Alternative Forms of Financing
Hugo van den Biggelaar
10270507
Ms. L.A. G
ó
rnicka
University of Amsterdam
Faculty of Economics and Business
Index Introduction 3 Private Equity 6 Definition 6 Background 6 Leveraged Buyout 6 Venture Capital 7 Growth Capital 7 EU vs. US 8 Growth 9 Credit Union 11 Definition 11
Credit Union vs. Banks 11
EU vs. US 12 Growth 12 Business Angel 14 Definition 14 EU vs. US 14 Growth 15 Super Angels 16 Crowdfunding 18 Definition 18 Crowdfunding models 18 Growth 20 EU vs. US 20 Conclusion 21
Sources - Website articles 24
Sources - Literature 26
Appendix 29
Private Equity: Interview – Guus Overdijkink 29
Credit Unions: Interview - Kor Schipper 33
Business Angels: Interview - Jan Docter 36
Introduction
An article in the Dutch newspaper NRC WEEKEND of 19th/20th April 2014 captured my interest.
It recounts the story of Saïd Bouniss, owner of three children daycare centers, who wanted to open a fourth. To achieve this he needed a small loan from the bank. However, his loan application was rejected, since the bank concluded that the loan was too risky and not sufficiently profitable for the bank. In the Economist (May 10th, 2014) I read an article on the
Hall & Woodhouse brewery. In 2010 this company, which had always financed its investments by borrowing from banks, applied for a renewal of their line of credit at the Royal Bank of Scotland (RBS). Their application was not declined, but the RBS informed Hall & Woodhouse the line of credit would apply to a much shorter period and the interest would be significantly higher. This incident made the Hall & Woodhouse management decide to no longer depend on bank loans.
The Saïd Bouniss and the Hall & Woodhouse management quest to get a loan are no exceptions. In fact this is ’business as usual’, which is based on the dilemma currently restricting the
financial market.
The financial crisis that emerged in 2007 based on the housing bubble in the United States of America (US), resulted in the sovereign debt crisis in the European Union (EU) in 2010. Based on economic uncertainty, the possibility that ‘borrowers’ are not able to pay back their loans and mortgages increased significantly. However, the banks are struggling as well. Many financial institutes, small and large, defaulted because of the consequences of the subprime mortgage crisis and the sovereign debt crisis.
Another reason a loan application is currently often declined, is the new Basel III agreement. Basel III was endorsed in 2010 and contains several phases, ending in 2019. This agreement demands banks to raise their Tier 1 capital from 4.5% to 6%. This is the ratio of the bank’s core equity capital in relation to its risk-weighted assets. Moreover banks were required to raise their common equity from 3.5% to 4.5% (Bank for International Settlements, 2013). The Basel III agreement also demands banks to ensure a leverage ratio lower than 3%. This ratio can be determined by dividing the Tier 1 capital of the bank by the bank’s consolidated assets (Bank for International Settlements, 2013). A smaller leverage ratio obliges banks to hold more reserves and therefore reduces their lending possibilities. Because of these new regulations, banks have less capital available to lend and are therefore not in a position to approve all loan applications.
Nonetheless, banks are supported by central banks to have a less strict policy when assessing loan applications. They are supported to grant more loans because this would lead to an increase in consumer spending and investment, resulting in economic growth and – possibly - the end of this economic crisis. For example, in the United Kingdom (UK), the Bank of England
implemented Funding for Lending. This program allows banks to borrow at a rate lower than the market rate. In that way interest can be lowered and therefore lending to businesses is increased (Government UK, 2014). In 2013 the demand for loans increased heavily. In the last quarter of 2013, the demand for loans in the UK increased with 33% for medium public non-financial corporations (PNFCs), with 4% for small and medium business (SMB) owners and with 9,5% for large PNFCs (Bank of England, 2014). This trend continues in 2014. In the first quarter of 2014, the demand for loans in the UK increased with 27% for medium PNFCs, with 19% for SMB owners and with 22% for large PNFCs (Bank of England, 2014). Although the level of approving loan applications is increasing as well, it is not nearly enough to meet the growing demand.
The dilemma is that on the one hand, banks are less willing and/or able to grant loans, while on the other hand banks should increase the level of approved loan applications to meet the substantial increase in demand for loans to stimulate economic growth.
Since the initial applications for a loan were rejected due to the dilemma referred to above, Saïd Bouniss and Hall & Woodhouse brewery reached out to financial nonbanking institutions to substitute bank loans. Since the beginning of the economic crisis, the popularity and importance of these nonbanking institutions has grown significantly, as entrepreneurs, companies and SMB owners always need capital. These substitutes for bank financing that are providing these funds might be the solution to solve the dilemma. These alternatives to bank financing differ in size, structure, capital made available etc.
This thesis will discuss and analyze four alternative funding methods to bank financing by answering the following research question:
“Are these four alternative funding methods to bank financing, being: private equity, credit
unions, business angels and crowdfunding, appropriate alternatives and which is the most appropriate alternative to bank financing?”
This research question is answered through literature review and on the basis of interviews. These interviews are held with four specialists, who all have extensive experience in the field in
which they operate. This combination of theory and practice provides a clear view regarding the usefulness as an alternative to bank financing. Following the analysis of these four alternative sources, a conclusion will state which is the most appropriate alternative to a traditional bank loan. In order to draw this conclusion, I will examine these four alternatives based on size, growth, differences between these alternatives in the EU and the US, the included interviews and literature.
Private Equity Definition
Private equity (PE) is defined as a type of equity investment for the medium- to long term in a company that is not traded publicly on a stock exchange (Cendrowski & Wadecki, 2012). Institutional investors such as insurers or pension funds and high net-worth investors invest their capital in a fund, which is managed by a PE house. These funds are then used by private equity firms to invest in a company in order to acquire a company or a part thereof.
The relationship between the investor and the PE house is referred to as a limited partnership. In this partnership the private equity firm acts as general partner (GP) and the investors act as the limited partners (LPs). After the LPs make their investment, the GP has on average 5 years to invest the capital. After these 5 years, the GP has on average another 5 years to pay back the initial invested capital and a part of the profit, if made (Kaplan & Schoar, 2005).
Background
Although private equity has found its roots in the 1940s, it became increasingly popular since the 1960s, resulting in a period of substantial growth in the 1980s with its heydays in 2000-2007. After 2007, the global financial crisis caused a tightening in lending standards and increased financial regulations, therefore reducing the number of PE deals. Since 2009 the private equity sector is growing again.
Leveraged Buyout
One of the strategies a private equity firm uses is a leveraged buyout (LBO). A LBO is financed with debt and is the most used strategy (Kaplan & Schoar, 2003), reaching its peak in 2006, when the total value of all LBOs in the US amounted to $502 billion (Dealogic, 2014). A private equity firm issues debt from investors and uses these funds to buy out the shareholders. The companies they usually target are mature, stable firms. The debt used to finance the buyout is not placed on the balance of the private equity firm, but on the balance of the acquired firm with the firm’s assets as collateral (Cotter & Peck, 2001).
