For Investors, Is Alternative Finance Collaborative or Disruptive ?

Rather than trying to supplant banking and venture capital, a collaborative model is emerging where digital platforms work side by side with traditional investors

Today we take a a look at the investor side of the alternative finance market, which is comprised of both retail and institutional investors. We foresee that equity crowdfunding, like debt-based P2P lending, will continue to evolve and attract ever more institutional investors going forward, boosting deal volumes and injecting more professionalism in the market.

The slashing of interest rates globally in the wake of the 2008 financial crisis pushed retail investors to look to non-traditional investments to boost returns. This major development boosted the popularity of the alternative finance market as an asset class. Since then, the increased access afforded by the online investment model has meant that the industry has secured its position alongside more traditional asset classes, drawing the interest of institutional investors.

As it stands, the investor side of the alternative finance market, incorporating both debt and equity, is made up of both retail and institutional investors. As the alternative finance market moves upstream, drawing larger more established SME issuers, institutions are becoming more involved. These institutions are investing in the space both through platforms and in the platforms themselves.

Retail

Retail investment into the P2P market has been primarily driven by the low interest rates available globally on bank deposits. When factoring in inflation rates, the picture for savers becomes even worse. In the UK for example, with interest rates at 0.5% after the financial crisis and inflation at around 2% up until recently, in real terms, capital deposited in banks was decreasing in value. Compared to the rates on offer from various different P2P platforms during the same period, it is easy to see why alternative lending has become so popular for consumers.

Other key drivers for P2P lending include: the diversification benefits brought about by incorporating new asset classes into a portfolio; consumers general dislike of banks as a result of their perceived role in the global recession; and the ability for investors to choose exactly where their capital goes.

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Crowdfunding Industry Overtakes Venture Capital and Angel Investing

By 2016 the crowdfunding industry is on track to account for more funding than venture capital, according to research firm Massolution’s annual report. With an estimated market value of $34 billion in 2015, crowdfunding has come a long way since its valuation of $880 million in 2010.

In comparison, the VC industry invests an average of $30 billion each year. Meanwhile the crowdfunding industry is doubling or more, every year, and is spread across several types of funding models including rewards, donation, equity, and debt/lending. In particular, equity crowdfunding – now being legalised in the US – holds huge disruptive potential.

Crowdfunding industry growth figures, as reported by Massolution

The crowdfunding market grew by 167% in 2014, continuing the exponential growth of previous years. Two months ago the thriving British FinTech (financial technology) sector witnessed its first billion-dollar business. The company? Funding Circle, a five year-old crowdfunding platform. Their $150 million funding round was over-subscribed.

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AIG Introduces Equity Crowdfunding Insurance For Investors

Global insurance provider, American International Group, Inc. (NYSE: AIG), has announced the launch of a new insurance vehicle, Crowdfunding Fidelity, which was developed specifically to protect investors on equity crowdfunding platforms against issuer fraud. The launch of AIG’s new insurance comes just a little over a week after Title III / Reg CF rules of the JOBS Act went into effect enabling issuing companies to raise up to $1 million online. These rules allow anyone to invest in early stage companies via a registered crowdfunding portal or broker dealer.

According to AIG, Crowdfunding Fidelity protects investors against the theft of issuer assets by issuer directors, officers, or general employees which cause a direct loss to the individual investor. The coverage is currently available to platforms in the UK and Canada. As other countries finalize regulations for companies to raise capital, this policy can be customized to local needs of equity-based crowdfunding platforms.

Alexander R. Baugh, head of global casualty business at American International Group, Inc., stated:

“Crowdfunding Fidelity is a great example of how AIG learns together with the industries and clients it serves to better meet their strategic needs. We are looking forward to building similar relationships with other platforms across the world and to expanding our offering to this sector.”

The company also revealed that Eureeca, an equity crowdfunding platform registered in the UK and based in Dubai, is the first platform to purchase the coverage and make this protection against issuer fraud available to investors.

Chris Thomas, Co-Chief Executive Officer and Founder of Eureeca added,

“The new power of the crowd and the desire to democratize investing throughout the world can unleash great partnerships. The success of the ecosystem depends on collaboration between all stakeholders. AIG has demonstrated its commitment to being a valued insurer to this new industry by engaging the crowdfunding space at such an early stage.”

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The next step for crowdfunding: “crowd-directing”?

Investors today have access to a wider variety of investments than at any other time in history; the rise of the alternative finance industry has democratised investment, and unquoted equity is no longer just the preserve of finance professionals and industry insiders.

We now have unprecedented access to investments, and crowdfunding platforms give us the ability to evaluate, question and guide the offers and the entrepreneurs. This open forum is forging an era of investor education and knowledge-sharing which some people believe is contributing to the success of the enterprise.

According to the Altfi 2015 report Where are they now? over 80% of the companies that crowdfunded between 2011 and 2013 are still trading. Of these, many have raised further capital at higher valuations – and one has even realised a return for investors. This compares favourably alongside an October 2014 report by the insurer RSA that found that 55% of UK small and medium-sized enterprises did not survive five years.

Is the survival rate better for crowdfunded companies because the crowd contributes to its success and collaborative decision-making is better at picking a winner? Or is it too soon to judge?

In his 2004 book, The Wisdom of Crowds, James Surowiecki suggests that a large group of reasonably informed and motivated people is able to make better decisions than a small group of experts.

The book suggests that the view of a crowd is more accurate than all but a handful of individuals and that no individual is able consistently to make decisions superior to those of the crowd.

Surowiecki’s work was published long before crowdfunding was conceived, and its findings changed the business’ understanding of leadership and management. However, as the premise emerges that crowdfunded companies are more successful than non-crowdfunded companies should we should we revisit Surowiecki’s findings and examine again why diversity works?

If we agree that the crowd is more capable of selecting successful businesses than business angels, venture capital partners (VCs) and traditional financiers, are entrepreneurs missing a trick if they then forget about the crowd after funding?

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PayPal drops purchase protection for crowdfunding

PayPal has announced plans to eliminate its Purchase Protection coverage for customers who give money to crowdfunding projects. The new policy takes effect on June 25th, 2016, and says “payments on crowdfunding platforms” are ineligible for protection. The broad move could be a response to the well-documented frequency of fraud and failure on crowdfunding platforms — one Kickstarter study found that 9 percent of all its projects failed to deliver rewards.

PayPal may also just be hoping to clear up some of the confusion that has surrounded its support for crowdfunding platforms so far; both creators and buyers have reported stumbling over PayPal’s terms. PayPal technically treats crowdfunding and “preselling” differently, even though crowdfunding projects often essentially function as preorders. As Glenn Fleishman reported on Medium, one of Kickstarter’s largest failures led to a messy refund situation where some customers who preordered the Zano drone outside of Kickstarter received their units first, and were able to receive refunds, while people who tried to receive chargebacks through Kickstarter were rejected.

The new policy means that people who use PayPal to support crowdfunding projects won’t be able to recoup their money by disputing the charge — meaning PayPal won’t provide relief if a project fails to deliver, delivers a broken product, or is completely fraudulent. The change mostly impacts Indiegogo; Kickstarter payments were already not protected by PayPal. (Kickstarter itself also does not take any responsibility for fulfilling rewards, and does not permit people who funded successful projects to request chargebacks.) We’ve asked PayPal to explain the reason for the change, but it’s likely the company just doesn’t want to assume the risk from crowdfunding’s ongoing trust problem.

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