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FINANCE & INVESTING | 05.11.2018
Equity crowdfunding started in its current form around 2011–2012. Since then it has been evolving and various models have been experimented with in various legal framework. Trying to summarise all the nuances of different legal frameworks is difficult, but on a high level I mainly see two types of equity crowdfunding models being used. I call these models the venture capital (VC) model and the investment banking (IB) model. Let me explain what I mean.
The VC model of equity crowdfunding refers to a structure in which an equity crowdfunding platform pools all the individual investors taking part in a funding round, and the pooled entity then makes one single investment into the operative company which is raising funding.
There are a couple different structures for how this pooled entity is created depending on the legal framework the model is operated within. Examples of this model are nominee structures commonly used in the UK, cooperative structures in the Netherlands, and in general all holding company structures. Here I will focus more on the holding company structures, as they are closer to our turf in the Nordic region.
In the VC model, individual investors are treated somewhat like limited partners (LPs) in VC fund structures. These individual investors jointly own a holding company which has made a single investment into the operative company, but they themselves are not direct shareholders of the operative company and do not have direct influence on the target company.
The VC model is a costly structure as the holding company must be serviced, incurring accounting and other operative costs. Many European equity crowdfunding platforms have also added additional earnings logics to the holding company structure, such as profit-sharing models in which the platform may take a cut (called a carried interest) of proceeds upon a successful exit by the operative company. In the world of VC funds, carried interest is typically around 20% of the profits, but the numbers can be smaller in crowdfunding models.
It has been argued that this structure is good for the operative target company, because the shareholder list includes only one aggregated investor, thus reducing the complexity of having many shareholders with different terms (hint: we suggest tackling this by streamlining terms to an elegant one-size-fits-all model instead of setting up a costly holding structure).
In the investment banking model of equity crowdfunding, on the other hand, investors become direct shareholders in the target company without extra layers of holding companies. This structure is identical to an investment in an IPO.
In this structure, shareholder’s agreements are often used to limit some of the shareholders rights to give the board of the company more powers to decide over exit and over new funding rounds.
As I wrote above, to limit complexity we generally suggest an elegant solution of one class of shares with a shareholders’ agreement. It is a neat and simple structure to handle possible new funding rounds. More shareholders doesn’t mean more complexity; more investment terms means more complexity.
So these are the two main equity crowdfunding models in Europe. There are still large variations around this, such as non-voting shares, platforms investing in the targets, platforms charging the investors, investors investing debt to the holding company, which will then make an equity investment into the target company, etc. But whatever the structure is, the key is that you as an investor understand what you are investing in. In my next blog I will explain Invesdor’s own structure!
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The information contained herein is not meant to be, and it shall not be interpreted as investment advice or a recommendation and investors must neither accept any offer for, nor acquire, any securities unless they do so on the basis of the information contained in the applicable investment material of a target company. Investing in securities of unlisted companies is associated with high risk.