Following the acquisition of a company, each deal represents a different situation. If it involves a medium-sized or small company, the management does not change. This is based on the fact that the current management knows the acquired company well and will not be easy to replace. In the event the acquisition involves a large company, the management can be replaced more easily. Other actions that will take place following the acquisition include selling of inefficient
parts, dismissal of employees etc. On average, the company is sold to another party, being another PE house or strategic partner, after several years. According to Guus Overdijkink1 this
period represents 5.7 years.
A private equity firm realizes highest returns by financing the acquisition with as much debt as possible. This is referred to as ‘creating leverage, because debt has a lower cost of capital than own equity. One point a private equity firm must take into account is that by creating leverage, the debt to equity ratio increases, and it is possible that the acquired company is not able to repay the debt and will default. This process is called ‘overlevering’. One famous example is the failure of Chrysler Group LLC by Cerberus Capital Management LP, which filed at $7.4 billion (Bloomberg.com, 2009). If an acquired company defaults because of a shortage of liquid assets and is thus not able to pay the outstanding debt, the invested capital is lost for investors as well as for the PE house.
Venture Capital
Another common strategy is venture capital (VC). This type of capital is provided to high-potential, capital-intensive, early stage companies. These firms need large amounts of capital in order to grow, but they are not eligible for a bank loan, because of the high-risk level these firms represent. Industries where venture capital is a common way of financing are: the biotech industry and the information technology (IT) industry. Companies like Apple, Intel and Compaq have all made use of venture capital (Sahlman, 1990). In exchange for capital, the private equity firm acquires a large part of the company as well as control of the company. If a company is financed by means of a VC, the company does not only obtain capital, but management skills and know-how as well. VC investments entail high risk due to default risk. VC investments are deemed high-risk/high-return opportunities. PE houses created VC funds to achieve high returns and to minimize high risk. These funds are used to invest in many different small start-ups, reducing the firm-specific risk the VC fund is exposed to.
Growth Capital
Growth capital is another strategy. When mature companies are in need of extra capital, they could, in order to raise capital, exchange this capital with a private equity firm for partial
ownership. This ownership is a minority investment, often less than 50%, meaning the company
1Guus Overdijkink has been a director at 3i, a London stock listed PE house. In 3i he was responsible for
LBO’s of firms with an enterprise value between €25 million and €1 billion. After 10 years he started his own company, Peconim, which focuses on PE support and helping family offices in their investment policy. See appendix; Private Equity: Interview - Guus Overdijkink.
maintains control. Companies who make use of growth capital are in need of this capital since they for example seek to expand, or wish to finance an acquisition and do not have the financial means themselves or wish to spread the risk.
EU vs. US
In the EU, bank financing is the most important form of finance, while in the US non-banking funds such as equity and bonds are more important. In 2001 bank loans to the corporate sector accounted for 42.6% of the GDP in the Eurozone, while in the US it only accounted for 18.1% (European Commission, 2013). Therefore, the EU is called ‘conservative’, because the non-banking sector is a relatively new sector in comparison with the non-banking sector. Besides this, Overdijkink views the financial regulations and legislative concerning defaults and the dismissal of employees in the EU as a reason for the fact that PE is more common in the US. These
regulations are stricter in the EU than in the US, making it harder to implement the changes a PE house views as necessary when buying out a company. If these cannot implement these changes, a PE house is less likely to conduct the buyout.
Although the EU is ‘conservative’, in both the EU and the US there is a significant increase in the use of private equity. In 2013, the amount of private equity invested in the EU totaled €180 billion, which is an increase of 19% when compared to 2012 and an increase of 106.9% with respect to 2009 (Annual European PE Breakdown, 2014). In the US, where the private equity market is much larger than in the EU, total private equity invested in 2013 was $426 billion, a rise of 4.4% with respect to 2012 and an increase of 173% with respect to 2009 (Annual US PE Breakdown, 2014). The $426 billion invested in 2013 is however still smaller than the pre-crisis peak value of $502 billion (Dealogic, 2014) reached in 2006.
Growth
In 2013 the total amount invested in buyouts in the EU was €149 billion, accounting for a large part of the total amount invested in private equity. In 2012 the total amount invested in buyouts was €123.4 billion, which means that the amount invested in buyouts increased by 20.75% (Annual European PE Breakdown, 2014). This rise is not explained by an increase in buyouts, but by an increase in the amount of capital invested per buyout. Although there was only an increase of 2 buyouts in the EU, from 811 to 813 (Annual European PE Breakdown, 2014), the average amount of money invested in a buyout is much higher, namely $0.18 billion in 2013 compared to $0.15 billion in 2012. This rise in average amount of money invested per buyout is not exceptional, but rather a trend that started in 2009. In 2009 the average amount invested was €0.09 billion, in 2010 it was €0.15 billion and in 2011 it represented €0.15 billion. This means that since 2009 the amount of money invested in buyouts has increased by 100%.
However, the pre-crisis values of invested amount of capital per buyout are still much larger. It is expected that in 2014 total amount of money invested in buyouts will rise again, based on
anticipated mega buyouts (Annual European PE Breakdown, 2014).
Figure 2: The growth of buyouts in the EU since 2009. Source: Annual European PE Breakdown, 2014.
Overdijkink provides two possible explanations for this trend. The first reason is that an investment in a smaller company involves a higher risk. Because of this, PE firms are now more focused on large firms. The capital needed to buyout a large firm is significant, hence the capital required per buyout increased. The second reason is that buyouts are now more expensive than 5 years ago. 5 years ago, the bank would have financed a large part of the PE deal. However, currently banks are less willing to lend capital to a PE firm. PE firms are therefore forced to
finance buyouts with equity instead of leverage.
VC investment in the EU has also s increased in recent years. While in 2009 the capital invested represented €4 billion, it was at highest in 2012 at a level of €5.5 billion. It reduced however to €4.9 billion in 2013. The average VC investment shows a decline since 2009. In 2009 VC
investments represented a capital of €4.2 million per investment, in 2013 it represented €3.2 million per investment. This means that the investment climate changed and venture capitalist now make more, but smaller investments (Annual PE EU Breakdown Report).
Figure 3: Growth of VC deals in the EU. Source: Annual European PE Breakdown, 2014.
However, Overdijkink states that the return on venture capital is not highly profitable, being -1% in Europe. In the US the average return on venture capital deals is higher, but this is mainly due to the average return on investments in Silicon Valley, which is 40%. If Silicon Valley is excluded from the average return in the US, it is -1%, which is the same average return as in Europe.
Credit Union Definition
A credit union (CU) is a union that is property of its own members with the purpose to supply its own members with loans (Srinisavan & King, 1998). The loans are usually short-term loans for consumers and small businesses. The loans for small businesses are known as member business loans (MBLs). These MBLs are subject to strict regulations in order to reduce the risk the CU system is exposed to (Howell-Best, 2003). The capital to provide a loan is obtained by deposits made by the members of the CU, which are referred to as shares (Howell-Best, 2003). Profit earned is paid out to members as a dividend.
The CU Executive Board are members of the CU, who are chosen by the other members. Each member has one vote, regardless of capital deposited. This is known as the one-vote-one-person system (Davis, 2001). The voting takes place each year and the chosen members will serve on the Board on a voluntary basis for a single year, without any kind of financial compensation (Taylor, 1971).
