The new investment landscape: Equity crowdfunding

Yasar, Burze Article The new investment landscape: Equity crowdfunding Central Bank Review (CBR) Provided in Cooperation with: Central Bank of The Republic of Turkey, Ankara Suggested Citation: Yasar, Burze (2021) : The new investment landscape: Equity crowdfunding, Central Bank Review (CBR), ISSN 1303-0701, Elsevier, Amsterdam, Vol. 21, Iss. 1, pp. 1-16, https://doi.org/10.1016/j.cbrev.2021.01.001 This Version is available at: https://hdl.handle.net/10419/297931 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. 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If the documents have been made available under an Open Content Licence (especially Creative Commons Licences), you may exercise further usage rights as specified in the indicated licence. https://creativecommons.org/licenses/by-nc-nd/4.0/ The new investment landscape: Equity crowdfunding Burze Yasar TED University, Faculty of Economics and Administrative Sciences, Department of Business Administration, Ankara, Turkey article info Article history: Received 21 April 2020 Received in revised form 21 November 2020 Accepted 27 January 2021 Available online 10 February 2021 Keywords: Alternative finance Crowdfunding Equity crowdfunding Entrepreneurial finance Crowdfunding platforms abstract Equity crowdfunding has emerged as a new landscape for financing ideas and innovations. While a number of countries has come a long way and developed equity crowdfunding platforms, a number of countries is taking it more slowly. This paper reviews how equity crowdfunding platforms function, the regulatory approaches around the world and academic contributions on signaling, success factors and social financing at equity crowdfunding platforms. The review suggests that further research may dive deeper into the socio-economic significance of equity crowdfunding and whether equity crowdfunding complements or substitutes traditional equity financing. Research contributions on the dynamics of equity crowdfunding in different geographical regions, motivations of funders, matching of funders and entrepreneurs, effects of regulations and evolution of potential campaign success factors are very critical for the development of the field. Despite debates about risks, equity crowdfunding seems to be a promising venue for financing entrepreneurs, democratizing demand and supply side of investments and contributing to economic growth. ©2021 Central Bank of The Republic of Turkey. Production and hosting by Elsevier B.V. This is an open access article under the CC BY-NC-ND license (http://creativecommons.org/licenses/by-nc-nd/4.0/). 1. Introduction Alternative finance market refers to capital raising activities outside the incumbent financial intermediaries, banks and traditional capital markets and has transformed the traditional fundraising landscape. The alternative finance market has developed mainly via a wide range of innovative instruments using artificial intelligence technology and online channels over the last decade after the credit crunch. Online alternative finance has started with online crowdfunding platforms (Fukuhara, 2020) but has rapidly grownwith the development of new online capital raising activities such as peer-to-peer lending and initial coin offerings. On online crowdfunding platforms individuals, institutions or professional investors come together to fund creative projects, social projects or businesses. Crowdfunding has emerged as a combination of two familiar concepts: microfinance and crowdsourcing (Bradford, 2012). In crowdsourcing, contributions (ideas, content or services) are collected from many people to achieve a goal. Microfinance is lending very small loans to very poor people who may have difficulty accessing financial services. Online alternative finance has grown and diversified significantly into investment, non-investment and lending models based on what is promised to contributors in response to their contributions. Lending, investment and non-investment activities account for 96.4%, 3.0%, and 0.6% of global online alternative finance volume (OECD, 2020). Cambridge Centre for Alternative Finance (CCAF) has identified 14 different models which differ considerably in business models employed, target markets, market dynamics, regulatory framework, governance, financial risk, innovation and internationalization strategies (CCAF, 2020). This paper focuses on and reviews equity crowdfunding which constitutes a small share of the global alternative finance market but is expanding at speed. Even though the size of the equity crowdfunding is very small compared to debt based models, it receives increasingly more attention from regulators and policy makers. If equity crowdfunding market is properly regulated, it may potentially become a significant source of small and medium size enterprise (SME) funding (European Union, 2017). Public awareness, understanding of risks and supportive regulation may contribute to the development of this market and increase its share in the total global activity. Equity crowdfunding has emerged as a market for founders where they can raise money from their close network including family, friends, customers and current shareholders as well as from a mass number of investors in return for an equity share in the business (Ralcheva and Roosenboom, 2019). Private companies can raise capital from the crowd through the sale of financial securities such as stock, debt, revenue shares and others without traditional financial intermediaries. Before equity crowdfunding, mostly E-mail address: [email protected]. Peer review under responsibility of the Central Bank of the Republic of Turkey. Contents