Crowdfunding of new ventures in the Netherlands By Jordy Oosterveld

Crowdfunding of new ventures in the Netherlands By Jordy Oosterveld

University of Groningen

Author note:

Jordy Oosterveld, Faculty of Economics & Business, University of Groningen Correspondence concerning this article should be addressed to Jordy Oosterveld Faculty of Economics & Business, University of Groningen, Nettelbosje 2, 9747 AE Groningen, The Netherlands.

E-mail: j.j.a.oosterveld@student.rug.nl

Preface

In front of you is my Master thesis, this is the last part of my Master of Science, Business Administration, Small Business and Entrepreneurship. In the research I have examined whether crowdfunding fills in a gap in contemporary new venture financing. I would like to thank a few people for their time, help and participation in this research. First of all, I want to thank Prof. Dr. P.S. Zwart as my thesis supervisor. Secondly I would like to thank Robin Slakhorst, co-founder of Symbid, who was able to help me finding entrepreneurs that were familiar with crowdfunding. Finally I would like to thank the entrepreneurs that have contributed to this research by sharing their experiences and opinions concerning new venture financing.

Jordy Oosterveld

Groningen, 28

of July 2013

Content

Executive summary 4

1. Introduction 7

2. Theory 9

2.1 Debt based financing 9

2.1.1 Bank loans 9

2.1.2 Friends and family loans 11

2.1.3 Leasing structures 13

2.1.4 Government subsidies 14

2.1.5 Trade credit 15

2.1.6 Financial bootstrapping 16

2.1.7 Debt based crowdfunding 17

2.2 Equity based financing 19

2.2.1 Insider finance: Start-up team, friends and family 19

2.2.2 Business Angels 21

2.2.3 Venture Capital 23

2.2.4 Equity based crowdfunding 25

2.3 Conceptual model 26

3. Methodology 28

3.1 Research design 28

3.2 Sample 28

3.3 Data collection 29

3.4 Data analysis 30

3.5 Validity and reliability 30

4. Results 32

4.1 Forms of financing 32

4.2 Financing nowadays 41

4.3 Reasoning in decision making process 42

4.4 Crowdfunding 49

5. Discussion and Conclusion 53

5.1 Research question and conceptual model 53

5.2 Suggestions for further research 55

5.3 Limitations 56

5.4 Additional retrieved information 56

6. References 60

7. Appendix 68

Appendix A: Overview debt based and equity based financing 68 Appendix B: Indicators debt based and equity based financing 69

Appendix C: Interview guide 70

Appendix D: Interview summaries 78

Executive summary

This thesis examines the role of crowdfunding in Dutch new venture financing. All different methods of new venture financing have been mapped, debt based methods and equity based methods. Based on all contemporary methods of financing, ten indicators have emerged.

Together with the different methods, the indicators show the entrepreneurial reasoning in choosing a new venture financing method. In this summary the findings from the literature and the case studies are described and discussed shortly. All research is based around the research question: Does crowdfunding fill in a gap for financing Dutch start-ups?

Findings from literature

In the theory all possible forms of new venture financing have been charted: bank loans, friends and family loans, leasing structures, government subsidies, trade credit, financial bootstrapping, debt based crowdfunding, insider finance, business angels, venture capital and equity based crowdfunding. Each method has pros and cons according to the entrepreneurs, therefore they are brought back to ten indicators in total: ownership and control, accessibility, selection procedure, financing costs, amount of capital, disclosure of intellectual property, relationship, feasibility, managerial help and ‘flying start effect’. Expected is that these indicators can demonstrate whether crowdfunding fills in a gap for Dutch new venture financing.

Findings from the case studies

The outcomes based on the entrepreneurs’ perceptions were not completely in line with the

theory. Of all new venture financing methods, lease structures and trade credit were not

mentioned at all. Besides, bank loans, government subsidies, financial bootstrapping and

venture capital were hardly put into practice. The only financing methods, which were truly

considered or used by the entrepreneurs, were friends and family loans, debt based

crowdfunding, insider finance, business angels and equity based crowdfunding.

The research pointed out that scarcity of start-up capital has increased lately, 80% of the respondents indicated this financial gap between €50k and €100k.

With the help of the ten indicators, the entrepreneurs were questioned whether crowdfunding truly fills in a gap in contemporary start-up financing. Two indicators, financing costs and the selection procedure, were not considered at all, apparently these were not important to them.

On the disclosure of intellectual property and managerial help the opinions were dispersed.

These two indicators were neither positive nor negative. Then four indicators were experienced as a pro: accessibility, the amount of capital, feasibility and the ‘flying start effect’. Finally two indicators were seen as a con: keeping control and ownership and the relationship. By including all possible indicators concerning crowdfunding, the positive ones outperform the negative ones.

So based on the entrepreneurial reasoning in choosing a new venture financing method,

crowdfunding indeed fills in a gap for financing Dutch start-ups. Crowdfunding is perceived

and used as a true new venture financing method and is implemented in the contemporary

entrepreneurial mindset. It fills in a financial gap somewhere between €30k and €150k.

1. Introduction

Small businesses, and in particular start-ups, play an important role for economic growth and job creation in society (Storey, 1994). The growth of small businesses and the amount of starting businesses lies in the hand of available capital in the market. According to several researchers (Stanworth and Gray, 1991; Storey, 1994), a lack of growth capital is a recurring phenomenon for SME’s. After the introduction of Basel II and Basel III by the Bank of International Settlements, the international set of standards concerning bank capital has changed (Lall, 2012; Delimatsis, 2012). These changes had negative effects on the capital available in the market, especially regarding to potential new ventures. The EIM, the Dutch Economical Institute for Small and Medium Sized Businesses, showed in their latest research in 2012, that 33% of the SME’s were not able to find the proper capital, in 2010 this number was still 19% (EIM, 2010, 2012). Capital scarcity has increased over the past two years.

There are many sources of finance available, though not every source is suitable for new venture creation by entrepreneurs with limited internal funds, resources, networks and reputation. It has been widely observed that new and small firms face financial constraints and experience difficulty in obtaining finance from external debt and equity financiers (Jonsson &

Lindbergh, 2011).

