-

ups operating crowdunding platorms.

Crowdfunding DirectiveWhile a Crowdunding Directive does not yet exist, we may be orgiven to envision one similar to the

Payment Services Directive and Electronic Money Directive, dening a role o a Crowdunding Provider

maybe similar in concept to the US Funding Portal, but detached rom a specic nancial instrument. Here

the notion o single European passport or this role could create legal certainty to be able to operate on a

cross-border basis without acing new compliance costs and procedures.




The Pillars of a Crowdfunding

Framework

Seeing much, suering much and studyingmuch, are the three pillars o learning.

Benjamin Disraeli

I we are to realise the true potential o crowdunding in Europe, the industry must create a collabo-

rative and open discourse amongst the industry, regulators, and citizens can generate the necessary

consent on best practices, refecting the needs and specics o dierent crowdunding business

models.

We believe a European Crowdunding Framework should include the ollowing pillars: Regulation,

Education, and Research.

RegulationRegulation is critical. However, we are not advocating regulation or regulations sake.

Instead o imposing heavy regulations that are likely to become more conusing between nation-states, we

should look at crowdunding intermediaries passing qualication criteria ocusing on the ollowing catego-

ries: operational and nancial transparency, security o inormation and payments, platorm unctionality,

customer protection, and operational procedures.

There might also be room or open collaborative sel-regulation and accreditation, ultimately signalling a

level o credibility to unders, entrepreneurs, and other stakeholders.

EducationEducation and training are central in the implementation o crowdunding into the European economy.

Providing entrepreneurs with access to inormation on how to run a successul campaign, identiying which

type o crowdunding is best or their business, and educating unders on how to choose a campaign are a

ew steps we believe will ensure best behaviour and best practices within the industry.

According to a study by Cutting Edge Inormation, online training may be one o the most eective andecient means to provide regulatory compliance, as well as educate potential unders. Examples o educa-

tional eorts include the Australian government and the Australia Council or the Arts which embarked on

a national strategy to explore the opportunities in crowdunding or cultural and creative projects.

Their National Crowdunding Roadshow oers citizens practical tips on r

European Crowdfunding Framework Oct 2012

Documents

Transcript of European Crowdfunding Framework Oct 2012