Financing for innovation of products and services (crowdfunding)

Financing for innovation of products and services (crowdfunding) Lidia Sanchis Marco Professor in Financial Economics at UCLM Coordinator of International Relationships at Law and Social Sciencies Faculty Bilingual seminar: University Social Responsability H2020-20/11/2107 1

2

For start-up companies, the answer to this question is a no-brainer: no innovation = no business It is as simple as that. In fact, a start-up which is not aiming at bringing any innovation in any of the aspects of the business where is trying to emerge from, has almost no reasons to exists. For large organizations, however, the root problem is another and it is related to how the global business ecosystem has evolved throughout the last decades. In the past, only large organizations had the capacity to easily access certain resources necessary to build a product. 3

Changes in the business scenario: I. Nowadays, thanks to cloud computing, we have remote services available to everyone, that with few hundreds of bucks are giving the possibility to validate hypothesis very quickly (think about Amazon EC2 from the infrastructure point of view or something more specific like QuickMVP). II. III. Also, social media had a major impact in advertising new products; imagine how much more expensive it was to advertise a product in the past while now you can basically "just tweet" about it and it might get viral. From the financing point of view, new tools are emerging: crowdfunding platforms can be used to effectively validate an idea, raise the necessary founds and even perform a pre-sale before anything is actually built. 4

MAIN AIM: How can we obtain funds for innovation projects? 6

INDEX 1. Financing clasification A) Traditional methods B) Alternative methods 2. Financing problems for innovation projects 3. Crowdfunding 4. Conclussions 7

1. FINANCING METHODS 1.A) TRADITIONAL METHODS -Banks loans -Equity -Fixed Income -Grants or institutional programs 8

Banks loans 9

Equity Pros: -There is no obligation to repay the money acquired through equity financing. Cons: -Founders must give up some control of the business -The company has more capital available to invest in growing the business. -Some sales of equity, such as initial public offerings, can be very complex and expensive to administer -More likely to be available to concept and early stage businesses than debt financing -Require complicated legal filings and a great deal of paperwork to comply with various regulations 10

Fixed Income Pros -The founders do not lose property Cons: -There is an obligation to repay the money -Suitable investment if you have a short term investment horizon -Interest on bonds is fixed; it has to be counted in financial decision making of the company -Here is a risk that the issuer of a fixed income instrument will not be able to repay the capital invested. -The emergence of emission costs associated with issuing bonds, which increase the costs associated with the acquisition of capital in comparison with, e.g. a bank loan. 11

Grantsand Institutionalprogramsin Spain Autonomous Employment Promotion: ICO Support for the creation and modernization of companies: Regional Programs On-repayable grants: Autonomous Employment promotion program and the programs to support the creation and modernization of companies. Specific for women entrepreneurs (PAEM program), rural development or for specific sectors. Financing without endorsement for innovative projects and startups offered by Enisa or some Autonomous Communities such as Andalucia with their reimbursable funds 12

GrantsInstitutionalprogramsin Spain Microcredits or lines of credit for entrepreneurs and business creation offered by some banks Retail aid program Aid to the social economy Aid and subsidies for the creation of employment and selfemployment: Bonuses in the quotation of self-employed, Bonuses for hiring workers, regional Aid for hiring Aid for local employment initiatives (I + E or similar projects) 13

1.B) ALTERNATIVE METHODS BUSINESS ANGELS RISK CAPITAL PARTICIPATORY LOANS DERIVATIVES CROWSOURCING 14

BUSINESS ANGEL An angel investor is NOT an investor with golden wings and a halo but rather an individual who provides startup capital to a new business and expects a percentage of ownership equity in return. Angel investing is a common business practice in the United States and also Europe. Angel investors often use their own capital when investing in startup companies Types: family, relationship, idea, archangel. Examples: Amazon, Starbucks and Apple One way to find local angel funding is to start at the website for the Angel Capital Association, which lists angel investors by state. 15

BUSINESS ANGEL Pros Can provide the needed capital for a startup Cons Rarely make follow-on investments Ability to raise capital in small amounts Can actually be deceptive Flexible business agreements Can bring forth vast knowledge and experience to a new company Does not require high monthly fees Are located everywhere, in practically all industries Can be costly Active company involvement can lead to problems Do not have national recognition There is no national register for angel investors 16

RISK CAPITAL - Types: Venture capital and private equity - Venture capital is a financing provided to companies with high growth potential in exchange. Investment capital in an early stage technology company, sometimes it will be nearly at the start of a company. - Financial activity whose main purpose is the taking of temporary holdings, in the medium or long term, in the capital of unlisted companies, to favor their birth, growth or expansion. Venture capital contributes to the company, in addition to its own resources, support and participation in business management - Private equity is focused on existing mature companies 17

