3
Equity Crowdfunding of Start-ups in France
3.1. Introduction
Fundraising in French start-ups1 exceeded $2 billion in 2016 and reached just over $3 billion in 2017 according to the CB Insights barometer (Les Echos Entrepreneurs 2018). Maddyness (2018a) announced that the average amount of funds raised is €3.3 million. In addition, transactions worth less than €1 million represent only 34% of rounds of funding.
Despite the importance of these figures, the failure rate of new businesses is 90% (Journal du Net 2017). This is due, among other things, to a funding problem. However, there is a variety of financing options. Alongside investment funds and business angels, the company has other alternatives to support it in launching its project: bank loans, grants, assistance from public bodies or equity financing.
But even though the opening to external investors is becoming more and more democratic, this solution is still rarely used by many entrepreneurs who do not want to lose their decision-making power within their company. However, only by opening up capital, very large amounts can be raised and, thus, quickly create strong growth in the company.
Equity crowdfunding (ECF) involves opening the company’s capital to the “crowd”. This new financing alternative is experiencing a remarkable growth, with €154 million raised in 2014. Experts estimate that €6 billion will be raised by 2022 (Poissonnier and Bès 2016).
In addition to financial needs, the role of the entrepreneur is central to the financial and economic success of a company. That is, the entrepreneur must know how to finance himself and mobilize resources to grow the business. It is therefore a question of recruiting the right people who will move the company forward, building and developing a viable business plan, mobilizing the right skills at the right time, increasing sales, etc. This is referred to as the entrepreneur’s human capital. According to Les Echos, it is defined as “the set of individual knowledge, skills, competencies and characteristics that facilitate the creation of personal, social and economic well-being” and “human capital is an intangible asset that can advance or support productivity, innovation and employability” (Les Echos 2011).
These elements lead us to wonder whether the ECF is a better financing solution for start-ups than the more traditional ones. In addition, it is a question of how the ECF can enable the company’s success while preserving the entrepreneur’s human capital.
This chapter will therefore address the following issue: How can ECF position itself as a successful financing alternative for start-ups given the entrepreneur’s human capital?
First, we will look at the evolution of start-up financing and the challenges of raising funds with traditional investors. Then, we will study participatory financing, its challenges and limitations in order to compare this method of financing with that of traditional investors. Finally, we will try to understand how current entrepreneurs concretely approach their financing in order to understand how ECF can position itself in relation to other financing alternatives.
3.2. Contextual framework: state of play on the financing of start-ups in France
The purpose of this first part is to explain the financing methods of start-ups in France. Entrepreneurs are not always aware of the different forms of financing available and how they operate. It is therefore important to understand how entrepreneurial finance has evolved and the challenges of fundraising.
3.2.1. The evolution of entrepreneurial finance and sources of financing
From financial institutions (such as banks) to individuals, there are many ways to provide seed funding for your project. The purpose of this first sub-section is to contextualize seed financing and to show the evolution of business financing methods.
3.2.1.1. State of play
French Tech2 has been breaking fundraising records for the past 2 years. The start-up activity is mainly concentrated in Paris with 342 deals made in the capital (Les Echos Entrepreneurs 2018). French start-ups have managed to be bought back at a very high price, such as Zenly, which raised a total of $33.7 million and was then bought back for $350 million by Snapchat (Challenge 2017).
The first round of funding is used to raise seed capital3 that represents the funds of a company to launch its activity. Then, in a second round, if a company wants to raise more funds to generate more growth, it can call on venture capital. The type of investors to be solicited therefore depends on the life cycle of the company. Figure 3.1 helps us to understand the different types of financing required by the company during its life cycle.
Figure 3.1. Typology of financing during the life cycle of the company
(Source: Frenchfunding.fr n.d.)
There are several ways to find funds to start your business:
- – love money, which is money collected from the entrepreneur’s relatives and often represents small amounts;
- – business angels, who are generally entrepreneurs who have already made a fortune in the companies they have created and form part of the capital of young start-ups by contributing funds, their knowledge and their network. They allow companies to raise more funds than love money;
- – the State, which in 2013 set up the public investment bank (in French, la Banque Publique d’Investissement, or BPI) whose objective is to set up a structure to help the development of entrepreneurship in France. The BPI therefore offers a seed loan to launch its activity;
- – traditional banks that provide loans to companies;
- – investment funds that specialize in seed capital such as the National Seed Fund.
The main players in seed capital today are business angels such as Pierre Kosciusko-Morizet, the founder of PriceMinister, Jacques-Antoine Granjon, the founder of vente-privée.com, and Xavier Niel, the founder of Free. It is these investors who raise the most funds at the seed stage, on average between €100,000 and €500,000.
Despite these substantial figures, the Gallois report to the French Prime Minister (2012) explains that “innovation is now recognized as an essential element of European countries’ growth” (Pommet and Sattin 2016), yet, according to the OECD, only 700 technology companies were created in 2014 out of a total of 267,000 companies. In France, innovation requires entrepreneurship that creates jobs and increases French competitiveness in a highly competitive global environment. In addition, at the end of 2016, 40% of very small enterprises (VSEs) and small and medium-sized enterprises (SMEs) still have difficulty obtaining financing. France is therefore contrasted because despite many means of financing, many companies have difficulty generating strong growth, particularly because of these financing difficulties during the start-up phase.
3.2.1.2. The rise of private investors
Venture capital markets increased from 10% in 1991 to 22.7% in 2008. The number of international investments in emerging countries rose from 8.7% in 1991 to 56% in 2008. Alongside the globalization of venture capital and entrepreneurship, the second major trend that has affected entrepreneurial finance over the past two decades has been technological innovation. The Internet and other technologies have made communication over long distances much easier and cheaper. As a result, this has had a significant impact not only on companies, but also on financial and intermediate markets, such as venture capitalists, private equity firms and investment banks. Globalization and technological innovation interact in their effect on entrepreneurial finance because the reduction in communication costs due to technological innovation has facilitated cross-border venture capital investments.
Another important development affecting entrepreneurial finance has been the rise of venture capital alternatives. First, the structure of venture capital firms evolved from limited partnerships with a fixed term of approximately 10 years to subsidiaries which provide longer investment horizons. Then, the business angels appeared and started investing significant amounts in start-up companies by taking a stake in the company’s capital. A less conventional source of funding has recently joined venture capital firms, namely crowdfunding. Participatory financing consists of mobilizing private funds via the Internet from a relatively large number of investors who may be future clients of the financed company (Chemmanur and Fulghieri 2014).
Business angels normally invest in the form of equity financing in the hope of obtaining a financial return on a future exit from the capital. Business angel investments are largely focused on new and emerging technology companies. They are particularly important from the point of view of regional economic development because the majority of their investments are local. As a result, they generally recycle and reinvest wealth created locally. Given the geographical concentration of venture capital investing in central regions, business is particularly important in peripheral regions. In addition to the capital invested, venture capitalists and business angels have a positive effect on the development of the company financed, thanks to a combination of their skills, their network and their reputation. They enable the company to properly develop their teams, better manage their skills, make the right strategic decisions and gain credibility with suppliers and customers. Business angel investments, therefore, improve business results and performance to the extent that resources are well managed by the entrepreneur. Hence, 51% of digital companies think it is better to raise funds from business angels than from investment funds or banks according to Syntec Digital.
Mason et al. (2016) studied the evolution of the business angel market. They explain that it has fundamentally evolved from an atomic, fragmented and largely invisible market comprising almost exclusively individuals investing alone or in small groups, to a market increasingly characterized by groups of business angels and highly visible unions that consolidate and optimize the financing decisions of companies seeking funding. The importance of business angels in supporting the development of entrepreneurial projects has been recognized by national and regional governments in various countries, including the United States and France. These investment activities are encouraged in various ways, including through tax incentives and support for business angel networks and other types of intermediaries that connect these investors with entrepreneurs seeking financing. In the 1980s and 1990s, business angels operated anonymously, investing mostly individually or with small groups of friends and associates in companies known through their personal social and commercial networks. At that time, the market for business angels began to transform in the late 1990s when they began to organize themselves into groups to invest collectively. Investor groups have emerged for two main reasons.
