Our last post highlighted the growing buzz around “alternative marketplaces” as a way to break out of the VC funding scene, democratize investment and access to capital and open a doorway to structuring debt instruments that let people demand more than financial impact. Increasingly, and across multiple generations (led by the young, like Greta Thunberg), people want to invest in ways that protect the environment and promote social outcomes that are equitable and uplifting.
At the same time, regulators are under intense pressure to ensure financial system stability by eliminating the types of “risky” finance needed by entrepreneurs. In the context of prudential regulation, even the trendy and important revenue-based aka cash flow-based financing instruments that have gained prominence recently are deemed risky. Cash flows can change. Hard assets of the kind favored as collateral in traditional lending can be sold. Unmaterialized revenues can not.
Todays’ alternative marketplaces are a confluence of two investment trends dating back more than a decade. The first was the launch of peer-to-peer (P2P) lending, described as crowdlending to indicate that this was something for regular people who lack the access of institutional investors to upside like wealth building IPOs. P2P quickly expanded to include funding not only for individuals, but for small businesses as well, drawing resources from institutional investors as well as from retail investors. Crowdfunding revenues are running around $17.2 billion per year in the US. The Asian crowdfunding markets see annual revenues of more than $10 billion, while Europe generates around $6.8 billion per year. The sad story and great opportunity lies in emerging markets. Crowdfunding revenues in Africa were only around $28 million in 2019 and in Latin America reached only $88 million.
The second influence emerges from the newly launched field of impact investing trying to build platforms that could connect small and growing businesses typically in emerging markets to investors in the US looking to incentivize social and/or environmental returns as well as the more traditional financial variety. These early pioneers, such as Mission Markets (global) and Microplace (US), faced numerous risk management, regulatory and compliance challenges that made developing a new impact investor base doubly hard. None of these early impact platforms lives on, but development of an investor class interested in more than just money has taken off.
Crowdfunding consists of 4 basic models and a range of variations. The core models are donation, reward, crowdlending and crowdequity. There are literally hundreds of platforms to choose from, but here are a few examples. Donation-focused models (Go Fund Me, Global Giving) capture less than 1% market share, but play an important role for charitable & social causes. Reward-based models arose to support entrepreneurs, innovation and creatives through platforms like Kickstarter and Indiegogo. Reward-based crowdfunding captures roughly 1% of total funding and fills a need for very early seed capital. Regulation equity crowdfunding got a blast of energy from an amendment to US regulations in March 2021 that increased maximum equity raise from $1 million to $5 million, a gamechanger for small, growing businesses. Equity crowdfunding accounts for about 4.8% market share. Two key players in this space are Investors Circle and WeFunder. The bulk of activity continues to center around crowdlending, which holds a 93.4% market share within the US crowdfunding industry. Crowdlending includes consumer-oriented P2P markets like Lending Club and Prosper, as well as SME focused markets like OnDeck.
The latest evolution in platform-based finance includes environmental marketplaces like Raise Green and social impact marketplaces like SVX in Canada and IIX in Singapore. While these marketplaces demonstrate the greatest commitment to both achieving and measuring relevant social and environmental impacts, they suffer from limited market-ready deal flow and weak investor interest, both of which reflect the traditional challenges of impact finance in emerging markets.
Alternative marketplaces enjoy some significant benefits over VCs and often over banks as well:
- Time to market – closing date is known and campaigns are comparatively fast (2-3 months)
- Cost effective – the rise of fintech has enabled platforms to outsource many of the risk & compliance tasks that tripped up earlier entrants that needed to develop expensive in-house capacity; on some platforms like IIX, there is no cost for a company to list on the exchange.
- Broader investor pool – accredited and sometimes retail investors have unrestricted access to alternative marketplaces and deals, which is not the case for VC or PE
- Greater transparency – investors and regulators have equal access to information, with disclosure requirements and investor access made clear in advance of and during investment periods.
The ability to react quickly to market needs and trends is another advantage. KingsCrowd, a regulation crowdfunding site that provides market analytics, noted that during the first five months of 2021, one-third of alternative marketplace finance went to “minority” founders, compared to the 2-4% of VC that reached this same group. KingsCrowd defined minority as black, indigenous, immigrant and LGBTQ.
As an industry, VC will not be overthrown by alternative marketplaces. With large pools of institutional money seeking opportunity, continued positive growth will likely overshadow any slowdown in the growth rate due to the rise of platform funding. VC will face some competition, however. Fundera predicts the crowdfunding market will reach $300 billion by 2020, forecasting a 16% CAGR through 2025. Overall, we can expect to see a notable shift, particularly across social venture, social enterprise and impact investing networks, to sourcing capital through alternative marketplaces using instruments that clearly define financial and extra-financial (impact) returns expectations and offer a fair deal to both founders and investors. I like the sound of that.
The Money in the Middle 