lists available at ScienceDirect Central Bank Review journal homepage: http://www.journals.elsevier.com/central-bank-review/ https://doi.org/10.1016/j.cbrev.2021.01.001 1303-0701/©2021 Central Bank of The Republic of Turkey. Production and hosting by Elsevier B.V. This is an open access article under the CC BY-NC-ND license (http:// creativecommons.org/licenses/by-nc-nd/4.0/). Central Bank Review 21 (2021) 1e16 wealthy and well connected investors like angel investors, venture capitalists and investors who are accredited could invest in startups. Equity crowdfunding might democratize the supply side of financial investments by providing the general public access to investing in innovative companies and potential financial returns. Furthermore, equity crowdfunding platforms provide a venue for individuals who want to make impact investments, see (Anirudh Agrawal and Hockerts, 2019;Yasar, 2021) for a review of impact investment. A distinctive characteristic of equity crowdfunding is that funders usually do not have professional investment experience and may have motivations other than pure financial return expectations (McKenny et al., 2017). Equity crowdfunding may possibly reduce the barriers and democratize access to finance filling the growing equity gap following the global financial crisis after which traditional financing like venture capital investments and debt financing declined severely (Bruton et al., 2015;Fraser, 2012;M.Rossi, 2014; World Bank, 2013). It is now recognized as a financing alternative to traditional finance sources and gaining attention of entrepreneurs, policy makers and practitioners. Equity crowdfunding platforms provide an opportunity for entrepreneurs to reduce their reliance on their social network and overcome the geographical constraint (Kim, 2013;Younkin and Kashkooli, 2016). Moreover under certain circumstances, equity crowdfunding may help entrepreneurs raise capital at lower costs than conventional financing sources mainly for three reasons: 1) Improved matching of creators with funders who are most eager to invest in their startups 2) Bundling equity sale with additional rewards such as early access to products or recognition 3) To the extent that in equity crowdfunding information conveyed to investors is more in comparison to traditional sources. For example, information on other investors’interest, potential customers’product modification ideas and early research on market demand may increase investors’willingness to pay for the equity (Ajay Agrawal et al., 2014). Moreover, search costs for funds and communication costs are lower online. Higher competition in the supply of startup financing, may drive down the cost of capital for traditional sources of early stage financing. On the other hand, entrepreneurs face other challenges in equity crowdfunding. First, entrepreneurs need to disclose information publicly on their product early on and this may increase the risk of product imitation. Another challenge is related to the investor management when there is a large pool of investors in the creator’s campaign. Moreover, follow-on financing may be harder when there is a high number of small investors and venture capitalists may not like this dispersion. Since it is hard to control information disclosures of funders, another risk is related to the community dialogues of the highly dispersed funders (Ajay Agrawal et al., 2014). Platforms are aware of these challenges and work on designing structures and offerings to overcome them. SMEs are choosing alternative financing more than ever (OECD 2020) and equity crowdfunding may become a critical funding source for SMEs/startups. In this respect research outputs are important to investors and policy makers. Since 2012, empirical research is progressing as a promising area of research under entrepreneurial finance but scholarly knowledge is still limited (Short et al., 2017;Block et al., 2018;Mochkabadi and Volkmann, 2020). Whereas equity crowdfunding has expanded exponentially in a number of countries such as United Kingdom, some countries such as Turkey and India, have been slow to adopt equity crowdfunding even though they had successful gift and reward crowdfunding (Bruton et al., 2015). Turkey recently passed regulation regarding equity crowdfunding principles and activities of platforms in October 2019 but equity crowdfunding is still illegal in India. This paper contributes to our understanding of this promising field of investment. In the next section, alternative finance models are summarized and compared followed by implications for businesses and regulatory developments across a number of countries. In the fourth section, functioning of equity crowdfunding platforms is discussed, followed by a review of equity crowdfunding literature on information asymmetries, quality signals, success factors and sustainability financing. Final section concludes the paper presenting debates over equity crowdfunding and future research avenues. 