First, they had difficulties in investing alongside venture capital investment funds due to the overly sophisticated investment instruments used by the funds, in particular liquidation preferences, anti-dilution rights, special subscription rights and enhanced monitoring rights.
Second, as the market evolved, there were fewer possible complementarities between business angels and venture capitalists, partly because of the decline of the venture capital industry at the time and its reorientation towards larger and later transactions in the financing chain. The collective investment of business angels has therefore made it possible to create a more relevant step in the financing chain for young companies. The group financing of business angels has made it possible to gather investors’ knowledge and improve the selection process of companies to be financed by reducing their investment risk. Finally, it allows the contractor to reduce the time and cost of fundraising.
3.2.1.3. The role of the State in the evolution of entrepreneurial finance
Many public subsidies have been put in place by the French government, particularly since the early 2000s, to motivate entrepreneurial innovation. There are now more than 5,000 public subsidies in France. Each grant has a very specific financing purpose and each company must apply for a specific purpose, such as human resources development or international development. A selection process exists, and the amounts proposed are often limited and gauged according to the company’s demand and need. The aid may be granted in the form of a grant or loan.
Bpifrance, a public investment bank (BPI), is a very successful institution set up by the government in 2013. The purpose of this bank is to support French companies in their innovation and project launch. It therefore offers financing solutions. Bpifrance financed €14 billion in 2014 and €13 billion in 2013. All companies, from very small businesses to international groups, can benefit from Bpifrance’s support. However, it remains a very useful support for very small businesses and start-ups, especially in the start-up phase. Furthermore, 15% of the companies created in 2014 received support from the BPI.
The BPI is present in each French region and offers support adapted to each stage of the company’s life cycle, from the start-up phase to stock exchange listing and venture capital. Working in partnership with private investors, the BPI is central to the economic development of the regions in France.
European grants, such as the European Investment Fund (EIF), have made it possible to set up, for example, the Innovation Loan and the Investment Seed Loan. It is statistically shown that companies with growth potential supported by Bpifrance are growing faster than other companies. This proves that the BPI is a guarantee of quality in its support and advice, in particular because it adapts to the needs of companies in each sector and each region.
One of the major roles of the BPI is to limit the failures of start-ups or VSEs in the start-up or creation phase, the most unstable and risky phases of a company (Gouvernement.fr 2016). In addition to public subsidies, associative networks also provide financial assistance such as loans within Réseau Entreprendre and Initiative France. Honor loans are interest-free loans without a guarantee. Digital start-ups and SMEs increasingly rely on public funding, in particular the research tax credit (CIR), which is a tax reduction calculated on the basis of the company’s research and development (R&D) expenditure.
The French government is trying to motivate national investment. The French save a lot (unlike other European countries) and do not take many risks. At the end of 2017, the French economy reached €4.8 billion, and only 36% is invested in risky assets, while, according to Syntec numérique (2017), 40% of start-ups and SMEs admit having difficulty finding financing and meeting their working capital needs. Since January 1, 2018, the State has abolished the wealth tax (ISF) in order to redirect French savings and thus promote investment in start-ups and SMEs (Maddyness 2017b). In addition, Minister of Economy Bruno Le Maire announced that he wanted to make it easier for French people to mobilize their retirement savings, which amounted to €200 billion at the beginning of 2018, and that he wanted to try to diversify life insurance because €1,200 billion was inactive on life insurance accounts in France (Maddyness 2018e).
We have therefore seen that small French companies are raising more and more funds in different ways and that many sources of financing are within their reach. Despite the positive results of private investment and the government’s efforts to facilitate access to financing, many companies still find it difficult to meet their working capital requirements. We will see in the next section how start-ups organize their financing.
3.2.2. Financing practices of start-ups
Hechavarría et al. (2016) explain that financial capital is one of the key resources that a company needs to operate and survive in the early stages of the investment process. First, they establish that the initial capital structure decision is important because it influences future results in terms of the time required to create and exit a new business. Start-ups that use higher proportions of external equity capital in their initial capital structure are much more likely to evolve quickly because they have more cash available to finance their projects and generate faster growth.
In addition, companies that use a higher proportion of debt and equity are also less likely to go bankrupt. The capital structure and the financing of the project in the start-up phase are, therefore, very important for the evolution and future of the company, knowing that an idea, however good it may be, cannot be developed without capital. It should not be forgotten that the function of financing a project is to be able to operate it.
Historically, companies of all sizes have chosen their financial structure based on the cost, nature and availability of financial alternatives. On the contrary, the financial behavior of small companies is different from that of large companies. That is, to raise funds from an external investor, it is necessary to convince him; and the younger the company is, the higher the risk is for the investor because he does not yet know if the company is sustainable – unlike a large company that already has market shares.
The risk is amplified with the presence of information asymmetry. Information asymmetry occurs when two stakeholders in an activity or exchange do not have the same information. The risk of a company failing is therefore very complicated to perceive. This makes it difficult to raise funds from external investors.
For small companies, the agency costs disappear completely since the manager is the owner of the company. According to Les Echos, “the divergence of interest between the different actors in the life of the company gives rise to a certain number of costs called agency costs”4. These costs are mainly due to external services, such as audits, in order to support decision making. Monitoring is therefore not necessary because of the exact correspondence between the agent’s and principal’s preferences. However, in cases where there is a separation of internal and external owners, agency costs reappear since shareholders’ expectations will not necessarily be the same as those of the manager. So loan contracts and new capital tend to be placed in private and these contracts sometimes include personal financial guarantees, and, therefore, often require owners to provide additional funds.
All these provisions help to encourage managers to act in the interest of external capital providers. This is why small firms rely less on external equity capital, according to Pettit and Singer (1972).
VSEs have particular characteristics and financing constraints, creating capital structure problems that are totally distinct from those faced by large companies or even small and medium-sized companies5.
Aktas et al. (2011) studied the cases of more than 55,000 small French companies between 1998 and 2006 to understand how they choose to structure their capital. This study shows that French VSEs are in line with the Pecking Order Theory (POT) developed by Myers and Majluf (1984). This theory explains that financing choices follow a hierarchical order, and that companies avoid the costs associated with asymmetric information, knowing that investors’ main motivation is to get rich. According to the POT, the company prefers internal financing to external financing, and debt to equity if it has to turn to external financing.
We remind you that the smaller the company, the smaller the limits of its activity and the greater the probability of failure. VSEs therefore face higher costs related to asymmetric information, with a direct impact on the cost of debt. As a result, French VSEs tend to use internal financing as a default means of financing. They still use debt, but as a complementary source of financing. Finally, as a last resort, equity capital is issued. Debt is therefore the most widely used means of financing because it is, after love money, the easiest means of financing during the start-up phase.
Based on the POT, Carpentier and Suret (2000) explain that before the 2000s, French companies measured their debt by a ratio-target and adjusted their debt level according to their size and profitability. Differentiating between companies with external financing needs and those with excess financing is essential to understanding the financial behavior of small businesses. VSEs tend to repay their debt in advance in a less spontaneous way if they experience excessive financing.
However, VSEs borrow more freely when they face a financing deficit and they finance almost all their deficit through debt. The financing behavior of VSEs, which seems to follow that set out in the POT, leads researchers to conclude that information asymmetry and agency costs have a significant influence on the choice of financing for French executives.
Hege (2001) sheds further light on the evolution of the capital structure of start-ups from the 2000s onwards, (the era of the Internet bubble and the rise of venture capital investment in Internet start-ups). This period was marked by the absence of debt and the growth of stock options, as well as the abandonment of dividends. This is because start-ups have begun to need contractual relationships that provide incentives for investors to maintain disciplinary leverage over corporate stewardship. In addition, it also allows strategic flexibility to be used as an essential competitive advantage.