The service provided per CU differs, however most CUs provide saving accounts, credit card accounts, checking accounts and online banking. A CU is a not-for-profit organization, which means it is an organization, which realizes a small profit in order to provide services to its members, instead of maximizing profit (World Council of Credit Unions, 2014).
Credit Union vs. Banks
In the research conducted by Allred and Lon Adams (2000) with respect to customer satisfaction in the US, they compared CU and bank service quality performance. Based on 14 criteria, 81 bank customers and 62 CU customers completed a survey. The survey results indicated that CUs are deemed to have a better service quality performance than banks. Allred and Lon Adams also asked the customers if they are regularly contacted with regard to their needs. 44% of the CU customers stated they are contacted on a regular basis whereas only 27% of the bank customers indicated the same. This research indicates that CUs provide a better service quality.
When comparing rates and fees charged by CUs and banks in the US, a CU has more attractive rates for its members and lower fees for services. In June 2014 a comparison of a 12-month deposit indicated that the average CU deposit rate is 0.45%, while the bank average is 0.28%. Both the deposit rate and the loan rate a CU offers its members are more attractive than the
rates offered by a bank. For a loan of $5000 with a maturity of 4 years started in June, 2014, an average CU loan rate is 10.25% against an average bank loan rate of 10.37%. An annual CU credit card fee is $25, while an average bank credit card fee is $58.20 (Daily Rate Comparison, 2014).
A CU can offer its members these rates because of two reasons. The first reason is that the share capital of the CU, which is the accumulated communal wealth, cannot be withdrawn and consists of the profits made from deals with members. The benefits of this savings capital are used to offer members better rates than the bank does. A leaving member is not entitled to this created wealth and passes this wealth on to future members (Davis, 2001). The second reason is that a CU is a not-for-profit organization, resulting in tax advantages for CUs that other financial institutions do not have (Howell-Best 2003).
EU vs. US
In the EU, the amount of CUs and the role they play in the financial market is much smaller than in the US. According to Kor Schipper2 this is based on two reasons. “One reason is the European
legislation with regard to credit unions. In Western Europe a credit union is viewed as a bank, resulting whereof the credit unions are held to observe the same rules and must pay the same taxes as banks. These rules make it impossible to start a credit union. Still, the demand for credit unions is increasing significantly, especially since the financial crisis. Many small entrepreneurs see their loan application rejected, while 5 years ago the bank would have had no objection to approve a loan application. Because of this development in the EU, entrepreneurs are now seeking other ways to finance their business and an alternative for bank financing is the credit union. Prior to the financial crisis no demand for credit unions existed.”
Growth
The popularity and growth of CUs can be explained by two factors. The fact that SMB owners have lower loan rates, while receiving higher deposit rates than at their banks. Furthermore, an individual such as a SMB owner might feel more valued as a customer at a CU, preferring a CU above a ‘normal’ bank. Another reason is that many loan applications at banks are rejected, while a CU approves them. These two factors cause many SMB owners to apply for a loan at a CU, making CUs becoming increasingly important in the financial market.
2 Kor Schipper has made career in the insurance business. The last position he held was General Manager
of the Stoutenburgh Advies Groep. In 2011 he founded the Kredietunie Midden-Nederland and continues to be a non-executive board member. See Appendix; Credit Unions: Interview - Kor Schipper.
A typical loan application made by a SMB owner varies between $50,000 and $250,000. Banks deem most of these loans too risky and not profitable enough. The past few years illustrated an increase in the number of outstanding MBLs (Howell-Best, 2003). In 1999, 1,493 MBLs were issued by CUs in the US, an increase of 7% when compared to 1,390 MBLs granted by CUs in 1993. Moreover, the mid 2000s indicated the aggregate member business lending to be $43 billion in the US, an increase of 115% when compared to $2 billion in 1993(Hales, 2002). In 2011 51,013 CUs with savings of $1221 billion, loans of $1016 billion, reserves of $141 billion and assets of $1563 billion were registered worldwide (Statistical Report WOCCU, 2011). In 2012 this increased to 55,952 CUs with savings of $1293 billion, loans of $1083 billion, reserves of $161 billion and assets of $1693 billion (Statistical Report WOCC, 2012) and this increase is continuing.
Figure 4: Growth of CU’s total assets, savings, loans and reserves globally. Source: World Council of Credit Unions.
Business Angel Definition
When a startup company is in need of funds in order to grow and does not have access to capital to achieve this growth, it usually turns to family and friends to raise capital, which Mason (2007) therefore referred to as ‘love money’. However, the capital collected is often not enough to realize the desired growth. When the ‘gap’ between ‘love money’ and formal venture capital is still too large, business angels can fill up this ‘gap’ (Wetzel, 1983).
A business angel or angel investor is an investor who finances young startups with informal capital in return for equity or convertible debt (Wetzel, 1983). A business angel supplies funds, a broad network of business contacts and most of the time he/she has an active role in managing the startup (Mason & Harrison, 2008). Many ‘angels’ are retired entrepreneurs who are
financially independent and are therefore able to invest capital and time. An angel investment is therefore necessarily made for financial reasons, but based on the willingness to assist young entrepreneurs and to guide and help them with their businesses.
An investment made by an angel is not only made in pursuit of profit and this fact distinguishes an angel investor from a venture capitalist, whose only concern is achieving a high return on investment. Another difference is that business angels invest their own money, while a venture capitalist invests capital from a venture capital fund, being capital from other investors. Another reason business angels and venture capitalist differ is the duration of their investment. Whereas venture capital investments have an average duration of 3 years (Schwienbacher, 2002), the average duration of a business angel investment is 5 years (Prowse, 1998).
EU vs. US
In the EU angel investments increased to €5,1 billion in 2012 compared to 1999. This is an impressive increase of 700%. In comparison with the US, where angel investing totals up to $21 billion, this amount is still small (European Angel Investment Overview, 2013).
According to Jan Docter3, the US angel market is much larger than the EU angel market because
in the US the number of high net worth individuals is much higher than in the EU. Statistically
3 Jan Docter is a seasoned Chief Financial Officer of two stock listed companies, Getronics and Corio.
Following his retirement, he became investor and financial manager at Booking.com. Currently he fulfills several non-executive board positions and invests in startup firms as a business angel. Most of these firms are ICT enterprises. See Appendix; Business Angels: Interview - Jan Docter.
speaking, 95% of all angel investments fail. This means that only 1 of 20 business angel
investments is actually successful. Most business angels in the EU do not have the kind of capital to make 20 investments in order to have one profitable one and therefore do not make any angel investments at all. If they wish to invest capital, they invest it in PE and VC funds. In this manner, they spread the risk and often receiving higher returns than when investing themselves. By investing in funds managed by PE houses, an investor also benefits from the knowledge and know-how of such firms.
Docter also deems the existing ‘ecosystem’ in Silicon Valley a reason for the difference in business angels between the EU and the US. This system, which includes the most creative minds, the most experienced investors and the largest capital to invest, does not exist anywhere else. As such not only the highest amount of angel investments are done in the US, but also the largest amount of venture capital investments. As already stated by Overdijkink and again by Docter, Silicon Valley is a self-fulfilling prophecy. Because of the already existing ‘ecosystem’, which is unique in its kind, all new ideas and new capital will head to Silicon Valley, reinforcing the ‘ecosystem’.