Pros: Business expertise. Additional resources. Connections RISK CAPITAL There is no repay schedule; which means you don t have to repay debt as a cost of doing business. Cons: Loss of control Minority ownership status. Bottom line Some VC firms require much more ROI than expected. This, in effect, means the VC firm is controlling your business; not you, the owner. VC firms are very easy to locate because they are documented in business directories. -Take too long to decide whether to invest in your business or not. 18

PRIVATE EQUITY: Lizarrán VENTURE CAPITAL: Google EXAMPLES Where to see risk capital companies in Spain: - The Spanish Venture Capital & Private Equity Association (ASCRI) : www.ascri.org - CNMV 20

PARTICIPATIVE LOANS -PLs are interesting for entrepreneurial finance because the borrower does not face internal capital dilution nor a high cost of funds in the initial years, whereas the institution granting the PL does not afford the cost of managing and selling portfolio equity stakes but obtains extra income from successful firms. -Types: convertibles in capital or not (must be repaid) -Offered by banks 21

PARTICIPATIVE LOANS Pros: -Longtime Cons: -Uncertaintly about the payments due to the interest part associate with the benefits -Notentranceofextraownwers -Not diluition of the property structure -Posibility to miss some payments at the begining but after the interest will be greater -Initial cost is lower than ordinary loans but greater in long term 22

DERIVATIVES Financial derivatives are contracts to buy or sell underlying assets. More than 90 percent of the world's 500 largest companies use derivatives to lower risk. For example, a futures contract promises delivery of raw materials at an agreed-upon price. This way the company is protected if prices rise. Companies also write contracts to protect themselves from changes in exchange rates and interest rates. Types: options, futures, swaps and forwards 23

DERIVATIVES Pros: Hedge risk Control the risk in some loans Insuring against risk Cons: Some OTC markets High uncertaintly Speculation High liquidity in large trades products Knowledge specific 24

CROWDSOURCING 25

CROWDSOURCING -Crowdsourcing can be a useful method for your ecommerce business to start generating ideas and deducing which of these ideas have merit. By harnessing the power of the masses, you find out what your customers and the public at large are looking for in your business. 26

CROWDSOURCING Pros: Significant cost savings No or very little overhead Free marketing Customer loyalty Talent seeks you Instant hiring/outsourcing potential Cons: Questionable ownership Paying more does not improve quality Bad reputation/marketing risk Wasted time Lack of member productivity Questionable intellectual rights 27

CROWDSOURCING 31

2. FINANCING PROBLEMS FOR INNOVATION PROJECTS Access to finance is one of the main challenges for European companies, in particular those that are smaller, younger and more innovative (European Commission, 2015h). Studies show that the total Small and Medium-sized Enterprise (SME) financing gaps for European countries are three to five times bigger than for the US (Silanes et al., 2015). At the same time, innovative companies face more limited access to business angel (BA) capital (EBAN, 2014) and venture capital than their US counterparts. In this context, alternative finance (AF) can play an important role in helping to fund innovative companies in their early growth and scale-up phase (Filippov and Hofheinz, 2016). Alternative finance in Europe is growing fast, but its size is still small compared to other world regions. 33

3. CROWDFUNDING -Crowdfunding is a method of raising capital through the collective effort of friends, family, customers, and individual investors. This approach taps into the collective efforts of a large pool of individuals primarily online via social media and crowdfunding platforms and leverages their networks for greater reach and exposure. -It is most often used by startup companies or growing businesses as a way of accessing alternative funds. It is an innovative way of sourcing funding for new projects, businesses or ideas. -It can also be a way of cultivating a community around your offering. By using the power of the online community, you can also gain useful market insights and access to new customers. 34

3. CROWDFUNDING -Crowdfunding platforms, giving the entrepreneurs, a single platform to build, showcase, and share their pitch resources, this approach dramatically streamlines the traditional model. Traditionally, you d spend months sifting through your personal network, vetting potential investors, and spending your own time and money to get in front of them. With crowdfunding, it s much easier for you to get your opportunity in front of more interested parties and give them more ways to help grow your business, from investing thousands in exchange for equity to contributing $20 in exchange for a first-run product or other reward. 35

3. CROWDFUNDING 36

3. CROWDFUNDING 37

How does crowdfunding work? 3. CROWDFUNDING Crowdfunding platforms are websites that enable interaction between fundraisers and the crowd. Financial pledges can be made and collected through the crowdfunding platform. Fundraisers are usually charged a fee by crowdfunding platforms if the fundraising campaign has been successful. In return, crowdfunding platforms are expected to provide a secure and easy to use service. Many platforms operate an all-or-nothing funding model. This means that if you reach your target you get the money and if you don t, everybody gets their money back no hard feelings and no financial loss. 38