Savignac (2007), in turn, provides more elaborate details of this reasoning. He explains that optimal financing methods for companies can be differentiated according to the level of risk of the company, the level of the entrepreneur’s guarantees, the life cycle of the company and its profitability. The risk level of a company is defined here as the probability of its success. Therefore, a high risk is equivalent to a high probability of failure. Three possibilities then exist: a bank loan, a contribution of funds from a venture capitalist or the inability to access external financing.
An innovative project is by definition new, so investors cannot be 100% certain of its success and therefore cannot know the company’s level of risk. They measure this level of risk before deciding whether or not to fund the project. According to the researchers, the lower the success rate projected by the company, the less access it has to external funding. Then, if the probability is sufficient, raising funds from venture capitalists is the optimal financing. Finally, if the risk is low, then bank lending becomes the optimal way to finance yourself.
The guarantees that the entrepreneur can offer are also taken into account in the choice of optimal financing. When the entrepreneur has some assets in the company, this gives investors a guarantee that the entrepreneur will make his project work and then reduce the company’s risk. Where there is still a risk and there are few guarantees, equity contributions by a venture capital company become the optimal mode. On the contrary, once the company has significant guarantees, usually later in its life cycle, the bank loan becomes optimal.
According to Savignac, other factors such as the model and the rate of return also play a role in choosing the optimal financing. The model represents the amount the company needs to complete its project. Thus, if the amount required is high, it is better to seek financing from venture capitalists who have the ability to take risks and invest large amounts. If the amount needed is small, the bank loan becomes optimal because the funds do not invest in small projects anyway. Therefore, the higher the rate of return of the project for venture capitalists, the simpler it is to raise funds from them, at least theoretically, even though the bank has doubts about the success of the project. The role of the model created by the entrepreneur is important because venture capitalists are sometimes willing to finance certain companies to which banks do not lend, or at least at a very high rate, given a poor assessment of the project’s probability and, consequently, of its expected return.
Venture capitalists then play an important role because, as experts in innovation projects, they are better than banks at assessing the probability of success of an entrepreneurial project that is mainly related to information asymmetry. This does not prevent these investors from calling themselves venture capitalists and investing in companies that are riskier than those financed by banks. This risk taking is reinforced in particular by an equity investment and is not satisfied with a simple repayment of the amount issued as banks do.
The researchers conclude that there is a limit to the financing of innovative projects by banks because the essential characteristic to be taken into account in financing is the risk of failure. Banks cannot neglect this risk, particularly because of the harsh regulations to which they are subject to in order to avoid bankruptcy in a system where a country’s economy depends on these banking institutions. On the contrary, the expertise of venture capitalists makes it possible to better identify young companies and information asymmetry.
Finally, each company can choose its own financing method, but there is an optimal financing method that will allow the company to grow, generate growth and gain market share more quickly. However, the tendency of small companies is still to favor internal financing. If this is not possible, they prefer to apply for a loan from the bank and as a last resort they use external equity capital from investors taking part in the capital. Savignac explains that raising funds from venture capitalists or business angels would be more affordable and would often be the most optimal means of financing for young innovative companies.
3.2.3. The process of raising funds from private investors
In order to further the understanding of entrepreneurial financing in this section, we will try to understand how the investor fundraising process works technically and what it implies for the company, the entrepreneur and the investors.
3.2.3.1. The challenges of fundraising
This section is based on Milin’s book (2018), which explains in detail how fundraising is carried out with the various stakeholders. The fundraising process is quite similar between business angels and venture capitalists. Here are the different steps:
- – Preparation of project presentation documents upstream. They are essential because they will be used by investors to learn about the project, and they include the following:
- - the Business Plan, which explains the concept of the project, its ambitions and functioning, as well as the projections over the next 7 years generally,
- - the Pitch Deck, which is a summary of the Business Plan and serves as a basic support to be used during the presentation to potential investors, in order to capture their attention and make them want to go further in the study of the project,
- - the Executive Summary, which is a one- to two-page document that summarizes the Business Plan and the Pitch Deck. This document must include all the key elements of the business plan to make investors want to meet the entrepreneur;
- – The valuation of the company is a very important step because it is on this information that the negotiations will be based;
- – Meeting with investors to pitch the project and try to convince them to invest;
- – Due diligence: the principle consists of the investor carrying out a complete audit of the structure he is financing in order to assess the state of the company. The purpose of due diligence is to minimize information asymmetry;
- – The negotiation will lead to the shareholders’ agreement and all the company’s governance rules. The main disagreements between the entrepreneur and investors will be the share price and the organization of governance. On the one hand, the entrepreneur wants to raise as much money as possible by minimizing his loss of control. On the other hand, the investor will try to invest a coherent and relevant amount in the project, try to be able to monitor the evolution of the project as much as possible and make strategic decisions by having enough weight on the board of directors;
- – Once all stakeholders have agreed, the last step is the closing of this fundraising event. The fundraising and project implementation can then be carried out.
When presenting the project to investors, they will try to understand what the project is, whether there is a potential market and how it will evolve in the coming years. They are interested in knowing when they can resell their shares in order to realize a capital gain on their investment.
In the business plan, they will particularly focus on the neutral or break-even point, that is, when the company will be profitable and make an income. They will also try to understand how the funds they invest will be used and for what purpose. The objective for an entrepreneur is to control as much as possible the dilution with which he will inevitably be confronted during a fundraising event. To do this, he must calculate the amount he wants to raise and estimate how many of his shares he is willing to lose. This will then determine the post-money valuation from which he can then deduct the pre-money valuation. Valuation is therefore a very important step and the entrepreneur must build it, well before meeting with investors.
Bessière and Stéphany (2014/5) focused on the evaluation of innovative projects. According to the researchers, among the different valuation methods presented in Table 3.1, it is difficult to apply those based on simulations and flow projections. The reason is that start-ups are doomed to change and can choose a strategic turn very quickly, which can challenge all projections in a matter of moments.
Table 3.1. The different methods of project evaluation
(Source: Duplat 2007)
| The Different Methods of Project Evaluation | ||
| Evaluation method | Valuation indicators | Data used to determine the evaluation |
| Patrimony |
|
|
| Profitability value |
|
|
| Comparables |
|
|
Three fundamental elements must also be taken into account: risk, time and information. First, in valuation, risk is defined more as an uncertain environment. Indeed, being an innovative project, we do not know if it will work. But investing in a project that will work later on will be all the more valuable. Uncertainty can therefore be a factor that increases valuation, as long as the business model and business plan are consistent. Second, an innovative project can work very early and very late, and can also change direction very quickly depending on the market. It is therefore essential that the project arrives on the market at the right time, that is, not too early to be able to have interested customers, nor too late to arrive on an ultra-competitive market. This is called “time to market”. Finally, information is also a key factor in the valuation of a project since an asymmetry of information could lead to over- or undervaluation and, consequently, to unbalanced financing. The most pragmatic way to evaluate a start-up would therefore be for researchers to evaluate the business model, in order to understand how the project will generate revenue, in what quantity and in what direction to move the revenue forward.
3.2.3.2. The post-fundraising operation of the company
Post-fundraising is a period that is very popular with investors. They have taken part in an adventure and want everything to go well. Investors can take a position on the company’s board of directors. It sometimes happens that some become employees of the company. The activities of the business angels have been sorted into four distinct roles:
- – the strategic role within the Board of Directors;
- – gather the resources necessary for the company’s success, particularly through its network;
- – the monitoring or supervision role;
- – the role of mentoring in order to bring all its experience and knowledge.