2. Online alternative finance models Online alternative finance market has grown considerably and provided extensive funding, a total of $304.5 billion for consumers, SME’s, start-ups, entrepreneurs in 2018 based on data CCAF has collected from main actors in the alternative finance markets in 171 countries between March 2019 and September 2019 (CCAF, 2020). Table 1 lists the alternative finance volumes by region and model. China by itself constitutes 71% of the alternative finance market, with $215.4 billion followed by the USA ($61 billion) and the UK ($10.4 billion) accounting for 57% of the total European market in 2018. About $162 billion of the total volume is funded by institutional investors such as pension funds, banks, mutual funds and family offices. Around the world, average funding provided by institutions is 50% with some outliers such as the USA with 85% and Africa and Middle East with 17% and 12% respectively (CCAF, 2020). $82 billion funding is undertaken by businesses with China leading the market with $49.56 billion and the USA and the UK following with $16.81 billion and $5.96 billion respectively. Global transaction volume declined from $419 billion in 2017 and this decline is mainly associated with the drop in the Chinese market. Excluding China, global alternative finance market grew by 48% from 2017 to 2018 (Fig.1). Table 2 lists the alternative finance volumes per capita categorized by economic development levels of countries in 2018. The data suggests that alternative finance funding per capita differs significantly between developing and developed countries suggesting that the promise of democratizing access to finance has not been realized yet in places where it is needed the most (CCAF, 2020). USA, UK, Latvia, Estonia and the Netherlands are the top five countries on a per capita basis. Even though Latvia and Estonia are not high in total volume, high adoption and market penetration rate pull them to top ranks on a per capita basis. Non-European countries that are doing well on a per capita basis are Singapore, New Zealand, Australia, Israel and Canada. In some developing countries like Slovakia, Slovenia, Zambia and Nigeria, funds are raised via international platforms. CCAF has identified 14 different models under debt, equity and non-investment models and major ones are listed in Table 3 (CCAF, 2020). Debt based models account for the majority of the global alternative finance activity around the world. China by itself made $215.37 billion from debt-based models and is the leader globally. Lending on online platforms includes peer to peer (P2P) or marketplace lending, balance sheet lending, invoice trading and securities. Peer to peer (P2P) or marketplace lending includes unsecured/secured loans to consumers or businesses provided by individual or institutional funders. Balance sheet lending includes unsecured/secured loans to consumers or businesses provided by the platform entity. Invoice trading is the purchase of business receivables or invoices at a discount by individuals or institutions. Securities include bonds, debentures and ‘mini’bonds purchased by individuals or institutions. P2P or marketplace consumer lending accounts for the largest part of the online alternative finance market as it is popular among borrowers who have difficulties accessing loans and those looking for lower interest rates. Another advantage of online lending is more accurate calculation of B. Yasar Central Bank Review 21 (2021) 1e16 2 credit risk default via use of machine learning and artificial intelligence than traditional finance (CCAF, 2020). Mini bonds’issue size is much smaller than the traditional bonds issued at capital markets. The alternative finance model that has raised the most funding is P2P/Marketplace consumer lending totaling $195.29 billion and accounting for around 64% of the total global volume including China and 36% excluding China. Then comes the P2P/Marketplace business lending with $50.33 billion, balance sheet business lending with $21.08 billion, balance sheet property lending with $11.02 billion, balance sheet consumer lending with $9.78 billion, P2P/Marketplace property lending with $5.72 billion and invoice trading with 3.22 billion account for 17%, 7%, 4%, 3%, 2% and 1% respectively of the overall transaction volume including China and 9%, 17%, 12%, 11%, 4% and 3% excluding China. Investment and non-investment models come after debt based models, but their volumes are far less compared to debt globally. Investment based models include equity crowdfunding, real-estate crowdfunding and profit sharing. Different from lending based crowdfunding, equity based crowdfunding is in effect business finance and more specifically finances SMEs (European Union, 2017). In equity crowdfunding, individuals or institutions fund businesses in return for a share in the company. In real estate or property crowdfunding individuals or institutions can provide equity or subordinate debt financing for real estate and obtain property share. In revenue/profit sharing, which is relatively a new model and popular in US and UK followed by Canada and Africa, individuals or institutions receive a share of profits or royalties in return for funding. Equity based crowdfunding amounts to nearly $5 billion of the global online alternative finance market and real estate crowdfunding accounts for $2.96 billion of this amount. Even though real estate crowdfunding is 60% of the total equity based Table 1 Alternative finance volumes by region and model in 2018, USD. Region Debt % of Total Alternative Finance Equity % of Total Alternative Finance NonInvestment % of Total Alternative Finance Total Alternative Finance Volume Billion China 215.37b 99.99% 22.18m 0.01% 5.80m 0.00% 215.40 US 57.67b 94.67% 2.55b 4.19% 696.50m 1.14% 60.92 UK 9.31b 90.77% 870.19m 8.48% 76.60m 0.75% 10.26 Europe 6.60b 85.48% 883.32m 11.44% 237.75m 3.08% 7.72 Asia-Pacific (exc. China) 5.34b 87.22% 504.84m 8.25% 277.28m 4.53% 6.12 Latin America 1.70b 95.26% 45.61m 2.56% 39.05m 2.19% 1.78 Middle East 754.14m 94.20% 35.63m 4.45% 10.78m 1.35% 0.80 Canada 705.69m 77.71% 43.52m 4.79% 158.94m 17.50% 0.91 Africa 183.76m 87.86% 11.85m 5.67% 13.53m 6.47% 0.21 Adapted from CCAF (2020),“The Global Alternative Finance Market Benchmarking Report”. Fig. 1. Global Alternative Finance Volumes, billion USD. Source: CCAF (2020),“The Global Alternative Finance Market