Only within the last couple of years has a new investment landscape materialised across Europe. More and more EU countries have begun turning to online capital raising activities and, specifically, equity crowdfunding. EU member states have historically significantly lagged between North America and the UK in their equity crowdfunding activity, with the UK alone accounting for almost 60% of all alternative finance transactions in Europe. So, why has the European investment landscape changed?
In this article, we’ll take a deeper look at the possible explanations for this changing European landscape and touch upon some of our predictions for the future. Like most explanations, there’s no single underlying cause as to why equity crowdfunding is now taking off in Europe, but rather a constellation of factors from regulatory changes to the effects of COVID-19 on the behaviour of investors and SMEs.
A constellation of factors
The first, and one of the most significant factors contributing to the change in Europe's equity crowdfunding behaviour, is the recent regulatory change introduced by the EU (ECSP, 2020/1503/EU). Under this legislation, all crowdfunding platforms in all EU member states must adhere to the new requirements and take the ESCP licence.
Crowdfunding platforms must act transparently and in the best possible interests of the investors. They must present rich information on specific and well-known business procedures such as complaint handling, due diligence and risk assessment to help ensure that new investors have the information to make sufficiently informed decisions.
Furthermore, SMEs wishing to raise capital on such platforms must provide investors with a Key Investment Information Sheet (KIIS) containing important numerics and facts regarding their business. Implementing the KIIS gives investors a transparent and concise overview of funds in a standardised format, minimising unintended risk.
Finally, all non-sophisticated investors must take a knowledge test once every couple of years to monitor their understanding of crowdfunding and the risks associated with such investments. Sophisticated investors do not have to undergo this process.
The overarching aim of this new legislation is to create a harmonised crowdfunding landscape across EU member states. Previously, only a few member states of the EU had regulations around alternative finance (e.g. UK, Finland, France), while the legislation in other states was either non-existent or incomplete, generating a general feeling of uncertainty around cross-border transactions. Under a single EU scheme, diverging rules across platforms and EU countries are no more, making equity crowdfunding easier than ever before.
Another factor contributing to the recent traction in European equity crowdfunding is the rapidly growing technology adoption in Europe. Since 2019, Europe registered a net gain of 100+ million digital users, with countries such as Finland, Sweden and the UK showing the highest adoption rates.
We could be quick to say that the high adoption rates caused the sudden boom in equity crowdfunding in Europe, but we must remember that correlation is not causation. Just because the digitalisation trend coincided with Europe’s changing attitudes to online capital-raising activities doesn’t imply that one caused the other. On the contrary, France, one of the most prominent players in the European alternative finance market, saw the most significant decrease in adoption.
Nonetheless, according to the EIB Investment Survey (EIBIS) conducted in 2021, 46% of firms in the EU confirmed that they’d invested in their digital transformation. A further 53% of European firms that had already undergone digitalisation invested further during the pandemic. This demonstrates the growing digitalisation in Europe.
So, why is this important? The first interpretation is that with the increased adoption of digital technologies, investors are more comfortable with technology and, therefore, less averse to investing digitally. The second is that the adoption of digital technologies has probably led to more digital innovation leading to more technology-based companies needing financing and turning to equity crowdfunding as their alternative finance option of choice. Either way, there’s undeniably a link between the recent increase in digital investment in Europe and equity crowdfunding’s recent increase in traction.
A limitation of other options
SMEs represent most non-financial businesses in Europe. Despite making up such a majority, SMEs face a financing gap – a significant disparity between the financial needs of the SMEs and the availability of external funding. The financing gap makes it hard for SMEs to acquire the external financing they need, with significantly more SMEs than large companies perceiving access to finance as their main problem.
In terms of external financing, SMEs must choose between 3 options:
- Non-bank financing
The first option for SMEs is to ask the bank for a loan to maintain cash flow. In this scenario, the bank gives capital to the SME in the form of a loan who then pays the creditor, i.e. the bank, a specific amount of interest at fixed intervals. At the end of the predefined period, the SME will have repaid interest on top of the principal amount they borrowed.
When turning to bank financing as a means of raising capital, SMEs face some challenges that are hard to overcome. They lack the assets necessary to act as security, the long-standing relationships with banks, and the audited financial statements needed to inform the bank of their financial health. All of the above result in a lack of funding for SMEs, with SMEs in Europe lacking an estimated €400bn of bank financing, illustrating the difficulty in acquiring external funding.
The second option is to look for financing from non-bank institutions. Similarly, the creditor loans money and the SME must pay back this amount on top of interest. Whilst it’s easier for SMEs to source this type of financing as they’re less stringent on their lending terms, it comes with greater risk and higher interest rates, making it harder for them to repay.
All of the problems with the above leave SMEs with option 3: crowdfunding.
Importantly, crowdfunding relies not only on SMEs but also on investors. Typically European investors keep large sums of money in the bank, but this isn’t the best option in the current climate. With inflation increasing each month, from 7.4% in April to 8.1% in May and 8.6% in June, money sitting around in savings accounts is losing value.
The current situation will likely make Europeans more open to alternative investments, one of which is equity crowdfunding. In an attempt to hedge against inflation, they’re likely to seek opportunities that won’t decrease the value of their money.
The final and briefly touched upon factor is COVID-19. On the SME side, these small businesses found it hard to find investment due to the disruption of typical financing options. The scarcity of traditional financing encouraged them to seek alternative financing options, including equity crowdfunding. The agility and flexibility of crowdfunding, which once induced fear, were happily welcomed by SMEs.
On the investor side, the traditional method of investing in public companies in person was no more. Instead, they could only invest money into private companies online, something they’d previously been sceptical about. During this time, investors became more comfortable with online transactions and, therefore, crowdfunding, increasing traction.
The future of equity crowdfunding
Equity crowdfunding is rapidly gaining traction in Europe and is likely to grow exponentially. With a more digitalised world, a more harmonised regulatory landscape, and a more open mindset from investors and SMEs, this could be the beginning of a new generation of alternative financing. I believe that equity crowdfunding is here for the long haul.
In the next few years, I expect EU countries to dominate more of the alternative-finance market, with the UK holding less market share in regards to raises but remaining dominant in the platform space, with Crowdcube and Seedrs remaining the go-to for raises. This is not to say that the UK will not still have their position as the key player in the European market, but that the increased ease of cross-border transactions and the changing attitudes towards online capital raising activities will spur the growth of other countries.
If you want to learn more about equity crowdfunding and how to partner with us for your next raise, get in touch.