Look at a practice in vogue:

Crowdfunding is a form of alternative financing that directly matches an individual investor with an entrepreneur who needs funds to invest in specific projects.

These projects can take many forms: art projects, philanthropic initiatives, public projects or even start-ups…

As an alternative to traditional funding, crowdfunding contributes to the health of the economy and the disintermediation of banks. In fact, this investment form allows investors to directly chose in which project they want to invest. Thus, in contrast with the conventional scheme where banks finance projects that seem the most relevant according to their criteria’s, crowdfunding allows entrepreneurs to address directly to investors and to submit their project without any intermediation.

Beyond its usefulness as a source of alternative financing, crowdfunding has a real marketing value, which if used properly, can contribute to the maximization of profits of the company. Indeed, crowdfunding is actually a form of crowdsourcing which consists in the use of the public to get ideas, feedbacks and solutions to develop the activities of the company. The philosophy of the system is that investors become real ambassadors of the brand.

Depending on what investors receive in exchange for their contribution, crowdfunding exists under different business models. Ranked in ascending order of complexity we find in particular: the simple gift, the gift with rewards such as an autograph, the pre-sale, the loan with or without interest and finally the equity.

If we look more closely at the loan with or without interest and at the equity model one realizes the importance for the entrepreneur to chose the business model he wants.

If for investment in equity often offers higher returns on investment, it is far from obvious that this solution is the most appropriate in all cases.

In fact, it is possible to identify a range of problems linked to the investment in equity.

First, the fact for an entrepreneur to open the capital of its company to a multitude of investors presents a risk of dilution.

Second, it is not always easy to value a company. Indeed, a problem of asymmetric information arises because the entrepreneur and the investor do not have access to the same information. Regarding crowdfunding, this information asymmetry is reinforced as investors are not professionals and therefore have very little access to information on the industry sector or on the business in general.

Finally, it is important to note that the acquisition of shares in the capital of a company is an illiquid investment whose exit horizon is uncertain. Although investors who participated in a crowdfunding operation can always buy and sell their shares, there is currently no established trading market that can help enhance the liquidity of this type of investment.

A solution to solve this liquidity problem would be to use the auction market to treat equity crowdfunding. However, in the current state of law, the use of this type of market would only be possible for crowdfunding operations that do not require the use of an investment platform.
As a matter of fact, for operations requiring the use of an investment platform the use of the auction market would not be possible because there is no such platform in Belgium that allows investors to hold shares directly. On the contrary, the investor holds shares in the platform, which are indexed on the return on investment of the underlying asset. In this way, it is actually the platform itself that holds the part of equity in which the investor invested (in the form of a holding company). Thus, in such a case, the investor investment is made even more illiquid...

07 November 2014

Ionathan Ventura - ionathan.ventura@peeters-law.be
Leo Peeters - leo.peeters@peeters-law.be