Growth
Before Wetzel began to research angel investments, not much was known about the scope of this sector in terms of money and in terms of investors. Nowadays, more data is available and it turns out that it has become a very important manner of financing in the world. In 2012, angel investments in the US totaled $22.9 billion, being accountable for 67.030 new startups and creating 274800 jobs (Annual Report Center for Venture Research, 2012). 8 years earlier, in 2004, angel investments totaled $22,5 billion in the US at which time it was accountable for 48.000 new startups and the creation of 141.200 new jobs (Annual Report Center for Venture Research, 2004). This means an increase of 8% in total capital invested, an increase in startups financed with angel capital of 39.58% and an increase in job creation of 94.62% in just 8 years. Furthermore, compared with 2011, when the average investment was $70.690, in 2012 it was $85.435, meaning that the average investment per individual increased with 20.86% in the US (Annual Report Center for Venture Research, 2011; Annual Report Center for Venture Research, 2012).
Figure 5: Growth of angel investing in the US. Source: Center for Venture Research.
Two important factors explain the increase in angel investments. The first factor is that the cost of starting a company has fallen sharply in at the last decade, resulting in a larger amount of startups. This lowers the threshold for angel investors to invest, simply because it is less costly. In 2003 in the US there were 42.000 angel-funded startups against 70.730 in 2013 (Annual Report Center for Venture Research, 2003; Annual Report Center for Venture Research, 2013). The second factor is that in the past few years VC houses started to invest in businesses at a later stage, leaving more room for angel investors to invest in early stages. In 2013, 45% of all angel investments were invested during the startup stage, which is a significant increase when compared to 2012, when startup stage investments accounted for 35% all angel investments (Annual Report Center for Venture Research, 2013).
Super Angels
More opportunities exist to invest in earlier stages compared to investing at later stages in companies. However, an early stage investment also means a higher risk than investing at a later stage. Angel investments are therefore viewed as high-risk/high-return investments (Lerner, 1998). In 2013, in the US, the average yield for angel investments represented 21.6% (Annual Report for Center for Venture Research, 2013). In order to reduce the risk, business angels started to pool their money and invest in several startups. These investors are known as ‘super angels’.
Some super angels are very successful, for example Ron Conway, founder of Paypal, who invested with his fund SV Angel in Google. Another example is Scott Banister, founder of IronPort, who manages a fund that invested in PayPal, Facebook, Uber and Zappo (Manjoo, 2011). Super angels are often viewed as a hybrid form between business angels and venture capitalists. In contrary to business angels, investment is a fulltime occupation for them.
Crowdfunding Definition
An alternative to bank financing is crowdfunding and this alternative financing is becoming increasingly popular according to Tom Vroemen4. Crowdfunding already existed before it was
used by entrepreneurs and was mostly used in the music and art industry (Lambert & Schwienbacher, 2010). The definition of crowdfunding, given by Belleflame, Lambert and Schwienbacher (2013), is “an open call, mostly through the Internet, for the provision of financial resources either in form of donation or in exchange for the future product or some form of reward and/or voting rights”. The webpage Kickstarter.com is the largest crowdfunding platform of the world and has proven to be a platform for several incredible success stories. One of them is the story of Pebble, a producer of a product, which in combination with an Ipod Nano, can be used as watch, raising more than $10 million, or the videogame Double Fine Adventure, which received $1.4 million of funds in one single day (Kickstarter.com).
The first of the three participants engaged in a transaction is the investor, who is ‘the crowd’, providing capital. The second participant, the initiator, uses this capital to develop his product or idea. The third participant, the website, makes this process possible by providing a platform where inventors can post their ideas and initiators can support these ideas with funds (Ordanini et al., 2011).
Models of Crowdfunding
An investor must not only to choose between a broad spectrum of possible projects and goals, but he/she must also choose between five different crowdfunding models. . These are the donation model, the reward model, the pre-purchase model, the lending model and the equity model (Bradford, 2012). The reward and pre-purchase model are often found on one site; however most crowdfunding platforms only use one single model.
The donation model is based on the idea that investors support initiators by donating funds. Approximately 22% of the crowdfunding business is based on donations (Belleflamme et al., 2013). A more suitable name for these investors would be ‘supporters’, since a ‘supporter’ will not receive any financial benefits. The reason a ‘supporter’ provides an idea with funds is beneficent and not profitable. Donation sites are often only accessible for non-profit or
not-for-4 Tom Vroemen is a young entrepreneur and founder of Crowdaboutnow.nl, the second largest
crowdfunding platform in the Netherlands. Since Crowdaboutnow.nl was founded in 2010, he fulfills a function as director within the company. See Appendix; Crowdfunding: Interview - Tom Vroemen.
profit organizations and they charge a small fee in order to maintain the site. However, at time it is possible to donate to a profit-organization.
The reward model is nearly the same as the pre-purchase model., which is why a crowdfunding platform often offers both. Both models share the fact that an investor does not receive any financial reward and differ with regard to the type of reward an investor receives. These forms of crowdfunding are the most common forms used. 76.5% off al crowdfunding projects promise a reward for the investor who supplies their projects with funds (Belleflame et al., 2010). The pre-purchase model is the most common model. Investors receive the product in which they invested their capital, often at a price below the planned selling price. If an investor donates $40, he will receive the product. In stores, this product will be sold for $55. The reward model is a model where an investor receives a ‘reward’. This can be practically everything, from t-shirts to ‘thank you’ dinners with the initiators (Bradford, 2012).
The lending model consists of two different types of lending. The first type is supplying a loan without demanding interest on this loan. The second type is supplying a loan where the supplier does receive interest. According to Vroemen this is the most used version of the lending model. The first type of loan is normally only supplied to entrepreneurs who are in need of funds to invest, while the second type of loan also is available to consumers who need it for their own expenses. The lending model sometimes contains elements from the donation model. A provider of micro-financed loans can attach more value to the fact that a company creates beneficial externalities than the return he/she receives on the loan (Mollick, 2012).
The last model is the equity model. In this model the contributors receive shares or return on the future profits the company they fund. Because of financial regulations, this type of crowdfunding was illegal in the US and in some EU countries. It had many similarities with issuing stock, except that issuing stock is bound to strict rules, while selling equity through a crowdfunding platform is restricted by almost no rules. Governments feared that many projects, that received the pledged funds, would not use the funds for the purpose they were given and forbade it. In 2012, the JOB Act was passed in the US, making it easier for small businesses to receive funds in exchange for equity. Because of this, Belleflamme, Lambert and Schwienbacher (2013) believe that the equity model has the highest grow rate, namely 39%.
Growth
Crowdfunding is a new and rapidly growing way of financing and Agrawal, Catalini and Goldfarb (2011) believe that this is because of three elements. The first element, due to the financial crisis, is that capital is scarce and entrepreneurs needed to find new ways of acquiring funds for their projects. The second element is the development of Web 2.0, making it possible to have a two-way communication between the investor and the initiator. The last element is described best as “the success of the companion crowdfunding phenomenon” (Giuduci et al., 2012). The amount of money raised in 2012 totals $2.7 billion, which is an increase of 81% when compared to 2011 (Crowdsourcing.org).