Benchmarking Report” Table 2 Alternative finance volumes per capita around the world. Top 20 Countries High Income Country On a per capita basis (USD) Upper-Middle Income Country On a per capita basis (USD) Lower -Middle Income Country On a per capita basis (USD) Low Income Country On a per capita basis (USD) 1 USA 186.88 Armenia 62.35 Moldova 16.66 Rwanda 0.93 2 UK 155.93 Georgia 51.73 Mongolia 11.91 Tajikistan 0.52 3 Latvia 132.12 Samoa 8.94 Indonesia 5.42 Uganda 0.39 4 Estonia 120.77 Botswana 6.84 Nicaragua 2.53 Liberia 0.18 5 Netherlands 104.83 Tonga 6.59 Zambia 2.35 Sierra Leone 0.18 6 Singapore 88.61 Albania 6.25 Philippines 1.09 Malawi 0.13 7 Israel 81.70 Bulgaria 5.75 Honduras 0.95 Togo 0.11 8 Finland 68.72 Peru 4.95 Timor-Leste 0.95 Haiti 0.10 9 New Zealand 56.54 Kazakhstan 4.76 El Salvador 0.73 Tanzania 0.10 10 Cyprus 53.32 Colombia 3.88 Kenya 0.68 Mali 0.07 11 Lithuania 48.92 Costa Rica 3.60 Cambodia 0.61 DRC 0.06 12 Australia 46.68 Brazil 3.21 Ukraine 0.60 Burkina Faso 0.04 13 Monaco 40.61 Paraguay 3.15 Solomon Islands 0.51 Madagascar 0.03 14 Sweden 29.27 Argentina 2.90 Zimbabwe 0.43 Mozambique 0.02 15 Denmark 24.97 Malaysia 1.96 India 0.40 Nepal 0.01 16 Canada 24.54 Macedonia 1.94 Cameroon 0.40 Benin 0.01 17 Slovenia 17.74 Mexico 1.85 Bolivia 0.30 Afghanistan 0.01 18 France 16.81 Guatemala 1.64 Kyrgyzstan 0.27 Burundi 0.00 19 Chile 15.44 Jordan 1.29 Senegal 0.23 Gambia 0.00 20 Germany 15.39 Romania 1.06 Vietnam 0.18 South Sudan 0.00 Adapted from CCAF (2020),“The Global Alternative Finance Market Benchmarking Report”. B. Yasar Central Bank Review 21 (2021) 1e16 3 crowdfunding activity, equity crowdfunding is more familiar among public. US leads the equity based crowdfunding model, UK is the second and Europe is the third with $278 million (CCAF, 2020). Israel constitutes 96% of the Middle East market with $34.3 million. The size of the equity crowdfunding is very small compared to debt based models but it receives more attention from regulators and policy makers. Public awareness, understanding of risks and supportive regulation may contribute to the development of this market and increase its share in the total global activity. Non-investment models include reward based and donation crowdfunding models in which funders do not receive a financial return. In reward based models, funders receive early releases of products or rewards. In donation based models, funders donate money for philanthropic or civic purposes to projects, individuals or companies. Even though these models constitute the smallest percentage of the global alternative finance market, reward based crowdfunding totals $876.8 million globally and donation crowdfunding even less, they are critical for countries who are new to the alternative finance as these models mostly precede other models (CCAF, 2020). US leads the reward based crowdfunding market with a volume of $385 million followed by the Asia-Pacific region, $201.5 million excluding China, and Europe, $175.4 million. Internationalization has been increasing in terms of platforms operating in multiple countries and engaging in cross border activities. Inflow of funds refers to funds transferred from funders/ investors abroad and outflows refer to funds which are transferred to fundraisers. Some alternative finance models such as P2P/ Marketplace consumer lending (48% outflows and 49% inflows), debt-based securities (54% outflows and 38% inflows), invoice trading (28% outflows and 34% inflows) and balance sheet business lending (36% outflows and 22% inflows) are characterized by higher level of cross border activities as listed in Table 3. Internationalization level is lower for other models such as real-estate crowdfunding, P2P property lending and equity based crowdfunding that require property as a security or local relations. The tendency to invest in companies in close proximity is a common phenomenon in equity investments and this local bias seems to hold for equitybased crowdfunding as observed in the low levels of inflow and outflow rates. Hornuf et al. (2020) confirm that local bias exists for equity based crowdfunding even after controlling for family and friends based on hand collected 20,460 investment decisions. Equity based crowdfunding seems to be mainly a domestic activity as investors may prefer to know the business owner to assess the risks of their investment. Moreover, equity investments are more regulated due to relatively higher risk and regulations may change from country to country. Investors may avoid cross-border investments because they feel more at ease and safer where they are familiar with the regulatory compliance. One of the main research questions is whether alternative finance has democratized access to finance and can lead to greater financial inclusion. Financial inclusion is defined by the World Bank as people’s access to financial products and services suiting their needs and has wide ranging benefits such as improving people’s potential to earn income and decrease poverty (Demirguc-Kunt et al., 2018). Having an account at a financial institution or mobile service provider is an indicator of financial inclusion as it enables individuals to save, access loans and manage financial risk. One metric for financial inclusion is an individual’s banking status and CCAF has asked the survey respondents to specify the number of customers who do not have access to traditional financial products and services or are unbanked. Based on the 36% response rate, they find that the highest percentage of unbanked customers is around 18% in Africa and Asia-Pacific excluding China. In the USA and Canada, the number of unbanked customers is minimal but the percentages of underbanked