It has become obvious that the relation between supply and demand for SME capital is

considered difficult. This mainly counts for traditional financing methods such as business

angels, banks or venture capital funds. Some contemporary entrepreneurs rely on the Internet

in seeking the required capital (Lambert et al., 2012). Nowadays, an entrepreneur has the

possibility to focus on crowdfunding. These are online platforms where a large audience can

provide a small amount of money instead of soliciting a small group of sophisticated

investors.

From an entrepreneurial perspective, crowdfunding has become a viable fundraising method obtainable for small entrepreneurial companies (Schwienbacher and Larralde, 2010), crowdfunding is able to fill in a gap for start-up capital. The choice of Dutch start-ups for crowdfunding is still an unexplored area. As most unconventional financing methods, it is not clear yet why crowdfunding has increased in popularity and what its advantages and disadvantages are compared to traditional financing methods. This brings us to the main research question:

Does crowdfunding fill in a gap for financing Dutch start-ups?

The sub questions are:

1) What alternative ways of financing are used nowadays 2) Which pros and cons exist for alternative ways of financing

3) Which indicators are important for entrepreneurs during the decision making process of new venture financing

4) When and why do entrepreneurs think of crowdfunding 5) What is the added value of the crowd in crowdfunding

6) How do start-ups consider the effect of disclosing sensitive data like its intellectual property

The research will be done on a qualitative basis, crowdfunding is a new topic in research

which needs an exploratory approach (Flick, 2006; Myers, 2009). Qualitative research tries to

understand people in their context. According to Miles and Huberman (1994), qualitative

research “provides a holistic view, through the participants’ own words and perceptions, of

how they understand, account for and act within these situations”. So crowdfunding cannot be

portrayed by its components but only by the complete picture of the entrepreneurs.

A case study of at least five crowdfunded companies will be conducted, all these companies have been funded by the Dutch platform ‘Symbid’. Symbid will facilitate during this research.

As one of the biggest online crowdfunding platforms in the Netherlands, it provides a crowdfunding infrastructure that enables individuals to actually become partial owners of new companies. What differentiates Symbid from other crowdfunding platforms is that it is equity based instead of debt based. Symbid will be explained thoroughly further on in paragraph 2.2.4.

Next, existing literature on SME financing is discussed, then the research design will be

illustrated. In the end the results are being revealed which leads to the discussion and

conclusion.

2.Theory

In general a distinction can be made between two types of new venture financing: debt based financing and equity based financing (Schwienbacher and Larralde, 2010). Both types of financing can be used for crowdfunding. To comprehend the types of financing, the most common financing methods and types of investors are being mentioned. Each of them is being explained based on its pros and cons from an entrepreneurial point of view.

2.1 Debt based financing

Debt based finance implies financing methods like bank loans, friends and family loans, leasing structures, government subsidies, trade credits, financial bootstrapping and crowdfunding (Schwienbacher and Larralde, 2010). The external parties involved exchange finance for debt bound by a detailed contractual agreement. In general, the accessibility to debt finance is considered difficult for new ventures. It often happens that required collateral, sufficient internal funds or stability in its cash flow cannot be demonstrated (Berger and Udell, 1998).

2.1.1 Bank loans

Banks can provide long-term capital for start-ups: bank loans. With the bank stating the fixed period over which the loan is provided, the rate of interest, timing and amount of repayments are agreed upon. The bank will usually require that the start-up provides some security for the loan. This is normally done by collateral and covenants which are personal guarantees provided by the entrepreneur. However as a starting entrepreneur, these sources might be difficult to obtain.

Less bank loans are issued over the past three years (EIM, 2012), the amount of rejections by

banks have increased. Risk assessment of banks play a major role in such a rejection.

Compared to large firms, SMEs pay the double amount of fixed and variable interest (EIM, 2012). Of all ways of financing, bank loans are the most popular one. Over 75% of the Dutch SMEs find their capital at a bank (EIM, 2012).

Bank finance leaves the entrepreneur with full ownership of the firm, avoiding dilution of entrepreneurial effort and loss of entrepreneurial control (De Bettignies and Brander, 2007). It is considered as the main reason to choose for bank loans as a debt finance. In practice banks often are passive investors and do not provide managerial input to client firms.

Concerning information asymmetry, bank loans are seen as safe since ‘private information’

from an entrepreneurial perspective can be retained (Ueda, 2004). E.g. if a shareholder enters the company, certain trade secrets or information should be disclosed.

A common problem that entrepreneurs face in the beginning is to attract outside capital, given the lack of collateral and sufficient cash flows and the presence of significant information asymmetry with investors (Cosh et al., 2009; Storey, 1994). The contemporary effects of the credit crunch enhances this (Lall, 2012; Delimatsis, 2012; EIM, 2012).

Due to competition, some small business managers do not provide external financiers with the

information demanded, such as trade secrets. Subsequently not only banks but external

financiers in general experience uncertainty, they have not obtained the necessary information

(Nooteboom, 1993). Scholtens (1999) elaborated on the information asymmetry issue

between entrepreneur and financier, the outsiders cannot assess the true value of the firm and

therefore can only assign average quality to this firm, which leads to average terms of

financing. It could induce high-quality firms to forego investments, since they avoid external

financing. Scholtens (1999) concluded that regarding bank loans, SMEs may be in a

disadvantaged position compared to large firms in terms of access to finance, predominantly

translated into higher funding costs.

In short, bank loans are the most common way of financing for entrepreneurs. It is perceived more difficult to obtain capital from banks nowadays, risk assessments play a major role in this. An advantage of a bank loan is that the entrepreneur can keep its shares and control, on the other hand practical managerial help is often lacking compared to equity based financing.

Compared to large firms, SME’s face higher funding costs due to information asymmetry.

Debt based financing: Bank loans

Pros: Cons:

Keeping control and ownership Easy accessible

No disclosure of intellectual property

High interest rates Tough risk assessment No managerial help

Collateral and covenants required

2.1.2 Friends and family loans

Friends and family loans are a form of insider finance, it is defined as funds provided by the start-up team, friends and family (Berger and Udell, 1998). The start-up team considers their funding as an equity investment straight away. Friends and family, however can choose between the two options: equity or debt. Concerning to Ebeling (2012) friends and relatives can make a gift, a loan, a loan convertible to equity or a straight equity investment. The first three options are debt based, the last one is equity based. The initial insider finance is required at the earliest stage of a firm’s development: “the start-up stage”.