In addition, one of the important points for the entrepreneur after the fundraising is the governance of the company. Filia and Grünberg (2016) outline an investor’s commitment through five governance processes:
- – the process of delimiting borders through which the investor will identify the company’s needs and manage access to external resources by focusing on contacts he knows and trusts. Through this process, the business angel is able to expose the company to ideas and initiatives that are consistent with their environment and industry;
- – the structuring process, which will enable the reorganization of the company’s structure in an optimal way, so that it can develop as much as possible. Business angels engage in structuring in several ways. They introduce and support more formal approaches to operational and strategic work by introducing strict accounting procedures, regular reporting of financial data, operational progress and cash flow planning. This structuring process will also reduce information asymmetries and relational risk:
- – the “leadership” process, whose purpose is to give meaning to everything that is done in the company, to give ambition to teams, a direction and to put in place real values, so that everyone moves in the same direction;
- – the implementation process, which is really the act of putting in place everything that has been decided. Business angels are often very involved in society and sometimes even in the operational work of the company. Some may be employed part-time or full-time by companies. This involvement ranges from solving the company’s organizational problems or developing the business model to providing practical assistance;
- – the monitoring process, during which the investor will look to see if everything is moving in the right direction, if the objectives can be achieved and if the company is competitive in the market.
Business angels therefore engage in five distinct governance processes, with cognitive and material dimensions, to reduce market and relational risks. But the institutional dimension of an investor’s participation after investment can have an impact on corporate performance. Some of the processes are not synergistic and can neutralize each other if used together. Companies and investors must therefore pay close attention to how and within what limits this governance should be put in place. It should not be forgotten that not all investors are involved in this way either.
In addition to governance, the other main challenges are to structure teams and generate growth (Milin 2018). A fundraising campaign gives the company the objective of investing and gaining market share. This is the main point on which investors will focus their attention. To gain market share, you need to recruit the right people with the right skills and position them in the right place. To develop, entrepreneurs can rely on investors and their address book or their own skills. One of the regular tasks for entrepreneurs is to report regularly to shareholders to keep them informed of the company’s progress.
3.2.3.3. Investor expectations
The work of Redis et al. (2015) focuses on what investors, particularly business angels, really expect from an entrepreneur and their investment criteria. Their research leads to several findings. First, there is a correlation between the level of investment of a business angel and its assets. That is, the higher the level of wealth a business angel has, the more he can afford to take risks and invest large sums. In addition, they also show that investors who have already had entrepreneurial experience tend to invest larger amounts and take more risk than those who have never had entrepreneurial experience. These comments must be qualified by taking into account the greater diversification of investments by these entrepreneurial investors. However, they did note that an experienced business angel, that is, one who has already invested several times, tends to be more cautious about the amounts invested.
Age is also a factor of caution. Their results show that an investor takes less risk as he gets older, while he takes more risk at an intermediate age. In summary, the main determinants of business angels’ investments, and therefore of their risk-taking, are the level of their assets, their age, their entrepreneurial experience and their seniority in the investment profession.
The investment choices of business angels are thus based on personal factors. But investors have other criteria for investing. Business angels’ decisions are sometimes made in groups. Investing in France can also lower their wealth tax rate. Investing in a few start-ups can thus be beneficial in order to lower the tax they pay as much as possible, and, indeed, they can make money if the start-ups work. The main choice in an investment is still the entrepreneur’s confidence in the business angel. That is, if the entrepreneur can show that he is able to mobilize the necessary resources and that he has the skills, motivation and ambition to succeed as an investor, he has a chance to convince him. This reduces the risk associated with asymmetric information that often holds back investors.
Through this first part, we have seen the state of financing of start-ups in France and the ways in which they should evolve. Many financing options exist and the government is working to democratize the financing of start-ups in order to promote entrepreneurship. However, many of them still feel that they have difficulties in obtaining financing and the opening of capital is not yet a desired or even accessible practice for all entrepreneurs. The process of raising funds from investors is cumbersome, and it requires a strategic choice on the part of the entrepreneur. Choosing your financing method is an important step for the company’s successful development. We will therefore address the subject of participatory financing in the next section, and in particular equity crowding, which is a new financing alternative and may be a more relevant means for young companies.
3.3. Equity crowdfunding: a fast-growing financing alternative
Many alternatives to innovation financing exist and the latest to be implemented is participatory financing. The purpose of this second part is to understand the functioning of participatory financing, in particular equity crowdfunding, and its challenges for companies. This will be the subject of two initial sub-sections. This will allow us to position ourselves with respect to this method of financing compared to traditional investors such as business angels or venture capitalists.
3.3.1. Presentation of participatory financing and equity crowdfunding
This section will be based on the book by Poissonnier and Bès (2016), who have studied in detail the origin and functioning of participatory financing. By its name, crowdfunding clearly shows the presence of new investors in the world of entrepreneurial finance. The crowd represents Internet users who invest in projects via specialized platforms. Participatory financing marks the democratization of corporate financing and the disintermediation of corporate financing, which has been previously reserved for traditional investors. Now, a simple link between investors and project leaders makes it possible to raise funds. This can be an attractive solution for some entrepreneurs and for investors who no longer need equity, assets or even financial knowledge to invest in a project.
3.3.1.1. Origin of participatory financing
Crowdfunding has emerged from a new financing system created in 2004 in Great Britain with the Zopa platform, namely the “credit peer-to-peer”. This system was intended to solicit the general public to help finance credit applications to people excluded from the consumer credit system. This system did not work, particularly because of the banking regulations that did not allow them to develop. However, he was the pioneer of financial disintermediation. They then repositioned themselves on solidarity micro-credit for small entrepreneurs who wish to develop slums and rural areas around the world. This was a success, as, in 2015, they identified a community of 1.5 million members who were involved in the fight against poverty around the world. It is therefore from 2010 that other reward donation platforms6 have been created, such as Kickstarter in the United States or KissKissBankBank and Ulule in France. Platforms have grown and now also allow companies to raise funds to develop their projects. With this system, companies can access investor communities around the world with just a few clicks. The English company Funding Circle, launched in 2010, was the first to offer companies the opportunity to raise funds.
The concept is a success and is booming with an annual growth rate that reaches more than 140% in Europe and North America in 2014 and exceeds 300% in Asia with $3.4 billion raised (Poissonnier and Bès 2016, p. 20). Today, there are more than 2,000 sites for participatory financing with €152 million raised in France in 2014 and €133 million in the first half of 2015 (Poissonnier and Bès 2016, pp. 19–20).
Global data prove the continued growth of this system: $16 billion was collected in 2014 compared to $35 billion in 2015. Experts estimate that the total cumulative amounts will reach €1,000 billion by 2022. The United Kingdom remains the country that uses this system the most because it represents 80% of the world’s collections. But France raised the second most in Europe in 2014 with €154 million (Poissonnier and Bès 2016, pp. 19–20).
Participatory financing has a positive impact on business creation and risk taking on the part of investors because the process reduces the complexity of the act of financing. Indeed, corporate fundraising campaigns are transparent and give the crowd full access to company information, including their product, service, strategy and the destination of the funds raised. This reassures the investor in his decision-making.
3.3.1.2. The different types of participatory financing
There are several types of participatory financing grouped into three main categories, namely grants, loans and investments (Poissonnier and Bès 2016, p. 57). Here is the presentation of the different types of participation classified from least risky to most risky:
- – donation for no consideration: the donor participates generously in fundraising because he receives nothing in exchange. This is the least risky level of participation because the donor is fully aware of the level at which he or she is participating;
- – gift with consideration: the donor receives consideration from the company in exchange for his gift, which is generally a more or less important gift depending on his level of participation. The level of risk is also very low for the same reason as the previous point;
- – peer-to-peer lending: an interest-free loan granted to the applicant for funds. The risk is that it will not be refunded;
- – crowdlending: the same principle as bank lending, where the contributor expects a repayment of his loan from the company with interest. Participants generally use this principle to optimize their savings. The risk is therefore higher because the amounts lent are larger than those of the grant financing;
- – finally, equity investment (crowd equity or equity crowdfunding) gives the contributor the opportunity to participate in the company’s capital. It therefore represents the most risky investment because the investor is exposed to all the risks of corporate default.