EU vs. US
According to Vroemen, the difference in the number of crowdfunding platforms can be explained by the difference in financial regulations involved in starting a crowdfunding platform. These regulations are stricter in the EU than in the US. In the US it is not required to have a license, resulting in a lower entry barrier.
In 2011, the US was home to the most crowdfunding platforms, being 191, which is 4.9% more than 182 crowdfunding platforms in the EU. 44 of these 182 crowdfunding platforms were British, making the UK the largest crowdfunding market in the EU. However, although the US was home to most crowdfunding platforms, most money was raised in the EU in 2011. This amount was respectively $654,000 in the EU against $532,000 in the US (Crowdsourcing.org). This illustrates that – on average - the capital invested per investment is higher in the EU than in the US.
Vroemen believes this difference can be explained by the difference in culture. “The US has an Anglo-Saxon culture, which is characterized by philanthropy and ownership. That is why Kickstarter.com is such a success in the US, and not so successful in the EU. The
reward/purchase model works in the US because people want to be part of it and tell others they are part of it. They want to help these entrepreneurs to finance their ideas and dreams.
In the EU and especially in Germany, the Netherlands etc. the Rhine-culture is predominant. This means that we give only to receive something in return (quid pro quo). That’s why the lending model is a more suited model for the EU.
Conclusion
In 2007 the financial crisis erupted with the housing bubble in the US. This bubble caused the sovereign debt crisis in 2010 in the EU. Nowadays, entrepreneurs are struggling to find funds they need to make essential investments. Banks are less willing to grant loans to SMB owners and entrepreneurs, because they deem these loans to be more risky than before the crisis. Besides this, a few smaller loans bare more administrative costs for a bank than one large loan and therefore a smaller loan is less profitable for a bank.
Another factor that influences the banks decision-making process is that new financial
regulations demand banks to hold more reserves. These regulations are known as the Basel III agreements and are set in order to prevent banks and financial institutions from defaulting. However, by demanding banks to hold more reserves, banks simply have less capital to lend. This implies that on the one hand banks are obliged to hold more reserves, but on the other hand are expected to approve loan applications more often in order to stimulate the economy. This creates a dilemma and many entrepreneurs and SMB owners who are in need of funds, search for alternative ways of financing their investments. The trend in recent years is that these alternative forms illustrate a growth in popularity because of the higher demand.
The objective of this thesis was to answer the following research question:
“Are these four alternative funding methods to bank financing, being: private equity, credit
unions, business angels and crowdfunding, appropriate alternatives and which is the most appropriate alternative to bank financing?”
The answer is that all alternative funding methods to bank financing are appropriate and that there is no best alternative, because they differ significantly from each other. Each alternative includes advantages and disadvantages that make this form of financing unique and best suited for a different party. The suitability depends mainly on the stage of the lifecycle the company is in.
For an entrepreneur who seeks funds to start his/her project or to develop his/her idea there are two possible investment forms, namely angel investment or crowdfunding. These types of financing include several differences. Crowdfunding is a rather new form of investment, whereas angel investments exist for quite a while. When financed by crowdfunding, the startup often
rewards the ‘crowd’ with the product they try to produce and the startup receives their funds, provided a specific start capital is realized. After receiving these funds, crowdfunding investors have no control over the company nor over what is does with the provided capital.
In the case of angel financing, a business angel or small group of business angels invest in a startup and most angels continue to be closely involved with the startup. Since most business angels are high net worth individuals who have sold their company or who are former Chief Executive Officers (CEOs) or Chief Financial Officers (CFOs), they have a vast, diverse and valuable network. A startup can profit from such a network. Business angels not only have an interesting network, they also have many years of experience, which can be of added value to startups.
If an entrepreneur wants to be independent, crowdfunding may seem a more attractive
alternative, however, the coaching and the network are highly valuable characteristics of angel financing.
For a more mature startup in need of $1-2 million to ensure further growth, a venture capital investment may be an attractive option. VC firms do not only provide capital for a startup, they also provide management skills and know-how. A venture capitalist often wants partly
ownership of the startup in exchange for capital. An entrepreneur must consider if this is what he/she wants; however, without the necessary funds, the startup cannot continue growth. A large and mature company in need of capital, which is not granted by a bank, could obtain growth capital at a PE house. Another more common option is that a PE house conducts a
leveraged buyout and in 5 years time sells the company to another party. In these 5 years, the PE house has supplied the company with capital in order to let the acquired company grow by means of acquisitions, expansions etc. After these 5 years, the PE firm can sell the acquired company with a profit.
For a SMB owner in need of capital, a credit union is a good alternative to bank financing. The members of credit unions consist mostly of SMB owners and because of the one-person-one-vote system a credit union is therefore also ran by SMB owners. The loan and deposit rates are better rates than any bank can offer and apart from these better rates, a credit union offers coaching and guidance. The US does not feature many credit unions, but the numbers are rapidly growing, and in the US many credit unions have been established.
These four alternative forms to bank financing, being: credit unions, private equity, business angels and crowdfunding, all show growth since the crisis started in 2007. This growth is expected to continue the next few years. Companies and entrepreneurs in need of capital do not only view these alternative forms as appropriate alternatives to bank financing, but in some cases even as a better form of funding. Most non-banking institutions supply an entrepreneur not only with capital, but also with management skills, know how and coaching. People do appreciate these extra services. If banks become healthy again and increase lending themselves, they will reclaim a share of the financial market. However, the position of the bank as a supplier of capital will be less important than before the crisis.
Sources - Website articles
Annual Report 2004. Center for Venture Research. Retrieved June 9, 2014 from http://www.paulcollege.unh.edu.
Annual Report 2012. Center for Venture Research. Retrieved June 9, 2014 from http://www.paulcollege.unh.edu.
Annual Report 2013. Center for Venture Research. Retrieved June 9, 2014 from http://www.paulcollege.unh.edu.
Annual Report 2012. Crowdsourcing.org. Retrieved June 12, 2014 from http://www.crowdsourcing.org.
Basel III phase-in arrangements. Basel Committee on Banking Supervision. Retrieved May 25, 2014 from http://www.bis.org/bcbs/basel3/basel3_phase_in_arrangements.pdf.
Cerberus’s Chryslers Bankruptcy Sets Record in U.S. LBO Industry (2009, May). Bloomberg.com. Retrieved June 8, 2014 from http://www.bloomberg.com.
Crowdsourcing.org. Retrieved June 13, 2014 from http://www.crowdsourcing.org
Daily Rate Comparison (June, 2014). Credit Union National Association. Retrieved June 11, 2014 from http://www.creditunion.coop.
Dealogic: LBO Volume Up 25%. Dealogic.com. Retrieved June 07, 2014 from http://www.dealogic.com
European Angel Investment Overview 2013. European Commission. Retrieved June 11, 2014 from htttp://ec.europa.eu.
Getting Banks Lending (February, 2014). Government of the UK. Retrieved July 5, 2014 from http://www.gov.uk.
Iedereen bankier (2014, April). NRC Handelsblad. Retrieved April 21, 2014 from http://www.nrc.nl.