According to Minola et al. (2008), most entrepreneurs make use of the ‘pecking order theory’, which states that firms prioritize the source of financing from internal (cash flow or entrepreneur’s own capital) to external, according to relative availability and cost. This is supported by Cosh et al. (2009). Companies prioritize their sources of funding in three ways:

internal funding (entrepreneur’s capital), debt funding and equity funding. In order to grow a

new venture working capital should be available, so internal funding alone is not sufficient.

Chua et al. (2012) underline this by illustrating that direct or indirect family invo lvement improves new venture’s access to debt financing.

The advantage compared to other ways of financing is that most governments have created a tax incentive for these kind of donations or loans. E.g. in the United States: donations up to

$13.000 are free of taxes and the interest rate for lending $10.000 is only 1,07% (Ebeling, 2012). In India loans can be completely tax-free. In the Netherlands such a fiscal incentive regulation is known as the ‘Tante Agaath Regeling’, the minimum loan issuance is €2.2269 and the maximum interest rate is pre-determined by law.

Swedish researchers showed that ethnicity could also be a reason to choose for loans from friends and family (Yazdanfar and Abbasian, 2013). Results suggested that ethnicity is a significant explanatory variable and an important factor in informal capital access in the start- up stage in term of loans from family members and friends. In Sweden it seems to be the case that immigrant families ‘back’ them by lending money.

According to Bortz (2012) the only thorny issue is the relationship between both parties, he underlines that the deal should be done on a professional basis, not on a personal one. To avoid conflicts, a contract can lay out the terms of the loan.

So loans of friends and family are easy to obtain and the existence of tax incentives are apparent. Though the underlying loan contract can pressurize the relationship and insider finance often is complementary to other sources of financing.

Debt based financing: Friends and family loans

Pros: Cons:

Easy accessible Tax incentives

Keeping control and ownership

Pressure on relationship

Small amount of capital

2.1.3 Leasing structures

Leasing is an investment instrument in which the ownership of the good is dissociated from its economic ownership. So the financer remains the owner of a specific asset. Leasing operations can be typed into two groups, mobility leasing (e.g. automobiles, machines and computers) and property leasing (offices and inventory buildings).

Leasing is an alternative to bank loans with growing importance for SMEs in Europe (Neuberger and Räthke-Döppner, 2013). Small and young firms use leasing to increase their debt capacity, although it is illustrated that older and higher qualified entrepreneurs have easier access to leasing than those who are younger or non-educated. In March 2012 33% of the Euro-area SMEs used leasing (Neuberger and Räthke-Döppner, 2013), which shows a significant contribution in debt based financing. The growing use of leasing can be explained by its effects of generating liquidity, firms may improve their credit rating, gaining better access to bank loans. These credit ratings have become more important over the years (Neuberger and Räthke-Döppner, 2013). Ezzell and Vora (2001) found support for their hypotheses that leasing reduces external financing costs and that leasing reduces tax rates.

Besides financial leasing, leasing institutions offer a wide range of services such as administration, machinery managements, debit management or advice. This makes SMEs able to profit from specialization.

The two most important reasons to choose for leasing are: transparency and predictability of

costs. A disadvantage of leasing is the deterioration of the equity ratio, since most assets

remain possessed by the financer. Also the accessibility of leasing for starting and non-

educated entrepreneurs is lower than for older ones. Yet leasing can help to generate liquidity

which improves the access to other capital.

Debt based financing: Leasing structures

Pros: Cons:

Retaining liquidity Low financing costs

No ownership and control Less accessible

2.1.4 Government subsidies

Several countries spend a large amount of money on innovation subsidies for SMEs (Meuleman and De Maeseneire, 2012). The argument to issue subsidies is often fostering innovation, governments issuance alleviates small firms’ tendency to underinvest in innovative activities. The ‘certification effect’ enhances the accessibility towards external capital. It has been demonstrated in the case of venture capital (Lerner, 1999) and short and long term bank loans (Meuleman and De Maeseneire, 2012). So government subsidies for research and development improves the access to external finance.

Funding authorities follow a strategy of ‘picking the winner’ (Cantner and Kösters, 2012), R&D subsidies are given to innovative business ideas, especially academic spin-offs. The team of the start-up and the initial capital available determine the receipt of subsidies.

Rebolledo and Sandonís (2012) found that if subsidies are issued on an international basis, it could even hurt a subsidized firm. This seems to be the case when it is disclosed to the public.

Annual subsidies may not be seen as a constant revenue. This could make SMEs vulnerable, innovative practices are initiated with the help of governmental money instead of own resources.

Governmental subsidies can create a flying start in the beginning of a new venture, the

‘certification effect’ enhances the attraction of other external capital. Yet it is not easy to

become selected, authorities are picky when it comes to issuance. Subsidy recipients are not

favoured compared to competition by definition, it could also lead to vulnerability.

Debt based financing: Government subsidies

Pros: Cons:

Flying start

‘Certification effect’

Tough selection procedure Temporary

2.1.5 Trade credit

Trade credit occurs when there is a delay between the delivery of goods or the provision of services by a supplier and their payment. For the seller this represents an investment in accounts receivable, while for the buyer it is a source of financing that is classed under current liabilities on the balance sheet (García-Teruel and Martínez-Solano, 2010). SME’s trade credit can reduce cash uncertainty. It can also create flexibility to variations in demand. Trade credit can create long term relationships with its suppliers (Ng et al., 1999), after all payments are in interest of both parties.

Financing literature shows that suppliers can help SMEs with lower creditworthiness to obtain funds which could not be reached beforehand (Petersen and Rajan, 2004), then it becomes complementary to other sources of financing. On the other hand, large firms that are more creditworthy and have some buyer market power receive larger early payment discounts (Giannetti et al. 2011) than SMEs do.

Trade credit is favoured by start-ups which have to maintain a large inventory. In a stable environment trade credit can work. In a competitive environment this is less the case, demand can shift and output cannot be predicted.

So by making use of trade credit, cash uncertainty can be reduced and creditworthiness can be

improved. Especially for start-ups that have to maintain a large inventory, trade credit is an

outcome. As long as the environment remains stable, a long term relationship will be build.

Though it is not the way to create an organization with stable liquidity, the dependency on just one or two suppliers is too risky.