3.3.1.3. The functioning of equity crowdfunding
Equity crowdfunding investors are Internet users. It is undoubtedly the most relevant system, with crowdlending, because the amounts collected are high and make it possible to solve the endemic problem of the undercapitalization of French companies and the provision of their working capital needs. In France, there are approximately 30 platforms, including Wiseed, which was the first to be created. Here are some figures:
- – €50 million raised since 2008, including €25 million in 2014;
- – average amount collected: €376,000;
- – the average amount invested: €4,500.
In view of the amounts raised, this system is automatically aimed at SMEs or start-ups because larger capitalization companies will use larger funds to raise larger amounts.
The equity crowdfunding process is less important than that of traditional investors. The steps outlined below still require some rigor and can take time.
- – Elaboration and selection of the file by the specialized platform
To raise funds, you have to go through a specialized platform. The company’s first objective is therefore to be selected by the platform. The average file acceptance rate is 2%, which shows a high selection by platforms as they try to build loyalty in their community. To do this, it is necessary to propose efficient projects in order not to damage the image of the platform and not to lose investors. The French government is also the institution that decides whether or not the platform can carry out its activity. Competition between platforms is therefore very important, which makes project selection more difficult. This is acceptable to the State, which is trying to encourage French savers to invest in companies, so the projects in which they invest must work. The company must build a file by presenting its project, and the amount it wishes to raise, then it must be selected by the platform.
It is important to specify that the entrepreneur must choose the platform on which he wishes to carry out his campaign, insofar as his file is accepted, in order to optimize his result. On the one hand, it is necessary to be well informed about the processes of the platforms, which may vary from one to the other, and on the other hand, to target a community of savers who might be interested in the project. Some sites specialize in specific sectors of activity or in a geographical approach, particularly in certain regions. In this case, it is better to choose a platform that already has a certain notoriety among savers and has a large community in order to increase the chances of obtaining financing from various people. It is important to check carefully the support method proposed by the site because if it is too weak, it is better to choose another one.
- – Setting up campaign pages
Once the application has been accepted, the platform helps the company to build its campaign and set up the campaign pages. The sites require a lot of information from the company and therefore consistent transparency. The law requires them to request this information, so that investors, who will not come into direct contact with the entrepreneur, can collect all the information they need to make the decision to invest or not. It is possible that some platforms subject to other legislation audit the company in order to give more information to its community. All documents such as statutes, balance sheets, income statements, business plans are required. Once the file is created, some platforms ask their community to approve the file. Then the file is put online and the campaign begins. According to experts, it is advisable to achieve 10–30% of the target in a few days to show that the project is worth the cost to the rest of the community. It is therefore recommended to have investors who wish to follow the project in advance.
- – Advertising the campaign
The campaign involves a communication effort on the part of the company to make the project known to the community. The entrepreneur’s objective is to source two ways of collecting funds: savings from investors who try to invest theirs, and self-collection that forces the entrepreneur to collect funds from other investors who do not seek to invest their savings. Several instructions should be followed: put the campaign on the home page of the company’s website, and send materials to the community such as newsletters or targeted and personalized messages according to the ambitions of the desired investor. Concerning self-collection, the entrepreneur must conduct a real communication campaign with his family and network in order to find other potential investors and increase his chances of reaching his objective. This is all the more important if the project does not generate a lot of community reaction.
- – The end of the campaign
The fence is largely managed by the platform. Once the campaign is over and the objectives have been achieved, the administrative and legal part must be built. This process is cumbersome and can take several weeks. That is, in all fundraising, drafting the shareholders’ agreement and organizing corporate governance are time-consuming steps.
In addition, fundraising also has a cost for the company. Generally, the platforms are remunerated at 5% of the fundraising achieved. But this can be negotiated on the entrepreneur’s side, especially if he has brought new investors to the platform and has therefore expanded the site community. In addition to these commission costs, companies will spend a lot of energy in the campaign, especially the entrepreneur, but also significant amounts for communication tools (video presentation of the project, legal registration of the operation, possible valuation of the company and the drafting of legal acts).
The equity crowdfunding process therefore seems more accessible than that of business angels or investment funds, thanks in particular to the help of the platform, which helps a lot in the preparation, monitoring and closing of the fundraising process. The selection process is also less complex than that imposed by traditional investors. In section 2.2, we will focus on the issues of equity crowdfunding.
3.3.2. The stakes and limits of equity crowdfunding
Financing by equity crowdfunding starts with a phase of evaluating the company. Governance impacts should also be considered before choosing this mode of development.
3.3.2.1. The valuation of the company
Business valuation is a major issue for fundraising. The question is whether the project and the business model are relevant in order to set a price per share that the platform will offer to the crowd. Bessière and Stéphany (2014/5) explain that two actors come into play in the evaluation, namely the platform and the crowd. They are studying the case of Wiseed, which is the first French equity crowdfunding platform to have been created and which is a key player in the field.
- – Evaluation of the platform
The evaluation of the platform consists of four phases:
- - the selection of the company by the platform that sets up its own selection criteria. The criteria are generally: the team that makes up the company, the product or service that brings something new, the company that seeks to raise between €100,000 and €1,000,000;
- - crowd vote: For the project to be validated, at least 100 members of the site community must subscribe to the project subscription. But not all platforms have yet implemented this process. It also makes it possible to obtain the opinion of a large number of potential investors and to highlight some points to be raised during the “due diligence” carried out by the platform;
- - crowd vote analysis: the platform studies the vote of its members in order to be able to measure their commitment to the project and the relevance of their voice;
- - due diligence performed by the platform: this is the most important step for the platform to understand how the company operates and to perceive its potential. The objective is to see, on the one hand, whether the project is viable in an existing market and whether the company has a real competitive concept. On the other hand, the objective is to understand the resources available to the company and how it organizes them to develop.
The platform sets the price of the titles before the campaign, but is based on the opinion of the crowd. The platform therefore makes it possible to validate the “time to market”. Indeed, a product that arrives on the market at the right time then sells better than a product or service that arrives too early or too late on the market. The validation of the project by the crowd strengthens the platform for the project’s potential, since the “time to market” is validated by the community. Exchanges with the crowd then make it possible to better understand the company’s potential and can also sometimes help to redirect or develop the project and its business model.
- – The role of the crowd
Experts explain that this type of financing involves three phases:
- - the validation by the crowd;
- - the financial evaluation of the project and the pricing of the securities;
- - the transaction.
The crowd then enters the first and third phases. In comparison with the evaluation process for business angels or venture capitalists, the motivations and expertise of the crowd are questioned and the evaluation risk differs because, as the project is put on the market, information asymmetries are amplified.
The crowd can be any Internet user, competent or not on the subject, who wishes to invest in a project, whether to follow the drift of the community, participate in the success of a project, take advantage of an opportunity or use their real skills to achieve added value on their investment. The composition of the crowd is central to the success of equity crowdfunding because it is with competent investors that the project gains credibility and therefore attracts other investors. But the crowd is generally not composed mainly of experts. Unlike business angels who make business valuation their profession, Internet users can invest in one click without having invested too much in understanding the project. Experts reveal that an individual perceives the assets they know as less risky. Affect then takes precedence over rationality. The crowd then invests in projects because they like it. However, it cannot say whether it is risky or not. An emotional logic takes precedence over a financial logic unlike traditional investment professionals.
Finally, information asymmetry is central to any business valuation at any level of investment, particularly for start-ups that are subject to three risks: managerial, technological and market. Unlike traditional investors, the crowd does not put in place post-fundraising monitoring processes, which does not reduce the risk of corporate failure. However, although the entrepreneur is confronted with a required public transparency, namely the disclosure of his business model and business plan, equity crowdfunding makes it possible to signal to the public, but also to other investors, that the project is of quality if the fundraising is successful. This could therefore make it easier for the entrepreneur to convince business angels or venture capitalists for a second round of financing. Nevertheless, we can see that platforms are beginning to refine their crowds and segment them according to sectors of activity in an attempt to bring in a little more expertise.