Manjoo, F. (2011). How “Super Angel” Investors Are Reinventing the Startup Economy.
Fastcompany.com. Retrieved June 12, 2014 from http://www.fastcompany.com
Shadow and substance (2014, May). The Economist. Retrieved May 28, 2014 from http://www.economist.com.
Statistical Report 2011. World Council of Credit Unions. Retrieved June 10, 2014 from http://www.woccu.org.
Statistical Report 2012. World Council of Credit Unions. Retrieved June 10, 2014 from http://www.woccu.org.
Trends in Lending (2014, January). Bank of England. Retrieved July 4, 2014 from http://www.bankofengland.co.uk
Trends in Lending (2014, May). Bank of England. Retrieved July 4, 2014 from http://www.bankofengland.co.uk
What is a Credit Union? World Council of Credit Unions. Retrieved June 10, 2014 from http://www.woccu.org.
2014 Annual European PE Breakdown. Pitchbook.com. Retrieved June 7, 2014 from http://www.pitchbook.com.
2014 Annual US PE Breakdown. Pitchbook.com. Retrieved June 7, 2014 from http://www.pitchbook.com.
Sources - Literature
Agrawal A. and Catalini C., Goldfarb A. (2011). Friends, Family and the Flat World: The Geography of Crowdfunding. NBER Working Paper, No. 16820.
Allred, A. T., Lon Addams, H. (2000). Service quality at banks and credit unions. Managing Service
Quality, Vol. 10, No. 1, January 2000, 52-60.
Belleflamme, P., Lambert, T., & Schwienbacher, A. (2010). Crowdfunding: An industrial organization perspective.
Belleflamme, P., Lambert, T., & Schwienbacher, A. (2013, July). Crowdfunding: Tapping the right crowd. Journal of Business Venturing.
Bradford, C.S. (2012). Crowdfunding and the Federal Securities Laws. Columbia Business Law
Review, Vol. 2012, 2-27.
Cendrowski, H., Wadecki, A.A. (2012). Introduction to Private Equity.
Cotter, J.F., Peck, S. (2001). The Structure of Debt and Active Equity Investors: The Case of the Buyout Specialist. Journal of Financial Economics, Vol. 59, Issue 1, January 2001, 101-147. Davis, K. (2001). Credit Union Governance and Survival of the Cooperative Form. Journal of
Financial Services Research, Vol. 19, Issue 2-3, April 2001, 197-210.
De Fiore, F., Uhlig, H. (2005). Bank Finance versus Bond Finance. What explains the difference between US and Europe. European Central Bank. Working Paper Series, No. 547, November 2005, p. 5.
Giudici, G., Nava, R., Rossi Lamastra, C., Vercondo, C. (2012). Crowdfunding: The New Frontier for Financing Entrepreneurship.
Hales, M. (2002). Member Business Lending Strategies. Credit Union Executives Society, September 2002.
Howell-Best, K.E. (2003). Can Credit Union Members Business Loans Meet the Need for More Credit to Small Businesses. North Carolina Banking Institute, Vol. 3, 2003, 405-422.
Kaplan, S., Schoar, A. (2003). Private Equity Performance: Returns, Persistence and Capital Flows. MIT Sloan School of Management. Working Paper 4446-03.
Kaplan, S. N., Schoar, A. (2005). Private Equity Performance: Returns, Persistence, And Capital Flows. The Journal of Finance, Vol. LX, No. 4, August 2005, p. 1793
Lambert, T., & Schwienbacher, A. (2010). An empirical analysis of crowdfunding. Social
Science Research Network.
Lerner, J. (1998). “Angel” financing and public policy: An overview. Journal of Banking & Finance, Vol. 22, Issues 6-8, August 1998, 773-783.
Mason, C.M. (2007). Informal Sources of Venture Capital. The Lifecycle of Entrepreneurial
Ventures International Handbook Series on Entrepreneurship, Vol. 3, 2007, 259-299.
Mollick, E. (2012). The dynamics of crowdfunding: Determinants of success and failure. Journal
of Business Venturing, Vol. 29, Issue 1, January 2014, 1-16.
Ordanini, A., Miceli, L., Pizzetti, M., & Parasuraman, A. (2011). Crowd-funding: transforming customers into investors through innovative service platforms. Journal of Service Management, 22(4), 443-470.
Prowse, S. (1998). Angel investors and the market for angel investments. Journal of Banking &
Finance, Vol. 22, Issues 6-8, August 1998, 785-792.
Sahlman, W.A. (1990). The structure and governance of venture-capital organizations. The
Journal of Financial Economics, Vol. 27, Issue 2, Oktober 1990, p. 442.
Srinivasan, A., King, F.B. (1998). Credit Union Issues. Economic Review, Q3, 32-41.
Schwienbacher, A. (2002). An Empircial Analysis of Venture Capital Exits in Europe and in the United States. University of Namur. p. 13.
Taylor, R.A. (1971). The Credit Union as A Cooperative Institution. Review of Social Economy, Vol. 29, Issue 2, 1971, 202-217.
Appendix
Private Equity: Interview - Guus Overdijkink, June 13, 2014.
Which business strategies are used at 3I?
Until 2003 we used two strategies, leveraged buyouts and venture capital deals, when we decided to focus on buyouts only. We experienced that venture capital deals simply did not have a satisfying return. Currently the return on venture capital in Europe is -1%, which is actually the same return you will receive on average if you close a venture capital deal in the US.
What do you mean when you say ‘actually’?
What I meant by saying ‘actually’ is that people often misjudge the return in the US on venture capital deals, because the return in the US on all venture capital deals is on average higher than in Europe. However, if you look more closely you will find that the return in the whole US is actually -1%, with one exception: Silicon Valley. In Silicon Valley the return is approximately 40%, raising the average return of the whole US. It is a kind of self-fulfilling prophecy. This is because the best of both parties reside in Silicon Valley; the best venture capitalists and the entrepreneurs with the best ideas. If you do not reside in Silicon Valley, venture capital is a high-risk/low-return model, which is why we do not use this strategy anymore.
Understood. What are ‘key’ factors if you want to take over a firm?
The most important factor is management. After all, they represent the management the company needs to grow. In contrast of what people often think, PE firms seldom replace
management, simply because they know the firm best. If you replace the management, you take a risk; how will you know you are able to install a better a management? Moreover, 3I focuses on middle market buyouts and in this market segment management is harder to replace in
comparison with large companies. Another aspect we take into consideration is the return (ROI). I assess growth possibilities, for example by means of expansion or acquisition(s). I also look at the balance sheet and the cash flow. Personally, I find cash flow the most important. If cash comes in, I am happy man.
What is the duration of your partnership with the acquired company?
Approximately 5.7 years. After this period, we sell the company and realize maximum profit.
During these 5.7 years, are you heavily involved with the affairs of this company?
I am intensely involved during our time as a shareholder. Although I rather not replace the management, I do like to place an auditor with experience and business know-how. During the 5 or 6 years as a shareholder, contact the CEO and CFO on a weekly basis. This is a process. First you mainly call to control them and your investment. After a while, you establish a confidential bond and from this point on you mainly focus on growth.
You mentioned that later on you begin to establish a confidential bond. Is this the point you start thinking about selling your investment?