Debt based financing: Trade credit

Pros: Cons:

Easy accessible

Good for relationship with supplier Reduces cash uncertainty

Stable environment required Short term minded

Supplier dependency High financing costs

2.1.6 Financial bootstrapping

Bootstrapping techniques jump in the gap of entrepreneurial initiatives that need smaller amounts of capital. In essence the small business manager tries to minimize the outside debt and equity outside the company, the absence of stakeholders gives the entrepreneur more space to develop its company. Financial bootstrapping has some overlap with the ones mentioned above, though it has become a collective term for short term debt financing (Winborg and Landstrom, 2001). Examples of financial bootstrapping are: use of manager’s credit card, withholding manager’s salary, use routines for speeding up invoicing, borrow equipment from others, practice barter deals, leasing equipment, receiving subsidies etc.

These techniques can be described as short-term financing, it refers to procedures that meet

the need of resources without relying on long-term external finance (Winborg and Landstrom,

2001). In the education on small business management and in the minds of small business

managers, there is a strong focus on financial market solutions, and a great deal of attention is

being paid in education and in counselling on how to approach institutional financiers such as

banks and venture capitalists (Winborg and Landstrom, 2001). Whereas bootstrapping

techniques diminish financial constraints and improve short-term profits.

Vanacker et al. (2011) demonstrated that the association between financial bootstrapping and venture growth is either nonexistent or positive. They stated: “More specifically, new ventures that use more owner funds, employ more interim personnel, encourage customers to pay more quickly, and apply for more subsidy programs exhibit higher growth over time”. Apparently it has a positive contribution in the early stage of a new venture.

So financial bootstrapping gives the entrepreneur more space in developing its new venture and can have a positive impact on the early stage growth and profit. Though it is focussed on smaller amounts of capital. Lots of techniques hold the entrepreneur liable for the consequences, which makes it a risky way of financing.

Debt based financing: Financial bootstrapping

Pros: Cons:

Flying start Short term profits

Keeping control and ownership

Small amount of capital

Risky for entrepreneur due to liability

2.1.7 Debt based crowdfunding

“During crowdfunding, the objective is to collect money for investment; this is generally done by using social networks, in particular through the Internet (Twitter, Facebook, LinkedIn and different other specialized blogs). In other words, instead of raising the money from a very small group of sophisticated investors, the idea of crowdfunding is to obtain it from a large audience (“the crowd"), where each individual will provide a very small amount. This can take the form of equity purchase, loan, donation or pre-ordering of the product to be produced” (Lambert et al., 2012). These last three are the case with debt based crowdfunding.

The concept of crowdfunding comes from crowdsourcing, which means that you use the

crowd to obtain ideas, improve services or get feedback (Ordanini et al., 2011). In the case of

crowdfunding the entrepreneur displays its idea online and demands a certain amount of capital. By the content demonstrated the entrepreneur should convince the majority of the crowd in order to be funded successfully. Within a certain time range, this amount of capital should be 100% covered. If the funded capital does not cover the request, it is turned down and the “funders” get their money back.

Normally these online crowdfunding platforms make a selection out of the ideas that are available, they hope to pick the ideas with the highest succession rate. Whether this is true depends on the crowdfunders. Some platforms choose to focus on specific markets. In the Netherlands crowdfunding undergoes a rapid expansion: €0,5 million in 2010, €2,5 million in 2011 and €14 million in 2012 (Douw en Koren, 2013). In 2012 this amount of money is gathered for 570 projects and companies. 95% of the successful Dutch crowdfunding campaigns took place on crowdfunding platforms and 5% on own websites (Douw en Koren, 2013). The most popular funded projects come from 4 categories: international collaboration, creative projects, sustainable projects and companies. Companies were responsible for the largest share of funding. Douw en Koren expect that crowdfunding continues to grow exponentially the coming years, the Netherlands will follow the developments in the UK and the US (Douw en Koren, 2013).

Crowdfunding entrepreneurs try to exploit as many alternative ways of financing as possible by avoiding traditional investment forms, just as bootstrapping and trade credits. On the other hand, entrepreneurs rely on external investment instead of relying on internal resources and active cash management techniques (Schwienbacher and Larralde, 2010).

Normally, specific valuable information is not disclosed towards investors, since competition

could be anywhere. In the case of crowdfunding an entrepreneur can choose what part of its

intellectual property he or she discloses online. The disclosure of the idea or concept is where

the information asymmetry issue between the investor and the entrepreneur arises. Yet this issue is not just something of the recent years (Cosh et al., 2009; Storey, 1994).

The platforms are easily accessible for starting entrepreneurs. Crowdfunding can be a good way to check the feasibility of certain products or services. In comparison to other debt based financing, debt based crowdfunding has the biggest overlap with bank loans. Eventually it could become a solid alternative if banks continue lowering the issuance of start-up capital. A downside is the intellectual property issue, it is difficult to determine when the crowd is willing to fund.

Debt based financing: Debt based crowdfunding

Pros: Cons:

Feasibility of product/service Easy accessible

Keeping control and ownership Flying start

Loss of intellectual property Tough selection procedure

2.2 Equity based financing

Equity based finance implies investors like insider finance, business angels and venture capitalists (Schwienbacher and Larralde, 2010; Berger and Udell, 1998). When an investment based on equity is done, the money goes directly to the company’s capital. In return the investor receives a percentage of shares. Sharing risk and obtaining control are two consequences of such a transaction.

2.2.1 Insider finance: Start-up team, friends and family

As mentioned before starting entrepreneurs have limited access to capital, the only capital

available from the start is their own. Insider finance, however, implies more than just the

entrepreneurs’ capital. Literature on insider finance is available, yet literature on equity based

insider finance is limited. Berger And Udell (1998) defined insider finance as funds provided by the start-up team, family and friends prior to and at the time of the firm’s inception. So three key groups are being distinguished. Initial insider finance is often required at the earliest stage of a firm’s development: “the start-up stage”.

Kotha and George (2012) found that entrepreneurs with specific industry experience and start- up experience are able to provide ownership more selectively and raise more resources from their helpers. Apparently the entrepreneur’s track record of experience in a specific industry or start-up gives confidence to the decision making process of funding.