3.3.2.2. The new mode of corporate governance
In addition to a new problem of project evaluation, a new form of governance arises since the company can open its capital to the crowd and can find itself with a multiplied number of shareholders. The analysis of this issue will be based on the work of Bessière and Stéphany (2015a, 2015b). They explain that entrepreneurs must mobilize financial and cognitive resources to succeed in their project.
Corporate governance is defined as the set of rules that explains how a company should be managed and controlled. When an entrepreneur opens his capital to new shareholders, they can then have a say in strategic decisions. Opening up capital to business angels or venture capitalists, who are specialized in investments and who know the sector of activity in which they invest, allows the entrepreneur to benefit from new cognitive resources provided by these investors in addition to the capital. However, in equity crowdfunding, where the crowd is not an investment specialist, the entrepreneur opens up his capital and may have difficulty mobilizing cognitive resources, knowing that the amounts raised are also lower.
The company’s fundraising platform provides assistance with governance management. The entrepreneur can choose either a “club” mode or a mode administered by a holding company. The club mode implies that each investor enters the capital of the company with a participation rate according to his investment and becomes a shareholder. He must then get personally involved to monitor his participation and the evolution of the company. Corporate governance will then be less well-structured and investor monitoring will not be effective if they do not feel involved. Despite the advantage that the crowd can bring upstream of the fundraising with validation of the project and ideas for evolution, contribution of cognitive resources subsequently becomes unstructured because, having many shareholders, the mobilization of resources on the part of the entrepreneur depends on his proximity to new investors. Then, the entrepreneur can choose to be helped by the platform after the fundraising thanks to the holding company mode. The platform then creates a holding company to bring together all the shareholders from the crowd. The platform also manages the monitoring of shareholdings and regularly informs the shareholder community about the company’s evolution and the strategic directions followed. Unlike traditional investors who hold several means of putting pressure on the entrepreneur, equity crowdfunding investors only participate with simple actions and do not really have any disciplinary levers.
The two new players in the seed capital segment, the platform and the crowd, thus bring new skills in start-up financing and new organization. This new form of financing, which differs from the OTC system of traditional investors, has advantages over other financing systems, but also obligations that may be binding on certain entrepreneurs, in particular the organization of governance with a number of shareholders that can then be increased.
According to the experts, governance means that involve three risks (technological, market, managerial) are not effective in equity crowdfunding, in particular because the shareholders do not have the means to intervene in the project. In fact, their participation is made only with ordinary shares, unlike convertible bonds, which many business angels use to keep pressure tactics. The modes of governance are then considered to be unstructured. But being still young, equity crowdfunding will continue to evolve. Industry specialists are planning an increasingly sophisticated crowd segmentation to concentrate investor knowledge to further improve the success of the project and why not syndicate with business angels. The two models could then become complementary. This is what we will study in the next section.
3.3.3. Complementarity of financing methods
The platform has arrived as a new intermediary with the objective of connecting investors with entrepreneurs who wish to raise funds. As Cieply and Le Nadant (2016) explain, at the beginning of participatory financing, experts spoke of disintermediation of financing for companies at risk.
Several developments show that participatory financing, in turn, becomes a financing intermediary. First, the law makes this type of financing intermediate with, in particular, the arrival of the regulation as of October 1, 2014, which very strictly regulates the functioning of participatory financing in France. Second, the founders and managers of a participatory financing platform must have sufficient financial training or experience in the field to be accepted by organizations such as the ACPR7 and the AMF8. Among the founders of platforms in France, more than 50% have experience in banking or private equity and 80% have at least 5 years of higher education in finance. Finally, specialists note a rapprochement between financial intermediaries and participatory financing platforms. Indeed, several banks have set up partnerships with platforms and analysts anticipate a potential withdrawal of banks from financing this type of risky project in the start-up phase in order to allow the platforms make the first filter for the selection of all projects. Several platforms also finance their activities by raising funds from banks, investment funds or business angels, which further strengthens cooperation between these intermediaries. For example, the SmartAngels platform was financed by raising funds from approximately 10 business angels, and the banks Bred, Crédit Coopératif and Neuflize OBC became shareholders of the Babyloan platform.
Participatory financing is then a way for entrepreneurs to find financing that banks or business angels cannot provide because the risk is too high and because there is insufficient profitability during the start-up phase. Traditional players in entrepreneurial finance have a strong interest in forming partnerships and working with these platforms to strengthen their investment choices in projects that the platforms have already selected, which minimizes the risk since the crowd already believes in the project. It also allows banks to diversify their client portfolios. As stated in postulate at the beginning of this reasoning, participatory financing confirms its role as a generalization of market intermediation, becoming a step in addition to the company’s financing chain and reducing the risk taking of other intermediaries.
Pommet and Sattin (2016) agree in this sense insofar as they show that “smoothing the financing chain is a necessary condition” for the growth of start-ups. According to them, there are many ways for companies to finance themselves, from tax deductions and subsidies to bank loans and fundraising. However, there is still a financing gap in the financing chain, especially in the seed phase, once love money is exhausted. This is due to venture capital funds increasingly losing interest in projects requiring smaller amounts, as the returns achieved are lower than when funds invest millions. It should not be forgotten that an investment requires time and commitment from the funds and that investing small amounts (on their own scale) in high-risk projects is of less and less interest to these investors. Business angels partially fill this financing gap, but the amounts invested are not yet large enough to allow companies to move to the next stage of financing. The platforms then come into play and propose high-risk start-up projects to the crowd.
Finally, the analysis by Redis and Satiut (2013) explains that repeat entrepreneurship makes it easier for entrepreneurs to access venture capital or business angel financing. They define repeated entrepreneurship as entrepreneurs who have already successfully financed a project with investors. They distinguish two categories of repeat entrepreneurs: parallel entrepreneurs who own several companies at the same time, and serial entrepreneurs who have created several companies, but own only one company at a time. The most substantial problem involving the entrepreneur for investors to manage is asymmetry of information. The fact that a company founder has already raised funds facilitates a relationship of trust with investors because he has already succeeded in convincing people to invest in the company. The entrepreneur already knows the process and the expectations of investors. Repeated entrepreneurship improves the entrepreneur’s human capital and allows him to raise funds more quickly, while being more efficient in setting up fundraising, contractual terms and negotiations.
Investors therefore prefer to finance a project led by an entrepreneur who has already raised funds and made a successful start in entrepreneurship. The positioning of equity crowdfunding in the start-up financing chain would make it easier for successful entrepreneurs to convince business angels or funds for a second round of financing. The reason is that they have already proven that the project has convinced the crowd, thereby reducing the risk for future investors.
In this section, we have therefore seen that equity crowdfunding has advantages and disadvantages for the entrepreneur and for investors. Nevertheless, equity crowdfunding is beginning to make its place in the start-up financing chain as a seed financier, relieving traditional investors in risk-taking and making it easier for young projects to find funds. Equity crowdfunding seems relevant to meeting the financing needs of small businesses. However, the role of the entrepreneur remains important in the development of the company since he or she makes strategic decisions for the future of the company, starting with the financing model. Therefore, it decides whether or not to go through equity crowdfunding. The role of the entrepreneur is characterized by his ability to mobilize the necessary resources to optimally develop his business. This is called human capital. In the next section, we will see how the entrepreneur fits into the development and success of the company and how he/she approaches the financing of his/her structure. In particular, a study of entrepreneurs was carried out in order to understand what they concretely think about the financing of their project, the opening up of capital and equity crowdfunding.
3.4. The entrepreneur at the head of strategic decisions
This final part aims to show how the entrepreneur perceives the financing and success of a business. Being generally the founder, it is up to him to take all the decisions to carry out his project, both in terms of organization and commercial development as well as in terms of financing the company. Following the development of the last two parts, we understand that the entrepreneur has a central role in the construction of the company since he builds his team and must convince investors to finance his project. We saw earlier that equity crowdfunding could be a very interesting and more accessible alternative for young companies. But how do entrepreneurs perceive their seed financing? Is participatory financing known to everyone? Is open capital financing well received by entrepreneurs? A study of entrepreneurs will attempt, among other things, to answer these questions.
