Crowdfunding: Opportunity & Challenges for Venture Capital

ECSF 25th March Brussels

Robert Wardrop Executive Director Cambridge Centre for Alternative Finance

Summary

Crowdfunding has grown to ~50% of VC annual investment volume in Europe •  In the UK, crowdfunding now dominates seed stage investment •  Debt crowdfunding is rapidly increasing: now 8x larger than equity crowdfunding

This introduces opportunities for VCs: •  Increase in qualified deal flow? •  Lower WACC with debt crowdfunding instruments? •  More large corporates engaging with crowdfunding?

And also presents some challenges: •  Seed stage valuations are increasing – how will this impact VC returns? •  Will value-added ‘curated’ platforms and engaged crowdfunders disintermediate VCs? •  Is the current model of crowdfunding sustainable – are there adverse selection & moral

hazard risks?

Taxonomy of ‘Crowdfunding’ for SMEs

Source: Moving Mainstream, Cambridge-EY (2015)

Extreme variation in crowdfunding volume 2012-2014

Source: Moving Mainstream, Cambridge-EY (2015)

Crowdfunding volumes for SMEs in 2014

88% of crowdfunding for European SMEs was via UK platforms, and UK volume is growing 40% faster than the rest of Europe.

Source: Moving Mainstream, Cambridge-EY (2015)

Crowdfunding dominates seed financing in the UK

Source: British Business Bank (2015)

Crowdfunding is cannibalising F & F and Angel (UK)

Cannibalisation of VC deals is increasing (UK)

Source: Business Funding Research Ltd (2015)

Crowdfunding is spreading across development stages

Deal Flow Opportunity Debt Opportunity

Rewards-based Equity-based

P2P lending Invoice trading Debt securities

Valuation challenge: Is the current model sustainable?

1.  Are crowdfunded equity financings overvalued? •  Evidence of investor bias: e.g. decision heuristics, local bias effects •  Investees/borrowers may be gaming platform metrics to encourage herding •  Challenging for VC deal sourcing, but an attractive opportunity for debt issuance

2.  Do platform incentives create a moral hazard problem? •  Primary source of revenue to platforms is from investees/borrowers rather than

investors: is this the right alignment of interest? •  Do investors really understand the returns and illiquidity of the asset class they are

funding?

London Underground, January 2015

Disintermediation via engagement?

Today, many equity crowdfunders are not passive investors

But as investor participation increases, more crowdfunding investors will need a value-added intermediary

Source: Moving Mainstream, Cambridge-EY (2015)

Disintermediation via data analytics?

Crowdfunding is generating huge amounts of data.

Intermediaries are providing increasingly sophisticated analytics.

Which players could disintermediate?

Which player in the crowdfunding ecosystem will be the value-added intermediary?

•  The originators (i.e. the platforms)? •  Fund managers? •  Analytics providers? •  Regulated banks? •  Financial advisors?

Source: Orchard, (2014)

Closing thoughts

1.  How can VCs exploit the opportunities and manage the challenges presented by crowdfunding?

•  Launch a platform, or partner?

2.  How can regulators and policy makers ensure that adequate investor protection is upheld while not stifling innovation?

•  Getting it wrong could kill the market, and reduce access to finance for SMEs – recent experience in the German Mittelstand bond market offers insights