Starting entrepreneurs possessing a start-up capital are more likely to start a business than other people (Blanchflower and Oswald, 1990), those who were given or inherited £5,000 were approximately twice as likely to set up a business. Apparently the possession of start-up capital that can be used as equity is considered to have a threshold effect. Another research (Basu and Parker, 2001) demonstrated that a mix of selfishness and altruism were key to participation in a family start-up. Conflicting interests may appear after family participation in family businesses, especially in the case of Asian entrepreneurs (Basu and Parker, 2001).

The Canadian financial consultant Brent Finlay quoted in the magazine Profit (2007):

“Bankers demand collateral. Venture capitalists want double-digit growth and rich exits. For many new entrepreneurs, there's no such thing as business credit. If they can't get much or any capital from their own personal financing leverage, they turn to friends and family". When it comes to equity arrangements, he suggests to use common shares to avoid different financial interests. He stated that friends and family should not account for more than 10% for its net worth due to conflicting interests. The creation of a professional contract is indispensable.

As mentioned earlier Minola et al. (2008) and Cosh et al. (2009) demonstrated that most

entrepreneurs make use of the ‘pecking order theory’, firms prioritize the source of financing

from internal to external. A focus on insider finance only is not sufficient, it should be complementary.

All in all, researchers agree on the fact that equity based insider finance is good, but complementary to other ways of funding. Contracts clarifying the risk involved should be demonstrated clearly. The higher the start-up capital of the entrepreneur itself, the more likely he or she will actually start a new venture. Internal funding has the highest priority, then debt funding and equity funding get inning.

Equity based financing: Insider finance

Pros: Cons:

Easy accessible Tax incentives

Small amount of capital Pressure on relationship Loss of control and ownership

2.2.2 Business angels

The term “Angel Investor” generally refers to a high net-worth individual who typically invests in small, private firms on his or her own account (Wong et al., 2009). It is a common method to finance a new venture in its early stage. According to Wong angel finance is an under researched topic. Angel finance is a source of start-up capital that is the informal venture capital. It fills in the gap between insider finance and venture capital. Insider finance mostly does not contribute more than a few thousand Euros and venture capital usually starts over €1 million (Wong et al., 2009). Venture capitalists generally shy away from pure start- ups and therefore wait until a company has completed one or two rounds of angel financing (Gregory et al., 2005).

The amounts invested can differ in different countries. The European Trade Association for

business angels, seed funds and other early stage market players (EBAN), describes seed

funds and early stage venture funds, as those who invest up to €0,5m. Whereas the Business Angel Network in the Netherlands states that it invests from €50.000 up to €0,75m (BAN Nederland). Around Silicon Valley this amount is again higher, an international classification for this type of finance is not present.

An important investment criteria is entrepreneurial passion. Mitteness et al. (2012) investigated whether perceived passion leads to higher evaluation of funding potential.

Surprisingly their results indicated that the relationship is stronger for angel investors who are older, more intuitive, have a high openness personality, or those who are motivated to mentor (Mitteness et al., 2012). Their findings provide evidence that perceived passion does make a difference when angels evaluate the funding potential of new ventures.

Research of Mason and Harrison (2002) indicates that informal investors do not receive sufficient deal flow. Due to a shortage of good business propositions, they are not able to invest as much as they would like to. The researched angels can only place 10% of what they want to invest. Surprisingly a good matching mechanism is lacking in this industry.

Angels take more risks than venture capitalists, they appear to nurture younger firms until the company is established enough for venture consideration. Besides, angels make smaller investments and use syndication when investing in riskier ventures (Wong et al, 2009)

So angel investors are investors that invest on own account and they fill in the gap between

insider finance and venture capital. They are relatively accessible compared to venture

capitalists. Capital is present, but good business propositions are hard to find.

Equity based financing: Business Angels

Pros: Cons:

Enough capital available Easy accessible

Tough selection procedure

Disclosure of intellectual property Lacking matching mechanism Loss of control and ownership

2.2.3 Venture capitalists

Venture capital is defined as outside equity that comes from professionally managed pools of investor money (Dolinger, 2003). As mentioned earlier, the method of financing is an important early-stage decision that affects the company’s future. Some differences between venture capital exist, the main difference is between professional venture capital and informal venture capital (e.g. angel investors). The former is institutional or corporate, the latter is on an individual basis. Another difference is the size of the investment, the capacity of the professional venture capitalists is in general larger than that of informal venture capitalists.

Venture capital is well-known due to its involvement in contemporary technological multinationals such as Microsoft and Intel. Compared to bank loans it is quantitatively less important (De Bettignies and Brander, 2007), in some industries VC’s are more present than in others. Especially in these sectors VC’s are concentrated: software, telecommunication and biotechnology. One discernment of VC’s is the “cherry picking” aspect (De Bettignies and Brander, 2007), there is a strong preference for ventures that can turn out “very well”. In other words, where they can share fully in the upside potential.

Researchers have found that VC’s are an important resource for firms in uncertain

environments (McMullen and Shepherd, 2006). Elaborating research is conducted by

Rosenbusch et al. (2013), they checked the effect of VC on funded firm performance. They

found a small positive relationship, especially firm growth was positively affected. Yet the profitability remained unaffected and the effects were reduced when funded firms were very young or mature. Evidently VC is less appropriate for start-ups in an early stage.

The entrepreneur’s choice between an angel investor or a VC is considered tough (Fairchild, 2011). The venture capitalist has higher value-creating abilities than the angel. However, the entrepreneur anticipates a closer, more empathetic and trusting relationship with the angel (Fairchild, 2011). So in case of low empathy, a VC is more suitable.

In general the entrepreneur benefits from the VC’s managerial input but must surrender partial ownership of the venture. De Bettignies and Brander (2007) pointed out that this dilutes the entrepreneur’s incentive to provide effort. Park and Steensma (2012) found that VC is particularly beneficial for new ventures when they require specialized complementary assets or operate in unstable environments. This underlines the advantage of managerial input. Also the problem of moral hazard exists, a change of behaviour of both parties’ interest.

Professional VC’s have proven to add value successfully, although it depends on the stage of the start-up. The sector and the potential of the venture depends on the success of capitalization. The managerial help can enhance the company’s growth, but a requirement is that the entrepreneur should be open to hand over part of its ownership.