customers who have access to some financial products and services are 25% and 38% respectively. CCAF suggests that the promise of democratization of access to finance has yet to be fulfilled and this may be related to platforms’efforts to Table 3 Online alternative finance models. Alternative Finance Model Volume (billion USD) Including China Volume (billion USD) Excluding China Market Share Excluding China % of Inst. Investors % of no significant changes to business model Cross Border Inflow Cross Border Outflow %of Banked Debt Based P2P/Marketplace Consumer Lending 195.29 32.00 36% 83% 62% 49% 48% 85% P2P/Marketplace Business Lending 50.33 7.60 9% 57% 59% 13% 10% 66% Balance Sheet Business Lending 21.08 15.00 17% 68% 58% 22% 36% 70% Balance Sheet Property Lending 11.02 11.00 12% - 25% - - - Balance Sheet Consumer Lending 9.78 9.40 11% 93% 28% 17% 0% 47% P2P/Marketplace Property Lending 5.72 3.90 4% 44% 74% 12% 3% 88% Invoice Trading 3.22 2.50 3% 63% 59% 34% 28% 60% Debt-based Securities 0.85 0.84 1% 31% 20% 38% 54% 89% Mini-bonds 0.33 0.05 0% - Equity Based Real Estate Crowdfunding 2.96 2.90 3% 16% 40% 7% 4% 93% Equity Crowdfunding 1.50 1.50 2% 23% 33% 12% 9% 94% Revenue Sharing 0.40 0.40 0% 70% 35% 2% 3% 70% Non-investment Based Reward-based Crowdfunding 0.88 0.87 1% 3% 51% 6% 19% - Donation-based Crowdfunding 0.64 0.64 1% 18% 85% 11% 2% - Adapted from CCAF (2020),“The Global Alternative Finance Market Benchmarking Report”. B. Yasar Central Bank Review 21 (2021) 1e16 4 get legitimacy and scale up first or the discrimination by institutions which are growing in numbers in alternative finance market as well. As seen in Table 3, banking status of customers also differs across alternative finance models. The equity based and real estate crowdfunding models have the highest percentage of banked customers whereas balance sheet consumer lending has the lowest percentage. While there are papers investigating the promise of democratization in reward-based crowdfunding, research for equity crowdfunding is limited. Guenther et al. (2018) investigate whether equity crowdfunding democratizes access to finance for remotely placed entrepreneurs or whether investors in equity crowdfunding, similar to traditional investors, are sensitive to the geographic distance between them and the potential investment’s location. Using a sample from one of the leading equity crowdfunding platforms in Australia, ASSOB, the authors find that home country investors are sensitive to distance but overseas investors are not. Home country investors’, both accredited and retail, likelihood to invest in equity crowdfunding projects decreases as the distance between them and the potential venture increases. Empirical evidence has shown that besides distant entrepreneurs, women have difficulties in accessing financing in capital markets. Vismara et al. (2017) investigate whether equity crowdfunding democratizes access to finance for women using a sample from one of the leading crowdfunding platforms in the United Kingdom, Seedrs, and show that gender diversity is greater in equity crowdfunding platforms than traditional entrepreneurial finance markets. On the other hand, another study shows that the likelihood of successfully raising funds in equity crowdfunding is not higher for women and minority entrepreneurs (D. Cumming et al., 2019). More research is needed on whether equity crowdfunding succeeds in democratizing the supply and demand sides of entrepreneurial finance. Future research can focus on other underrepresented or underserviced groups (which vary in age, gender, socioeconomic status, ethnicity, geography or religion) in entrepreneurial finance markets. Further analysis can examine whether the funded ventures succeed and grow in a similar fashion to ventures raising capital via traditional channels. 3. Implications for businesses and regulatory developments One of the priorities of many countries has been supporting small and medium size enterprises to get financing for their important contribution to innovation, creation of jobs and economic development (World Bank and CCAF, 2019). After the financial crisis, SMEs had difficulty obtaining financing since banks limited loans and venture/growth capital shrank. For this reason, accessible funding options became critical for them to pass the valley of death and grow (European Union, 2017). CCAF states that alternative finance has become a significant source of financing for SMEs (CCAF, 2020) and SMEs are choosing alternative financing more than ever, while straight debt usage has been slow (OECD, 2020). In the United Kingdom, start-ups and SMEs used 68% of the total funds raised via online alternative finance channels in 2017, and equity crowdfunding accounted for 12.9% of the total early and venture stage equity investment (Zhang et al., 2018). OECD notes that online alternative finance volumes for businesses are mainly concentrated in a number of countries but are growing in all Scoreboard countries (48 countries including both OECD and non-OECD countries). In 2018, inflation adjusted growth rate is 54% and the growth rates are high specifically in emerging and small economies (See Fig. 2). If this growth continues, SMEs can become more resilient in times of financial crisis, credit tightness and liquidity shortages during pandemics such as COVID-19 (OECD, 2020). While in developed markets such as United Kingdom and Australia growth rates are starting to settle at 9% and 6%, in China which has the world’s largest alternative finance volume (See Fig. 3), the market shrinked by 57% after regulations for platform eligibility and operations were put in force to prevent fraudulent behavior and protect