No, during the first year of the investment you are already searching for potential buyers. This is based on several reasons. First of all, you let people get used to the idea that company will be sold again, possibly with a short-term. Secondly, when you know at which time you will sell the company, you can determine a strategy that suits this point.
Which possible buyers do you approach?
This depends and differs per company. Sometimes I approach another PE firm, on other
occasions I approach a strategic party, as long as we have a return of approximately 20 to 25% a year on equity. However, most of the time, a return of 20 to 25% is not realized. It is either much higher or much lower.
What do you do if it turns out that the return is significant lower than the desired 25%?
As soon as the return declines, I begin to search for a possible explanation and solution for this decline. The explanation is not necessarily found within the company. A good example of a decline is Daaldrop. Daaldrop is a company that operates in the boiler industry. These boilers are mostly used for new houses. The market for new houses faltered due to the financial crisis and therefore Daaldrop experienced lower sales. In our view the solution for this problem was finding new distribution channels for Daaldrop. As soon as new channels were found, the return started to rise and eventually we sold Daaldrop with profit.
Clear. Another question. Why is the PE business significantly larger in the US than in the EU?
I do not know why exactly, but I do know that PE has its roots in the US and therefore simply exists longer in the US. Another reason could be that in EU, more financial regulations and rules related to dismissal of employees and defaults apply. Because of these rules, it is harder to implement the changes you had in mind for the company you want to buy. Another factor could be that in the US everybody speaks the same language and is bound by the same laws, while in the EU this differs per country.
Lately, the investment per buyout is larger than before, but the dealflow is less than before. Why?
There are two reasons for this trend. At first, buying a small company is more risky than buying a large company. This causes PE firms to focus on large companies and these companies are more expensive, resulting in larger buyouts, but also in less buyouts. Secondly, banks are financing smaller parts of the deals, resulting in the fact that the same deal 5 years ago is now more costly, because a larger percentage of enterprise value is accounted for by equity.
If you are an owner of a company and you are in need of capital, should you choose PE or bank financing?
Depends on what you want to achieve. A bank loan is less expensive compared to private equity, but you are bound to all sorts of covenants. PE is more expensive, but you will not only receive capital, but management expertise as well. Apart from the aforementioned, a PE firm cares about her investment and is much more concerned with the state of affairs of your company. The only thing a bank cares about is that you pay your loan on time. It is scientifically proved that a company using PE compared with a company financed by bank performs better. After 5 years, it experienced more growth in terms of employees, sales volume etc. The only thing you need to ask yourself is this question: do I want to own a pie with the value of $5 for 100% or do I want to own a pie with the value of $50 for 50%?
PE and especially venture capitalist are often described as the cowboys of the financial world. Do you experience this description to be negative?
On the one hand, I understand this perspective. On the other hand, I experience to be people are narrow-minded. It is true, we buy a company and after 5 years we sell it. There is no emotional involvement, only a hopefully profitable ending of partnership. The larger the profit, the better
the deal. We always accept the highest bid, no matter what the plans of the acquiring party are. However, if you think clearly, the company with the highest bid will, most of the time have the best future plans with the acquired company, why would it otherwise acquire this company? Often the management is no longer aware of profitable situations. Therefore please explain to me what is wrong with buying a company and selling it after 5 years with a higher enterprise value? A good example is Vendex. A few years ago, Vendex was struggling and experienced a LBO. The only thing the acquiring party did was selling its own real estate and subsequently leasing it back. They changed the name to Maxeda and sold it with huge profit. Some people find this a dirty business, in my opinion it is pure logic. The management of Vendex was sleeping and the PE firm profited from this.
Last question. Have you ever acquired a company, which was a bad decision? For example, it overlevered?
I have never made a buyout that overlevered. However, overlevering itself is not necessarily a bad thing. A good example is the HEMA LBO. The balance sheet of the HEMA shows mostly debt, but the cash flow is good. Sales volume has even risen since the buyout. HEMA generates enough cash, however, not enough to repay its debt. The debt must be reduced. This is not per se a problem for the PE Firm, which is Lion Capital. The only one suffering now is the shareholder.
Yet the HEMA was acquired by Lion Capital 7 years ago. This could not have been their goal.
You are correct, this was not their intention. The reason for this is that the HEMA has a much lower enterprise value than when they bought it. This is due to overlevering, but is based on the fact that the multiplier has decreased since the buyout. The enterprise value is determined by multiplying the EBIT by this multiplier. This multiplier is only influenced by the state of the economy. At the moment, the state is very poor, resulting in a low multiplier and thus in a low enterprise value. Lion Capital is therefore waiting for the multiplier to rise until they can sell it with profit.
Credit Unions: Interview - Kor Schipper, June 10, 2014.
Kor, you are one of the founders of the first credit union in the Netherlands, namely Kredietunie Midden-Nederland. Can you tell me why you started this and how you did it?
It started very simple. I organized business lunches with entrepreneurs with the purpose of networking. Discussions were held and people exchanged thoughts on topics occurring in the economy and their businesses. One of the topics I often heard related to bank loans. The entrepreneurs all had bad experiences with banks since the beginning of the global crisis. Loan applications were simply rejected, even though they had been customers for years and thought they had built a valuable relationship. This reason for the rejection is based on the fact that it is simply not attractive anymore for banks to finance small businesses, because of the higher costs involved. A loan application costs approximately €4500, so a bank is more eager to approve 1 loan of €1,000,000,- instead of 10 loans of €100,000.
When I heard this, the next meeting I organized, I invited all the banks to listen to these
problems and to get involved in the discussion. The only bank that showed up was ING and the result was zero; the discussion was emotional and intense, but ING and the entrepreneurs did not find a solution to the problem. When I came home that evening and turned on the television, I saw Ronald Lampe, a retired Rabobank executive, on television. This program introduced the phenomenon credit union to me. The next day I called him and we immediately created a group of 5 men to ensure that this idea of a credit union in the Netherlands became a fact.
After operationalizing the idea, we approached the media and politicians to implement the idea. Some prominent politicians joined our cause and the next meeting I organized was attended by an astonishing number of 200 entrepreneurs! At this point, the Rabobank began an offensive to frustrate our plans. The Rabobank went to the Dutch Bank, claiming that a credit union must meet the same rules as a ‘traditional’ bank, making it impossible for us to operate. This was a difficult phase, because it is hard to fight such a mighty force.
At this moment we operate as a credit mediator, which is an intermediate form until we reach the final form, which is a credit union similar to the credit unions in the US. Apart from the Dutch law presenting a problem, European law also forbid credit unions as a legal form of financing. The law states that if a customer can deposit funds and these funds can be used to grant a loan to another customer, you operate as a bank and are therefore bound by bank laws. As I said before, we are not able to operate under bank legislation. We are simply too small. At the moment the
amendment for the Dutch law is completed and waiting to be approved, in contrast to the European law, which we are also held to observe. In fact, we are waiting until Brussels finally makes an amendment.
That’s quite a story. What does the Kredietunie Midden-Nederland looks like at the moment?
It consists of 5 organizations, being the bakery union, Bovag, Zeeland, Brabant and Kredietunie Midden-Nederland. Our members are solely entrepreneurs and our own members are in control of the credit union. The board is chosen using a one-person-one-vote system, meaning that every member has one vote, regardless the size of his/her share.