Equity based financing: Venture capitalists

Pros: Cons:

Large size of investment Managerial help

Flying start

High value creation

Tough selection procedure Less accessible

Track record required

Loss of control and ownership Moral hazard

Disclosure of intellectual property

2.2.4 Equity based crowdfunding

The explanation of crowdfunding in a broad sense can be found in paragraph 2.1.7. Equity based crowdfunding differs in purchasing equity of a project or company instead of the issuance of a loan, donation or pre-order. Also here the amount of capital should be 100%

covered, otherwise the request will be turned down and the funders will get their money back.

The biggest success story in the Netherlands is the “Windcentrale” which raised €7 million (Douw en Koren, 2013). That makes them 50% accountable of the national annual crowdfunding turnover in 2012.

A comparison is difficult to make, since quantities differ in a large extent. On average

€12.000 is financed per project, for companies the average is approximately €38.000.

According to literature the quantity bandwidth is comparable to insider finance and angel finance (Ebeling, 2012; Wong et al., 2009; Douw en Koren, 2013). Equity based crowdfunding has overlap with the angel investors syndication (Wong et al, 2009), since more investors are attracted for a relatively risky project. The difference is that crowdfunding is focused on attracting a larger quantity of funders. According to the founder of Symbid, Robin Slakhorst, the contemporary equity gap is between €30.000 and €150.000. This gap in new venture financing is supported by several researchers (Wong et al, 2009; EIM, 2012; Mason and Harrison, 2002; Lambert et al., 2012; Schwienbacher and Larralde, 2010).

Symbid is the biggest Dutch crowdfunding platform that is equity based. Their infrastructure

manages the correct alignment between the entrepreneur and the crowdfunders. They are

responsible for creating a process and environment where the information of the start-ups is

objectively exposed towards potential funders. Symbid enables individuals to become partial

owners of new companies, it enables the collection of equity and takes care of a proper

distribution of shares for investors. Hereafter Symbid loses its legal entity in the relation

between investors and company.

After 100% successful funding, all capital received from investors is transferred into a single cooperation: a single purpose vehicle. A single purpose vehicle is a legal entity, usually a limited company or partnership, that is created to fulfil a specific or temporary objective. In this case it is the entrepreneur’s venture. Symbid asks a 5% succession fee from the entrepreneur. Through the ‘Inner Circle’ the investors are able to communicate with the entrepreneur. Symbid will help in this research by facilitating the contact with crowdfunded companies.

Equity based financing: Equity based crowdfunding

Pros: Cons:

Feasibility of product/service Easy accessible

Flying start

Disclosure of intellectual property Tough selection procedure

Loss of control and ownership

2.3 Conceptual model

In this research the role of crowdfunding in Dutch new venture financing is examined. All alternative ways of financing have been discussed now. Based on its pros and cons, an entrepreneur can choose between different ways of financing, all of them are based on debt financing or equity financing. In total 35 pros and cons are counted, some come back more frequent than others (Appendix A). Similarities between the pros and cons can be spotted, e.g.

one indicator can be put in a positive and negative context for an entrepreneur. Likewise some

pros and cons are overlapping each other. Therefore all pros and cons are brought back to 10

indicators in total (Appendix B). The table in appendix B demonstrates the categorization of

all pros and cons.

The following 10 indicators have been found and are being used for further research:

ownership and control, accessibility, selection procedure, financing costs, amount of capital, disclosure of intellectual property, relationship, feasibility, managerial help and ‘flying start effect’. Entrepreneurial reasoning in choosing a new venture financing method is based on the methods of financing available in the market plus the level of importance of the indicators.

Expected is that these indicators and methods of financing can demonstrate whether

crowdfunding fills in a gap for Dutch new venture financing. The gap in new venture

financing is estimated between €30k and €150k.

3. Methodology

3.1 Research design

The purpose of this research is to explore whether crowdfunding fills in a gap for financing Dutch start-ups. The starting point is that crowdfunding enhances the availability of growth capital in the Dutch market. All methods of new venture financing have been defined, accompanied with all indicators that can influence the entrepreneur’s choice of new venture financing. The indicators are derived from the pros and cons based on the scientific literature.

Some pros and cons are relevant for crowdfunding, others are relevant for other methods of financing. To get a theoretically underpinned answer on the main and sub questions a case study is conducted. This study will illustrate which relationships are important for entrepreneurs or managers in choosing their new venture financing method. In the case study indicators will demonstrate whether crowdfunding really fills in a gap in new venture financing.

Myers (2009) mentioned the advantages of qualitative research. He stated that qualitative data is sensitive to context and by using creativity, imagination and the researcher’s interpretation it is able to develop a theory. According to Eisenhardt (1989) a case study increases the possibility of generating a new strategy. “A case study is a research strategy which focuses on understanding the dynamics present within single settings” (Eisenhardt, 1989). Combining data forces the researcher to re-examine the perceptions.

3.2 Sample

This research focuses on Dutch entrepreneurs that used or are using the crowdfunding

platform Symbid to obtain capital from the market. Only the entrepreneurs or managers which

were active during the crowdfunding process are used as respondents in this research. These

companies may not be older than 5 years. The entrepreneurs and their managers are found

through contact with Symbid. There is no division made in sectors, Symbid facilitates

crowdfunding to all kind of companies. Of each company an entrepreneur or manager will participate, these persons are contacted by phone in order to check whether they are willing to cooperate in this research. Only those entrepreneurs or managers that are willing to cooperate are being contacted to participate in the research. Until April 2013 Symbid has financed 14 companies successfully, 23 companies are still waiting to be financed. Symbid is able to facilitate 37 potential companies in total. Expected is that around five entrepreneurs or managers will participate in this research.

3.3 Data collection

The data is collected through qualitative research. The research is conducted through five in-

depth semi-structured interviews with five different entrepreneurs or managers. An interview

guide is developed for these interviews (Appendix C). Two interview guides are constructed,

one in Dutch and one in English. All companies are based in the Netherlands but can be

founded by foreign entrepreneurs. The first part of the interview consists out of open ended

questions, interviewees can come up with their own answers. If necessary, probing is used to

gain additional information about a certain subject. Interviewees will be asked which forms of

financing they have used and why (questions 1 - 3), how financing is perceived nowadays

(questions 4 - 7), what reasons are important in this decision making process (questions 8 - 9)

and how crowdfunding is experienced (questions 10 - 15). Subsequently interviewees are

being asked which indicators are important to them. Interviewees can indicate their level of

importance in their reasoning of choosing a new venture financing method. The categorization

is based on the 10 developed indicators. Interviewees are being asked to value the importance

of certain statements (statements 16 - 25), consisting of a five-point Likert scale. These

statements cannot be found in literature, but are self-created. The reason to use a five-point

Likert scale is explained by John Dawes’ research (Dawes, 2008), he mentions that a five- or

seven-point Likert scale may produce slightly higher mean scores relative to the highest possible attainable score, compared to those produced from a 10-point scale.