investors. The number of P2P Platforms decreased from 6000 in 2015 to 427 in October 2019. After some frauds at a number of active platforms in Korea, another developed market, the alternative finance market for businesses plunged by 77%. In terms of online alternative finance volumes as a percentage of GDP, China, the UK, Estonia and Israel are the leaders and surpass the median value of 0.0168% (see Fig. 4). Like the rest of the economy, the pandemic may affect the development and growth of equity crowdfunding. A number of equity crowdfunding platforms collaborated with governments and some debt-based crowdfunding platforms provided the most critical funding to SMEs during the lockdowns (Kraemer-Eis et al., 2020). However, like the rest of the financial sector, crowdfunding platforms may be negatively affected by the uncertainty the pandemic has created and investors may refrain from making new investments. Some equity crowdfunding platforms have already reported losses and declines in the investment activity (Mason, 2020). On the other hand, social distancing and the shift to online communication during COVID-19 may spur more interest in crowdfunding platforms in comparison to traditional channels. Initial evidence on the impact of the COVID 19 pandemic on equity crowdfunding campaigns shows that the total amount raised in the first two quarters of 2020 is much higher than the amount raised in the same period based on a sample of Italian equity crowdfunding projects (Battaglia et al. n.d.). The study also reports that during the pandemic, backers are more likely to fund technological projects and projects with high amount of R&D expenditure. (see Fig. 4) Equity-based models have accounted for only 8% of business financing in 2018 globally but equity crowdfunding is becoming a more significant source of equity finance in some countries for SMEs which are critical for job creation and economic growth (CCAF, 2020). In the United Kingdom, equity based crowdfunding has grown to £333 million in 2017 from £3.9 million in 2012 and provided significant seed and early stage funding (Zhang et al., 2018). In 2017, equity crowdfunding funding accounted for 12.9% of seed and early stage equity financing in the United Kingdom (Zhang et al., 2018). Countries around the world develop policies and make regulatory changes in the interest of investor protection to enable the crowdfunding channel which can complement traditional financing and broaden the financial system. For example, the European Commission’s Capital Markets Union project adapted an action plan to integrate and strengthen the capital markets including the crowdfunding market in September 2015. Many countries have passed regulations on equity crowdfunding but the regulatory approaches seem to be highly dispersed in terms of limitations on the investor type, investment amount and platforms’solicitation methods (Estrin et al., 2018). Some regulatory approaches are very liberal and some are very protectionist. The disparity in approaches may be partly explained by differences in political-economical approaches to the state’s role, economic structures and support to increase entrepreneurial activities in a country (Claus and Krippner, 2019). The United Kingdom is known to have the most developed equity crowdfunding market and this does not come as a surprise given it has also deep capital markets (Groh et al., 2012;Vismara, 2016). The UK had the highest number of active crowdfunding startup platforms among the European countries by the end of 2014 (Dushnitsky et al., 2016). The Financial Services and Markets Act (FSMA) 2000 regulates all kinds of securities activities including crowdfunding. The Financial Conduct Authority (FCA), which is the regulatory body for crowdfunding, amended rules governing B. Yasar Central Bank Review 21 (2021) 1e16 5 crowdfunding in April 2014 to ease the development of crowdfunding. Key objectives of the FCA were protecting consumers and promoting active competition for their interests. In 2012, the UK government also gave tax incentives to seed stage startups to spur investments in them. Tax relief and capital gain taxexemption were given to businesses with fewer than 25 full time employees and which raised no more than 150,000 pounds. Investors may tend to take on risks if there exists tax incentives for investing in startups. Empirical evidence shows that investors invest more money in firms eligible for such tax incentives and sophisticated investors invest even more (Chen et al., 2018). United States was slower to pass on the regulations which were not put into force until 2015 and 2016. Before equity crowdfunding, the privilege to invest in startups belonged to mostly wealthy venture capitalists and angel investors. These were accredited investors whose net worth, excluding their houses, exceeded one million dollars, or those who earned more than $200,000 over the past two years. The Jumpstart Our Business Startups Act that enabled equity crowdfunding was passed by President Barack Obama in 2012. The intention was to boost funding of small businesses in the United States. However, the two regulations weren’t implemented until 2015 and 2016. Regulation Crowdfunding was passed in 2016 and allowed non-accredited investors to invest as little as $100 in startups and founders to advertise their fundraising campaigns and raise up between $50,000 and $1,070,000 each year through equity crowdfunding. Regulation crowdfunding allows investors to invest 5%e10% of their net worth or income each year through an equity crowdfunding platform, a dealer or a broker. Companies can also raise capital from investors under Regulation D, Rule 506b and Regulation Aþat equity