Pros: Itprovidesaccesstocapital. It hedges risk. CROWDFUNDING Cons: Significant resources (money and/or time) may be required Failed projects risk damage to the reputation of your business Itservesasapromotionandmarketingtool Someone may see it on a crowdfunding site and steal your concept It s easier than traditional applications. It is free and efficient Not For Large Investments Most crowdfunding platforms use the all or nothing model and need speed 39

TYPES OF CROWDFUNDING BUSINESS AND CONSUMER LENDING (Pier 2 Pier) EQUITY BASED CF DONATION BASED CF REWARD CF INVOICE TRADING COMMUNITY SHARES PENSION LED FUNDING DEBT BASED SECURITY 40

Comparisonwithotheralternatives 45

MainworldCrowdfundingPlatforms 47

EXAMPLES OF CROWDFUNDING STORIES 49

KICKSTARTER EXAMPLES: Pre-order model 50

KICKSTARTER EXAMPLES: Pre-order model 51

KICKSTARTER EXAMPLES: Pre-order model 52

INDIEGOGO EXAMPLES: Reward Based Model 53

INDIEGOGO EXAMPLES: Reward Based Model 54

INDIEGOGO EXAMPLES: Reward Based Model 55

GOFUNDME EXAMPLES: Donation model https://www.youtube.com/watch?v=g0iy8qg7j-i 56

GOFUNDME EXAMPLES: Donation model 57

GOFUNDME EXAMPLES: Donation model 58

KIVA EXAMPLES: Loaning model 59

KIVA EXAMPLES: Loaning model 60

KIVA EXAMPLES: Loaning model 61

Someadditionaldata aboutcf platforms: On average only about 100 investors are obtained per campaign. The average collection is just over 3,000 euros. The investors contribute between 40 and 75 euros. 50% of campaigns on Kickstarter are cultural. Games are the category that most raises in Kickstarter. Fashion is fashionable in crowdfunding. 39% of successful projects on Kickstarter are music or film. Food is a very successful category in crowdfunding. There are very few projects that exceed one million euros. 62

MAIN PLATFORMS IN SPAIN Verkami and Lanzanos are reward based crowdfunding platforms for creative projects. Both are founded in 2010. Goteo (2010) is a platform for civic crowdfunding and collaboration on citizen initiatives and social, cultural, technological and educational projects. Libros.com is a crowdfunding platform with the focus on the publishing of books Crowdcube, Crowd Angel and Capital Cell : equity crowdfunding 63

Success example in crowdcube https://www.crowdcube.es 64

RECENT DATA ABOUT CROWDFUNDING IN SPAIN -Equity crowdfunding in Spain is growing rapidly, with Spanish-based crowdfunding platforms already raising more than 60% of the total funds raisedin2016, in the first three months of 2017 alone. -According to statistics collected from 1 January to 31 March 2017, 5.6M has been invested in 19 companies, across the equity crowdfunding market in Spain, in the first quarter of the year. This figure give us a clear sign that equity crowdfunding is now being recognised as aprimarysource of funding for Spanish startups. 65

- 2016 Report abstract from http://www.spaincrowdfunding.org/ 66

- 2016 Report abstract from http://www.spaincrowdfunding.org/ 67

Why is the equity crowdfundingsector growing in Spain? 1) The enactment of the Spanish Crowdfunding Law (Law 5/2015), which now regulates a private capital market for the first time ever in Spain. 2) Support from public institutions, such as ACCIO, the agency for business competitiveness, which has helped provide visibility for the sector and equity crowdfunding platforms. 3) Collaboration between platforms and traditional investors, which has helped facilitate larger funding rounds by enabling different types of investors, such as institutions, business angels, to invest alongside the crowd. 4) An increase in follow-on rounds from companies that have used equity crowdfunding and returned for further funding. 68

4. CONCLUSSIONS Financial crowdfunding can play a fundamental role as a complement to traditional sources of financing, above all for companies in their early development phases and for higher risk projects which experience difficulties in accessing financing from banks, given that the latter tend to have greater risk aversion. Thus, financial crowdfunding may help business initiatives and innovation to flourish, driving economic development. What is more, in a context of a credit drought and economic crisis, it could become a key element in alleviating financing needs, contributing to economic recovery, at the same time as it offers high returns on saving. 69

4. CONCLUSSIONS A balanced regulatory framework is therefore necessary, one which enables this complementary source of funding to develop at the same time as it protects retail investors and avoids potentially systemic risks. Furthermore, in the case of the European Union, we need legislative harmonisation to prevent fragmented markets. Finally, over and above the role played by regulators, it is crucial to raise the level of financial literacy among the population. 70

REFERENCES Fillippov S., Hofheinz P., 2016. From Startup to Scale-Up: Growing Europe's Digital Economy. Silanes L., McCahery F. J., Schoenmaker D., and Stanisic D., 2015. The European Capital Markets Study: The Estimation of the Financing Gap of SMEs, Duisenberg School of Finance, Amsterdam 72

74