All interviews are taken in a similar way and the interviewees are asked the same questions.

The interviews are being recorded, by taping it becomes possible to listen back the answers.

Anonymity is agreed upon beforehand, this is to receive honest answers and not socially desirable answers and to guarantee confidentiality. Therefore the data is processed anonymously.

3.4 Data analysis

First of all the recorded interviews are transcribed. Notes and recordings taken during the interviews are the two sources of information for the transcriptions. Each interview is transcribed independently. The interviews will be summarized and analyzed, a link is made between the separate interviews and the theory discussed. Part of the analysis is to summarize and structure the content, the main goal is to reduce the amount of material retrieved. Cross case searching is put into practice (Eisenhardt, 1989), all five interviews are compared with each other. For each finding in a case, other cases are searched for similarities or differences.

The goal here is not to rely on first impressions but combining the data to search for new findings. According to Eisenhardt (1989), this will make the findings more accurate and reliable. Answering the main research question and sub questions are prioritized.

3.5 Validity and reliability

Very little literature is available on the topic of crowdfunding, this is why Eisenhardt’s

theory-building research (1989) is appropriate. She mentioned that “times when little is

known about a phenomenon, current perspectives seem inadequate because they have little

empirical substantiation”. She stated that reliability of the research can be guaranteed if

quotes of the interviewees are used to substantiate the findings.

Simon (2011) elaborated that the number of participants in a qualitative study should reach a point of sufficiency in order to improve the validity and reliability of a qualitative study.

According to Simon (2011) this is achieved when a representative number of participants are

typical of demographics such as age, race, gender and experience. In order to secure the

trustworthiness of the research, all respondents of the approachable size should be

experienced in start-up financing and crowdfunding in particular.

4. Results

Of all 37 potential companies, seven entrepreneurs were directly approached whereof five entrepreneurs were willing to participate in the research. Two entrepreneurs rejected to participate in the research due to time shortage or legal matters. All five entrepreneurs are financed through crowdfunding or are waiting to be crowdfunded. The interviews with the five entrepreneurs can be found in Appendix D. The entrepreneurs and their companies were active in different industries: telecommunication, gaming, hospitality, hardware and education. Each of them had positive and negative experiences with equity based crowdfunding. These five entrepreneurs reflect the group of start-ups that have made use of equity based crowdfunding. There are some differences between the moments of investment between the companies. All companies were founded in the last three years, except for company A. Yet the entrepreneur has become active in marketing its product the last two years, so all companies could be considered true start-ups.

In the following paragraphs all subquestions will be answered separately. In the discussion and conclusion section the research question will be answered.

4.1 Forms of financing

Subquestion 1: What alternative ways of financing are used nowadays?

Eleven forms of financing have been defined according to the literature. The ones the

entrepreneurs have actually thought of are demonstrated in table 1. These forms are

considered as potential forms of financing according to the entrepreneur. Remarkably enough

none of the entrepreneurs thought of leasing (0) or trade credit (0) as a form of financing. The

ones that were popular among start-up companies were bank loans (5), friends and family

loans (5), debt based crowdfunding (5), insider finance (5), business angels (5) and equity

based crowdfunding (5). These ways were mentioned by each entrepreneur. Then a few forms

of financing were considered by a part of the group: government subsidies (2), financial

bootstrapping (3) and venture capital (1). These numbers imply the ways that are considered by the entrepreneurs, not the ones that are actually used.

Possible forms of financing

A B C D E Total

Bank loans x x x x x 5

Friends and family loans x x x x x 5

Leasing structures 0

Government subsidies x x 2

Trade credit 0

Financial bootstrapping x x x 3

Debt based crowdfunding x x x x x 5

Insider finance x x x x x 5

Business Angel x x x x x 5

Venture capital x 1

Equity based crowdfunding x x x x x 5

Table 1 Overview of possible forms of financing

The forms of financing that were actually used are demonstrated in table 2. The interviewees described that a lot of forms were potential, but not all were put into practice. Surprisingly 6 out of 11 forms of financing were not used at all, bank loans (0), leasing structures (0), trade credit (0), financial bootstrapping (0), debt based crowdfunding (0) and venture capital (0).

Insider finance (5) and equity based crowdfunding (5) were used by each entrepreneur.

Friends and family loans (3), government subsides (1) and business angels (2) could be

considered moderately popular.

Forms of financing actually used

A B C D E Total

Bank loans 0

Friends and family loans x x x 3

Leasing structures 0

Government subsidies x 1

Trade credit 0

Financial bootstrapping 0

Debt based crowdfunding 0

Insider finance x x x x x 5

Business Angel x x 2

Venture capital 0

Equity based crowdfunding x x x x x 5

Table 2 Overview of forms of financing actually used

The eleven possible forms demonstrated represent the majority of new venture financing, yet one form was missing according to Entrepreneur A: “Accelerator programs have gained ground lately, it fills in a gap in the contemporary world of new venture financing”.

Accelerator programs are organizations founded by informal investors with an entrepreneurial background. These organizations obtain a small percentage of a start-up’s equity in the beginning. In return the start-up receives accompaniment of professional mentors and housing for approximately 6 months. The goal is to professionalize the start-up. In elaborative research accelerator programs should be included as well.

So all forms of financing demonstrated mirror the contemporary ways of start-up financing.

Though accelerator programs should be added, whereas leasing structures and trade credits can be excluded.

Subquestion 2: Which pros and cons exist for alternative ways of financing?

All pros and cons have been defined in literature. To check whether the theory is in line with the conducted interviews, all pros and cons are checked for differences and similarities. The findings according to the interviewees are demonstrated below.

Debt based financing

Every entrepreneur considered a bank loan as a potential way of financing.