crowdfunding platforms in the USA. Investors can raise unlimited dollars under Regulation D and Rule 506b campaigns, however, only accredited investors can invest in these campaigns and the founders cannot advertise Regulation D campaigns. Regulation Aþcampaigns suit the needs of later-stage companies as they can raise up to 50 million dollars publicly. Turkey passed the regulation for crowdfunding in October 2019. In order to be listed as an equity platform, joint stock companies which have minimum TRY 1,000,000 paid-in capital can apply to Fig. 2. Annual percentage growth in the online alternative finance market for businesses, 2018. Source: OECD Scoreboard (2020), “Financing SMEs and Entrepreneurs 202000 Fig. 3. The online alternative finance market for businesses by region, 2018 Source: OECD Scoreboard (2020), “Financing SMEs and Entrepreneurs 202000 B. Yasar Central Bank Review 21 (2021) 1e16 6 the Capital Markets Board of Turkey. Individuals who are not accredited investors can invest as much as TRY 20,000 in a given year through equity crowdfunding. However, they can also invest as much as 10% of their declared yearly income as long as it does not exceed TRY 100,000. Start-ups that will raise capital through equity crowdfunding are required 1) to conduct technology and/or production activities 2) be established within the last 5 years as of the date of information form 3) have an actual registered website that they regularly monitor and control. The following companies cannot collect funds through equity crowdfunding: 1) Public companies 2) Companies whose management control belongs to another legal entity 3) Companies in which the Capital Markets Board of Turkey holds shares with a significant influence. 1 Among Association of Southeast Asian Nations (ASEAN), the earliest country to pass equity crowdfunding regulation was Malaysia. Securities Commission Malaysia (SC) released the regulatory guidelines and requirements for registration and governance of equity crowdfunding platforms in December 2015. Since then Malaysia’s alternative finance has grown progressively and as of May 2019 ten equity crowdfunding platforms were registered (World Bank, 2019). In Asia, China has the greatest potential in crowdfunding capital as it is expected that household investments will be around US$50 billion per year by 2025 (World Bank, 2013). The Securities Association of China issued first draft of equity crowdfunding regulations in 2014. China Securities Regulatory Commission issued an Implementation Plan in October 2016 to limit the prohibited activities and it did not include other aspects of equity crowdfunding platform licensing and prospectus requirements (Lin, 2017). Since then there is no sanction on ECF platforms which behave like investment and fund managers (Lin, 2017). The earliest country in Europe to pass equity crowdfunding legislation is Italy and the Decreto Legge went into effect on October 20, 2012 (Hornuf and Schwienbacher, 2017). However, the legal procedures were too restrictive and inhibited the growth of the equity crowdfunding market. The estimated value of the market was only V1,600,000 while it was worth nearly V50 million in neighboring France in the same year (European Crowdfunding Network, 2016). Until the regulatory change in 2017, only ‘innovative startups’were allowed to raise capital in the equity crowdfunding market in Italy. Since the regulation opened up the equity crowdfunding market to all SMEs, the market has been growing and the total volume in 2018 was three times higher than the volume in 2017 (Ziegler et al., 2019). The tax relief was increased to 40% in 2019 and this is also expected to spur growth. France passed the first regulation for equity crowdfunding on October 1, 2014 and significantly amended it on October 28, 2016 (ECN, 2018). Canada approached equity crowdfunding on a provincial level rather than a nationwide level and each province has its own regulation (Vismara, 2016). This has significantly inhibited the growth of Canada’s equity crowdfunding market as it is difficult for a platform in British Columbia to list a startup registered in Ontario (Rose, 2019). Table 4 lists the top countries in equity crowdfunding volumes and major regulatory developments. The development of the equity crowdfunding market varies across countries and this variation may be related to differences in regulations besides the development of the financial markets, institutions and culture. Further research can look into how regulatory approaches affect the growth of equity crowdfunding markets. 4. How equity crowdfunding platforms function Equity crowdfunding platforms, like other types of crowdfunding platforms, are two-sided markets which match founders with funders. However, unlike other crowdfunding methods, in equity crowdfunding, investors take on higher risks and expect a financial return. Besides backers’monetary return goals, three critical differences between equity and rewards based crowdfunding are: (1) pledged amount is significantly higher (2) average campaign goal is considerably higher (3) projects are valued before the funding (Vulkan et al., 2016). Hence, equity crowdfunding is regulated more heavily than rewards based crowdfunding. Founders are restricted on information they share with the general public and they must make certain disclosures and follow certain rules. Platforms distribute the campaign information but they do not often verify the information disclosed in updates that entrepreneurs share (Dorfleitner et al., 2018). Fig. 4. The online alternative finance market for businesses as a percentage of GDP, 2018 Source: OECD Scoreboard (2020), “Financing SMEs and Entrepreneurs 202000 