3.4.1. Meeting with entrepreneurs: presentation of the study conducted
The study was conducted with five entrepreneurs who have created their own business or are in the process of building their project. To answer these questions, a qualitative study was chosen to gather concrete opinions from entrepreneurs. This will help to understand the issues faced by the founders and the parameters to which they pay attention in order to make their decisions. Meeting entrepreneurs directly in their workplace also allows them to better immerse themselves in their environment and their culture, and to better understand their opinions on the strategic choices they make. Moreover, entrepreneurs are workers who live in risky situations on a daily basis and it is always more interesting to have direct feedback. This will therefore give us a practical idea of how to integrate the entrepreneur’s human capital into the success of a project.
Here are the different entrepreneurs we met:
- – Fabien Jouvet – President of SKIPPER Group
Date: May 12, 2018; Location: CAMPUS SKIPPER (company headquarters) located in the city of Pouzin (07250 – Ardèche); Duration of the interview: 1 hour
SKIPPER Group is an independent group based in the Rhône Alpes region, which over the past 20 years has developed a logistics outsourcing concept coupled with transport management and traceability solutions. The group specializes in logistics and tailor-made transport organization. In 1991, Fabien bought the logistics part of the Debeaux transport business from the Commercial Court following the death of Bernard Jouvet, Chairman and CEO, and the company’s bankruptcy. Fabien then started from scratch, and had to find financing again and relaunch the commercial activity. Today the group generates a turnover of 30 million euros and employs nearly 300 people.
- – Quentin Brenier – Founder of LeCarrossier
Date: May 12, 2018; Location: Le Café Victor Hugo in Valence (26000 – Drôme); Duration of the interview: 45 minutes
Quentin is in the process of launching his business. LeCarrossier is the first platform in France to connect individuals and bodybuilders in order to give visibility to bodybuilders and find the cheapest quote for motorists. Quentin embarked on this adventure in 2017 and is starting to list his first bodybuilders on his website.
- – Antoine Levraux – in the process of creating his company
Date: April 21, 2018; Location: Numa in Paris (75002); Duration of the interview: 40 minutes
Still in the process of creating and implementing his project, Antoine did not want me to disclose the name of his company and the purpose of his activity9.
- – Lucas d’Urso – Co-founder of Dough Paris
Date: May 10, 2018; Location: in Lucas’ apartment, which serves as his office for the moment; Interview duration: 45 minutes
Lucas embarked on this entrepreneurial adventure in 2017 with his partner. They will start their activity in the coming weeks after one year of project construction. Dough Paris is a platform for connecting companies that offer occasional assignments with students looking to earn some money. The platform can be likened to an online temp agency for students.
- – Yannick Mbengue – Co-founder of WAST
Date: May 4, 2018; Location: WAST shop in Paris (75018); Duration of the interview: one hour
Yannick embarked on this adventure in 2016 with his partners. WAST offers a laundry and dry cleaning service at home in Paris. In just 8 hours, they collect the customer’s belongings from home, wash them, iron them, and then return them to the customer. They started their activity at the beginning of 2017 and opened their first store in 2017 as well.
During the interviews, we addressed three main questions:
- – opening up the capital to external investors;
- – financing by equity crowdfunding;
- – the success factors of a start-up company.
The study of these interviews will be divided into two sections, one dealing with their perception of equity crowdfunding funding and the other with their perception of the success of a project. We will also explore some aspects with the work of researchers.
3.4.2. The perception of financing by entrepreneurs
The first question put to the entrepreneurs was: how did you finance the start-up of your activity? Everyone talked about savings and love money. They explained that this money was available very quickly thanks to their family who supported them in their early days. The facility was the key factor in their choice of this financing method. Public aid could have been a solution for some of them, but, in this case, the administrative constraints faced by entrepreneurs are long and laborious with a long selection process afterwards. Only Fabien and Lucas used an additional means of financing. Fabien made a bank loan in addition to his family’s money because it allowed him to obtain more funds at once and in a simple way. In particular, he has benefited from historically low interest rates. He also chose not to open his capital in order to make his decisions alone. On the contrary, Lucas carried out a participative fundraising campaign, but not in equity crowdfunding because he needed substantial funds to follow his business plan, and his family’s money was not enough.
All respondents felt that their choice of funding was optimal for the launch of their activity because it allowed them to have enough funds to set up what they needed to start and to monitor their “willingness to maintain controlled development” through financing means they knew how it worked. None of them have received financial training. On the contrary, they all come from business schools. Although their training did not allow them to master all means of financing, they launched their business quickly and were able to test their market first.
However, the optimization of their means of financing can be questioned for Antoine and Fabien who admit that they were not aware of other financing alternatives before launching. Seghers et al. (2012) worked on the impacts of the entrepreneur’s human capital on his knowledge of financing alternatives. They report that the acquisition of financial resources is a key process in the start-up and growth of new businesses. In a theoretical context, financial decision-making is simple: all investment projects that create value will find sufficient financing, and financing decisions do not influence the value of the company. In practice, however, the process of obtaining sufficient and adequate financing is particularly difficult for small and new businesses. They then highlight a problem of information asymmetry, namely the fact that entrepreneurs do not have complete information on financial alternatives. This lack of knowledge can lead entrepreneurs to select only those financing solutions they are familiar with, which could lead to sub-optimal financial structures.
They also find that entrepreneurs with higher levels of human capital have more financial knowledge. Human capital improves through business education and previous experience in accounting or finance. They conclude that entrepreneurs’ knowledge of financing alternatives in start-ups has a key role to play because a good knowledge of financial alternatives is the basis for making good financial decisions and optimizing the development of their company. In conclusion, even though Fabien shows us that not knowing the different means of financing possible at the beginning of an entrepreneurial adventure does not prevent us from succeeding, it is still recommended to read them in order to optimize your financial decisions because they are the basis of a company’s development. Fabien completed his remarks by saying that he has mastered his development, but his company has taken time to evolve. As we have seen in the previous sections, an optimization of the company’s financing can impact its speed of evolution. The role of the entrepreneur therefore has a first impact on the evolution of the company because if he optimizes the financing of his company, the latter can evolve quickly, whereas if the entrepreneur decides to control his development without taking too many risks, the evolution of the company can take a little more time or even not evolve at all.
Then, we discussed the question of opening up capital to external investors and the answers were very divided. For some, the opening of capital is “a mandatory step to accelerate the development of the company”, but is not mandatory at start-up. Second, the loss of capital and the fear of losing power is what restricts others from not being in favor of opening up capital. For Fabien, his “desire for freedom is stronger than his desire for a very strong development”. However, he is the only one who is not prepared to call on external investors to finance a possible project requiring significant investment. Fabien is the oldest leader. One might therefore think that young entrepreneurs are less reluctant to open up capital. This observation is consistent with the figures analyzed in the first part. The latter show that investments by business angels and specialized funds are increasing year on year for start-ups, without forgetting the effort on the part of the French government, which would like the French to invest more in French entrepreneurship.
In addition, entrepreneurs are aware of external investors who bring an outside perspective to their strategy and experience in addition to larger funds. Most of them are ready to call on external investors such as business angels to raise funds deemed necessary for their further development. However, most of them believe that it is difficult to raise funds from external investors, particularly because of a complicated selection process. Moreover, “the crazy years of major fundraising campaigns based on a simple idea are over. From now on, the selection process is much more complex, it is very often necessary to be able to justify a proof of concept except when it is 100% a technical project”10. They then think that it is complicated to raise seed money from investors if the concept cannot be shown and if the project is not fully linked to new technologies. However, Quentin is the only one who thinks it is not complicated to raise funds from external people. He is aware that more and more money is invested each year in France by venture capitalists and business angels, which is confirmed by what we saw in the first part. According to him “if the product or service meets a real need and the team founded is solid, then there is no problem finding investors”11. Although opinions differ, it is important to note that the role of the entrepreneur is important because it is up to him to set up his project and his concept, so that he can convince investors. The size of the team also plays a role in the relevance of the project because without a team and without competence, it is difficult to convince people to raise funds. The role of the entrepreneur is also important in the foundation of his starting team.