Suppose I am an entrepreneur in search of capital. In my search I come across Kredietunie Midden-Nederland. Which steps do I need to take to be granted a loan?
At first you become a member of the union, otherwise you will not be eligible for a loan. After you have become member, you will present your business plan to the financial commission. They will decide if your plan is solid. If they decide in your favor, you will present your plan to the board. After this presentation, you will be assigned a coach, who will assist and monitor you until you have paid off your loan. Now it is time to find the capital you need. Because of financial regulations, we ourselves cannot provide you with a loan, but our members can. We match ‘borrowers’ and suppliers by placing all loan applications on a crowdfunding platform and lenders can then select which application they want to finance. Your application can be between €50,000 and €250,000 and the maturity must be between 36 and 84 months.
And what if I am not able to pay my loan anymore? For example, I default. Who carries the risk of the loan?
At the moment, the risk is carried fully by the lender. However, this is not our goal. When we finally reach our goal, which is to be a true credit union, not just a mediator, the risk is ours. Fortunately, there is little risk because all the applications are approved before they are placed on the crowdfunding platform and if it goes wrong, the coach will notice this immediately and act accordingly.
Your members receive quite a service and you are a not-for-profit organization. How do you finance your services, for example a coach?
This is the beautiful part about credit unions. Because it is run by entrepreneurs for
entrepreneurs, most of the services we provide are on a voluntary basis. We really just want to help each other. The board members spend a lot of time helping the credit union. The coach only receives €500 on a yearly basis, paid by the loan taker. The rate a borrower pays is 8%, while the lenders receives 6%. The margin of 2% is for the credit union, so we can continue to provide our services.
Last question. Why do you think there are way more credit unions in the US than in the EU?
I believe there are two reasons. One of them is the European legislation related to credit unions. In Western Europe a credit union is perceived as a bank, restricting credit unions to the same rules and taxes as banks. These rules are impossible to observe, making it impossible to start a credit union. Still, the demand for credit unions is increasing significantly, especially since the financial crisis. Many small entrepreneurs see their loan application rejected, while 5 years ago the bank would have not even doubted to approve the loan application. Because of this
development in the EU, entrepreneurs are now searching for other ways to finance their
investment and one alternative for bank financing is the credit union. Prior to the financial crisis there was no demand for credit unions, which is why credit unions did not exist in the EU and to a lesser extent in the US.
Business Angels: Interview - Jan Docter, June 16, 2014.
What made you decide to be a business angel?
Well, to be honest, I am not a risk seeker, but I became interested in a particular type of sport in which I believed I had more than average knowledge and skills. So when if I come across an option, which catches my attention, this is because I believe it is a good project. One condition is applicable to my investment at all times; I am always closely involved in the project. Some people like to go to the casino and place their bets on a random set of numbers, hoping they win. The numbers I choose are all numbers of which I believe the probability that the ball will hit them is larger than the other numbers.
It could be that a group of business angels approaches me with a possible investment and I do not have the expertise to assess whether this is a good investment. If I know these angels well and trust them and they do have the expertise to assess whether it is a good business initiative, I sometimes follow them.
What makes an investment interesting for you?
My focus is primarily on investment opportunities in the technological sector. In this sector you come across a brilliant idea every day. So the idea itself is not an important criterion. For me, the most important criterion is the person or the team behind the project. Most angel investments fail because of failure of the team. The implementation of the idea is the most important part of the investment. For an idea or project to succeed, you need several qualities. Creativity, nuance, drive and financial thinking are all necessary. This is why I am looking for a team who has the perfect mix of all these qualities. It is also the reason why I am more skeptical about projects that are run by a single individual, because it is almost impossible to have all these qualities.
What is the duration of an average angel investment you make?
An investment takes at least 5 years before I receive any return. Keeping my age in mind, I want the liquidity of my investment as short as possible. I do not want my money to be bogged down in an investment for a long time.
You are talking about return on investment. Is that the main reason you make angel investments?
No, certainly not, enjoy coaching young entrepreneurs. On the other hand, there are less
expensive hobbies and I do want a return on my investment. An average investment is between the $50,000 and $100,000 and on average 1 out of 20 investments is successful. Most of my investments are not successful, so my investments are in line with the statistics. Some of the investments I made that defaulted are a Canadian startup and a Dutch startup involved in art identification. Once I invested in a Turkish company and received my investment back again, even though it did default.
Did you have any successful investments?
Some investments I made were successful, but often enough they are not. One of my successful investments is with a group of investors in several Brazil based companies. As stated, statistic illustrates that 95% of the investments fail. So if you want to make a profit, you must invest 20 times in order to - statistically speaking - have one successful investment. That is the reason why angel investment in the US is much larger than in the EU.
What is the reason that angel investment is larger in the US?
The US has much more high net worth individuals than the EU or the Netherlands. What is viewed in the Netherlands as ‘wealthy’ is perceived as average in the US. Because of this, they can make much more investments and actually invest 20 times in a startup and have 1 successful investment. Most business angels in the Netherlands do not have this kind of capital, resulting in the fact that these individuals mostly invest in PE or VC houses, spreading their risk. Another advantage of investing in a PE or VC fund is that these firms have more know-how and knowledge and therefore –principally speaking - make better investments.
Do you think it is possible that a certain point angel investment in the EU can reach the same level as in the US?
At the moment, the infrastructure in the Netherlands is not capable of hosting such a growth in angel investment. This is based on several reasons. One reason is that many startups searching for possible investors head to Silicon Valley, because Silicon Valley represents the best growth possibilities. Business angels with the best know-how and the most capital reside in Silicon Valley, which is why it is more attractive for startups to try and find their luck in the Valley than
in Amsterdam. Silicon has a special type of ecosystem. This ecosystem consists of creative people, financial people and people with know-how. I am not saying that the EU does not have the capabilities to create such an ecosystem, however, I do believe it is quite hard to create a system that can compete with Silicon Valley.
If such a system is created in the EU, it should be created in Berlin, Amsterdam, Munich and Stockholm. These are all cities that have the competences to eventually create an environment that resembles the environment in Silicon Valley. Currently, only one condition is missing to create such a system. Young angels with money. The current business angels are older and these angels have to assess projects and ideas based on a technology they probably not fully
understand. For this reason, it is necessary that young millionaires start to make angel investments, however, relatively few young millionaires reside in the EU.
Some developments are positive, but the backlog with Silicon Valley is still too large.
Apart from the fact that young millionaires should invest more in startups, do you have any other suggestions to create an ecosystem as you described above?
Well, first of all I would propose that the government does not interfere with these types of investments. Governments could decide to make some kind of fiscal arrangement for business angels, but their interference should stop there. If a bureau without any experience in the business or know-how needs to make a decision if a startup project is a good one, I can guarantee they will make a wrong decision.
Another proposal I would like to make is that universities and young startups should work together more closely. Although the TU Delft and the TU Eindhoven are increasingly working with entrepreneurs, the development is still too slow. This is a big difference with the US and eventually this will help to create the environment in Amsterdam that is needed to make the business angel market grow.