1 Turkish Official Gazette dated 3 October 2019 and numbered 30,907. B. Yasar Central Bank Review 21 (2021) 1e16 7 Companies that can raise capital through equity crowdfunding are private companies. In other words, public companies listed on stock exchanges cannot raise additional capital via equity crowdfunding platforms. Entrepreneurs that are selected by the platforms can make an open call to raise funds and investors decide taking into consideration the provided information on the campaign page. Some platforms e.g. Crowdcube and Seedrs do not let entrepreneur pitches to go public before a certain investment threshold is reached. The purpose is to ensure sufficient time to secure entrepreneurs’lead investments and provide the close network of family, friends, customers and business contacts to invest before everyone else. Founders set a minimum funding goal and there are two models used in crowdfunding platforms. The founder keeps all the money if he/she reaches his/her funding goal in the ‘all or nothing’model and nothing otherwise. In the ‘keep-itall’model, the founder keeps all the money raised. Compared to traditional angel or venture capital investments, investments in equity crowdfunding are considerably smaller most of the time. While some platforms accept investments as low as V5 or $5, some platforms resemble virtual business angel networks limiting investments to accredited investors who have either high income and/or wealth (Hornuf and Schwienbacher, 2016). Investing is rather easy on the platforms as investors just hit the invest button, specify the amount of their investments and transfer the money to the escrow account if their application for investment is approved (rarely investments may be rejected or reduced toa lower amount). There are numerous payment options such as credit cards, bank accounts, wire transfers and Bitcoin. Once the campaigns are over, standardized investment contracts that the crowdfunding platforms provide are signed online. The platforms facilitate payment settlements and charge a certain percentage of what is raised. The duration of campaigns are determined in the beginning and usually runs for 30e60 days. There are two opposing views on campaign duration in terms of signaling confidence in the project and quality. A number of papers suggests a negative relation between campaign duration and reward based funding performance (Marelli and Ordanini, 2016). In contrary, other research suggests that funders appreciate more time to effectively screen and analyze projects and show that campaigns which are longer than 30 days may have higher probability of success in donation or reward based platforms (Gordon et al., 2013;Lagazio and Querci, 2018;Zheng et al., 2014). Equity fundraising round sometimes lasts around three weeks and closes at the announced deadline but it may close earlier if the funding target is met. If there is more money provided than the initial funding goal, in other terms, if the round is “oversubscribed”, then the investors may be waitlisted. In such cases, it is most often first come first serve basis but founders have the option to choose which investors to accept and they may prefer the ones who can be of most help to their startups. Investors can help founders, by introducing them to networks, giving feedback on products, giving business advice and transferring knowhow. Investors cannot directly reach founders and all of the communication is conducted via the platform website. Cancellation of investments is rare but both investors and founders have the right to do so. The cancellation of investment is usually possible when the funds are still in the escrow account but the cancellation is less likely when the round is officially closed and the funds are transferred to the startup. 2 However, in equity crowdfunding, investors can sell their shares in a company after a year to an interested buyer. The high number of investors create liquidity in the market unlike older times when only accredited investors were able to invest and the market was not large enough to provide liquidity. A number of initiatives has been taken to develop secondary markets for equity but none has been particularly successful. Blockchain technology can offer a more costefficient solution and France has adopted a decree in December 2017 to ease the records and transfers of financial securities using this technology (Schwienbacher, 2019). Funders may have different motivations for engaging in crowdfunding platforms and these incentives can be: 1) Access to investment 2) Community participation 3) Support for an idea, product or service 4) Formalization of contracts especially for Table 4 Regulatory developments and equity-based crowdfunding volumes (million USD). Region Country Regulatory Developments/Year 2015 2016 2017 2018 United States Title II of the JOBS Act/2012 590 550 240 510 Title III of the 2012 JOBS Act/2016 United Kingdom Financial Services and Markets Act/2000 361 336 450 484.7 Tax incentives/2012 Amendment/2014 Europe Total 176.9 242 237.9 278.1 Finland Finnish Crowdfunding Act/2016 6.2 28.8 50.7 67.9 Spain The Law on Promoting Business Finance/2015 5.3 10.1 21.2 48.4 Germany Retail Investors Protection Act 23.7 47.4 19.7 37 (Kleinanlegerschutzgesetz)/2015 Amendments to the Investment Products Act (Verm€ ogensanlagengesetz)/2017 France Regulation Crowdfunding/2012 75.1 43.3 48.4 Amendment/2016 Sweden No specific regulation 6.5 46 34 The Netherlands Crowdfunding Regulation/2014 17 27.15 17.82 Amendment/2016 Italy Regulation Crowdfunding/2012 5.4 1.7 4.8 Turkey Regulation Crowdfunding/2019 Asia-Pacific 98.6 100.9 162.1 Total (exc. 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