Nevertheless most entrepreneurs did not try to contact a bank and those that tried were turned down. It confirms the assumption that a new venture financing gap is existent. Entrepreneur B argued that “it is all due to the aftermath of the credit crunch and this will take a few years”, while entrepreneur D stated that “the selection procedure is very difficult and the interest rate is ridiculously high, at least 10% is the current standard for start-ups”. Entrepreneur E looked at it from another angel: “apart from the fact that it is difficult to be picked, it is always cheaper than giving away equity in the beginning. Moreover, the decision making process could be faster than crowdfunding”. Entrepreneur E added two positive aspects, namely the speed in decision making and the financing costs. All entrepreneurs agreed on the fact that it has become impossible for start-ups to be qualified for a bank loan nowadays. High interest rates, tough risk assessment and requirements of collateral and covenants were mentioned as disadvantages. The maintenance of control and ownership and the accessibility of the bank were mentioned as advantages. The pro that was missing was the none disclosure of intellectual property. The missing con was the absence of managerial help.

Friends and family loans were mentioned by each entrepreneur as a potential form of funding, in reality 3 entrepreneurs made use of it. Two of them found funding through family and one found funding through a friend. Entrepreneur D stated that “it is a relatively easy way of getting money, although in risky ventures it could become a private matter”. Entrepreneur E elaborated on that: “compared to other forms there is no time lost, that is a big advantage.

Still there is always the downside of an emotional bond. Your uncle or aunt could, for

instance, ask how business is going during family reunions”. So the availability and speed of capital from friends and family are considered as pros and the relationships with the issuer as a con. The small amount of capital was not seen as a disadvantage, besides the tax incentives and maintenance of control and ownership were not considered as advantages.

Leasing structures were not mentioned by any of the entrepreneurs, apparently the entrepreneurs do not consider leasing an appropriate form of financing. Theory stated that leasing could be seen as a serious alternative to bank loans. It could be that entrepreneurs did not consider leasing as a separate standing form of financing, since start-ups can only make use of leasing on a small scale due to its poor accessibility. Since all pros and cons of leasing structures were not mentioned, elaborative research is needed to investigate this type of financing.

Government subsidies were mentioned by entrepreneur A and E, though only entrepreneur A received an actual subsidy. He stated the following: “I made use of the Dutch subsidy program ‘innovatievoucher’, it was suitable for me since I had to create a prototype, this lowered the barrier of issuance”. Entrepreneur E mentioned that “the subsidies in the Netherlands are well structured, entrepreneurs know the tough selection criteria beforehand. I cannot imagine any disadvantage. Nevertheless I know companies that have created an unhealthy business model surrounding governmental subsidies, these are ‘subsidy junkies’ in my opinion”. So the entrepreneurs agree on the downsides of subsidies, namely the tough selection procedure and the temporal effect. The pros like the certification and flying start effect are, however, lacking.

Trade credit was not mentioned by one of the entrepreneurs. The entrepreneurs did not

consider trade credit as a form of new venture financing. There is a possibility that

entrepreneurs do not think of this form since trade credit is normally issued by suppliers based

on a long term relationship. Start-ups normally miss such a track record to build on such a

relationship. All pros and cons of trade credit were not mentioned, so elaborative research is needed to investigate whether and why trade credit is among the potential forms of new venture financing.

Financial bootstrapping was mentioned by entrepreneurs C, D and E, while none of them actually bootstrapped his business. Only entrepreneur C elaborated on this way of financing by stating that “it is a good way to stimulate revenue early in the beginning”.

Entrepreneurs D and E mentioned the form but did not consider it seriously. The reason that financial bootstrapping is underrepresented could be because the amount of capital is relatively low and it is a collective term of several short term techniques. Only short term profits are called as a pro of financial bootstrapping. Whether the small amount of capital and the high amount of risk is a con and whether a flying start and maintenance of control and ownership are a pro should be tested in further research.

Debt based crowdfunding was mentioned by each entrepreneur, though not put into practice by one of them. Since all entrepreneurs were facilitated by Symbid, an equity based crowdfunding platform, the outcome was already obvious beforehand. Interestingly they made a trade-off between debt based crowdfunding and equity based crowdfunding. It very much depended on the sector the entrepreneurs were active in, a product based sector automatically made debt based crowdfunding more interesting. In a product based sector the crowdfunder can receive the product. Entrepreneur A is active in the hardware industry and made a prototype, he mentioned that “the next time I will make use of crowdfunding, this will be debt based. This will probably not be in the Netherlands, but on an international platform like ‘Kickstarter’ to enhance the international interest”. Entrepreneur B is also product based and had the same opinion, he did not want to give away shares in a second round.

Entrepreneurs D and E agreed on the fact that the decision between debt based or equity based

crowdfunding is industry dependent. Entrepreneur E, for instance, offers a service, which

makes it less interesting to make use of debt based crowdfunding. So according to the entrepreneurs debt based crowdfunding is a potential way, since the maintenance of control and ownership is assured and the product/service is checked by the crowd. Also the flying start effect is cited. A con like the loss of intellectual property was perceived by two entrepreneurs, the others were not afraid of competition. The existence of a tough selection procedure was not mentioned. Also easy accessibility was not described, elaborative research on debt based crowdfunding is needed to check this.

Equity based financing

Insider finance was considered and used by each entrepreneur. Insider finance can consist out of equity from the entrepreneurs, friends or family members. Surprisingly all entrepreneurs only used their own equity, in most of the cases to maintain their control and ownership. Entrepreneur D stated that “insider finance is complementary to other forms of financing. An entrepreneur should be able to fill in a gap until €30k himself, otherwise there is a chance that you are not taken seriously while knocking at the door of other funders”.

Entrepreneur E agreed on the fact that “funding between €10k and €30k is easy, although the emotional bonding with a family member is a drawback here as well.”. So the entrepreneurs agreed that insider finance is easy accessible and that it is better to avoid the loss of control and ownership to friends or family due to relational matters. Tax incentives and the small amount of capital were not mentioned as a pro or con respectively.

All entrepreneurs have considered to attract business angels, but only entrepreneur C and E succeeded. In all interviews business angels were mentioned as the most appropriate way of financing during the start-up stage. Yet opinions differed, entrepreneur A argued that

“angels demand standards that are too high and the loss of share is a downside. In my case I

was too early since I could not demonstrate my prototype yet”. Entrepreneur B saw a market

movement in the capital market: “more private capital is available to invest, because the