So, we come to the question of equity crowdfunding. This method of financing is known to all the entrepreneurs interviewed. For the latter, this method of financing seems to be a good financing solution and they would all be ready to use it, except Fabien who does not wish to open his capital. However, he would be willing to use other methods of participatory financing, in particular crowdlending. They believe that this funding method “makes it possible to test the community’s responsiveness to its concept” and therefore to validate the project with the crowd before raising funds. Beyond the validation aspect of the project, entrepreneurs are aware that equity crowdfunding can provide more funds than they have raised with their loved ones’ money and that it can be a springboard for the company.
However, none of them have yet used equity crowdfunding. Either they have not taken the time to devote themselves to a crowdfunding campaign that “requires a strong commitment to communication and networking” on the part of the entrepreneur, or they do not yet dare since they have never raised funds before. The decision is all the more important because even though they say that they are ready to do so, they know that opening up capital implies concessions. This approach can “encroach on strategic decision-making” and therefore on the company’s governance structure. However, they all agree that equity crowdfunding investors will theoretically have less control over the company’s strategic decisions.
In conclusion, young entrepreneurs say that they are ready to open their capital for the development of their business. As far as the oldest entrepreneur is concerned, the opening of capital is only envisaged on the condition that the company grows even further; otherwise, he wishes to keep all decision-making in absolute terms. Equity crowdfunding therefore seems to be an alternative that is becoming more democratic and seems to seduce entrepreneurs. The limitation of this analysis is that no entrepreneur interviewed has already opened his capital and therefore could raise funds in equity crowdfunding.
In the next section, we will try to understand how entrepreneurs perceive a business’ success and whether the place of financing choice is central.
3.4.3. The success of the company as perceived by entrepreneurs
Entrepreneurs have a positive view of equity crowdfunding. They think it can be a good method for the company. First, it makes it possible to create a community of members of the project. In a second step, it makes it possible to raise substantial enough funds to be able to develop it. But starting from the fact that each entrepreneur wants to build a project that works and creates added value, do they consider that the way the company is financed is the main factor for success?
Venkuviene (2014) focuses on development obstacles for start-ups. According to its results, the success of early-stage development is influenced by many factors, both at the macroeconomic and microeconomic level of the company. He concludes that start-ups must be able to react quickly to market changes that directly affect their business. They must therefore continue their development while remaining at the cutting edge of technology.
In addition, the results of his study revealed that heavy administrative and legal tasks are the most restrictive problem for start-ups in the initial phase. Other significant barriers are mainly related to financial restrictions, such as lack of working capital, overwork at the beginning and lack of initial capital. The question he then raises is how some start-ups succeed and some fail. They then reveal the main factors for business success, namely the entrepreneur’s leadership skills, the ability to work with well-managed people and human resources.
All the entrepreneurs interviewed here believe that financing is one of the key issues in managing a company, especially when launching a project. If the entrepreneur cannot find a way to finance his idea, he will not be able to sell it. As Venkuviene states, financing is therefore the first step to a successful entrepreneurial project.
However, unanimously, the project team is the main success factor. They all explain that a company needs to mobilize several skills to succeed and a project is built with several people in order to benefit from several opinions to make the best strategic decisions. A company also lives today thanks to its culture. The creation of a team spirit and a healthy environment is “a creator of a dynamic essential to the success of the project”12. Fabien affirms that it is necessary to “give meaning to the project for those who compose it and those who surround it”13. Finally, Fabien insists on the fact that the life of an entrepreneur requires time and is not always simple. It is important that the latter’s relatives follow him in this adventure.
In conclusion, the role of the contractor is central to the construction and success of the project. From financing to team recruitment, he makes all the decisions. He is the one who builds with his means and those of his network. He must highlight his ability to mobilize all the resources at his disposal in order to optimize his choices and the construction of his project. This is called the entrepreneur’s human capital. The latter therefore has a very important role in the construction of the company and in its evolution. Even though human resources seem to be the most important for entrepreneurs in the success of a project, financing remains the key point to start and found the team. Concerning equity crowdfunding, entrepreneurs generally seem to be attracted by the idea of using this method of financing, which brings several positive points for the company. In particular, it helps to reinforce the entrepreneur in his choice of activity. However, what still hinders companies in the choice of this financing is the loss of capital. Nevertheless, the figures show that the opening of capital is becoming more democratic year after year, which can be beneficial for crowdfunding platforms.
3.5. Conclusion
To optimize the development of their structure, entrepreneurs must choose the right financing. The last means to have been put in place is participatory financing, in particular through equity crowdfunding. However, despite all these alternatives, many companies report difficulties in accessing certain types of financing. Many of them fail to develop because of this funding concern.
In this context, we posed the following problem: how can equity crowdfunding position itself as a successful financing alternative for start-ups, given the entrepreneur’s human capital? We conducted a study divided into three main parts to answer this question. We also went to meet with entrepreneurs to get their opinion on the issue and to try to understand how they perceive the financing of a young structure.
Historically, French entrepreneurs do not finance their companies by opening up their capital. However, the researchers explain that it can be beneficial for the development of a young company and we notice, all the same, that it is becoming more democratic. The start-up ecosystem is experiencing a particularly strong growth in external financing. This effect is mainly due to the increased number of private investors, particularly business angels, and to the efforts of the French State. The latter promotes investment in start-ups in order to promote entrepreneurship in France and to gain in competitiveness in the face of highly competitive globalization.
In addition, private investors provide much more funding than other financing methods and offer the company more experience, knowledge and network. This is also the reason why entrepreneurs are increasingly trying to call on these investors, often specialists in a particular sector of activity, to optimize the development of their company. However, the selection process is difficult for young companies, and not all entrepreneurs can access it. This rigorous selection is due in particular to the high risk of young structures that have not yet proven anything, in particular innovative start-ups that offer services or products that have not yet taken a significant market share.
The arrival of equity crowdfunding brings interesting new elements for young structures seeking funding, with two new actors: the crowd and the platform. First, the selection process is simplified. The crowd also participates in validation of the project before launching the fundraising campaign. This makes it possible to validate it with a community of members who can be representative of a potential market. In addition, equity crowdfunding makes it possible to raise significant amounts of money and the platform supports the company throughout its campaign to achieve its objectives and also after the fundraising. Equity crowdfunding therefore makes it possible to reduce the risk of the project since it is validated in advance by potential consumers.
The challenge of platforms today is to segment the crowd in order to create communities of investors with a little more expertise in distinct sectors of activity, in order to further reduce the risk of project failure. We then came to the conclusion that equity crowdfunding is not positioned as an alternative to traditional investors but rather as a complementary financing phase. A smoothing of the start-up financing chain has indeed been created. Business angels and investment funds can participate in a second round of funding or even join forces with equity crowdfunding more easily because, as the project is validated by the crowd, the risk has significantly decreased.
According to the study conducted among entrepreneurs, equity crowdfunding is interesting insofar as they wish to open up their capital and they know the different means of financing. But this is without counting on significant human capital to develop the company in the right way. This includes human resources, which are the main factor in the success of a project following funding.
Equity crowdfunding is therefore tending to become more democratic, since it fits perfectly into the financing chain and provides the necessary elements at the right time for a company in the start-up phase. The platforms are gradually becoming more specialized, particularly in crowd segmentation. Although this reduces the risk of the project, it would be interesting to see if platform specialization would make access to this type of financing more difficult and if entrepreneurs would still be interested.