 This podcast is brought to you by LMU Munich. Thank you very much to the organizers for inviting me here. I'm delighted to be here. I'm going to talk in English if it's okay. That's what was agreed before. And I also want to congratulate the organizer for well-timing the conference. They probably had the good four sites that Germans would play later today against the French. And in that sense, we can see that academics sometimes have good four sites on some of the important events in life. I was asked to talk about after-crowd investing or life after-crowd investing, and particularly what happens when after the campaign is over, potential issues that can arise. I'm not going to talk that much about regulation, only a bit on the end. Lars has talked a lot about this, especially the reforms already, so I'm only going to touch upon a few aspects. What I'm going to do is more discuss a few items in particular in terms of second rounds, exit strategy, and in particular the anti-delusion provisions, so the delusion provisions that do exist, and the potential impact it may have. Lars mentioned briefly why crowd investing is particularly interesting, or important to look at from a regular perspective, and that is a very distinct type of crowdfunding than other forms. This slide is actually supposed to say similar things that he already said in English. The interesting thing is that a few years ago when crowdfunding, crowdinvesting started, there were very few platforms present, and most of the time people opened just a platform and did it on their own. There was a lot of variation across the different campaigns. Platforms have standardized this, and I think that has also contributed to the professionalization. Still there are a number of differences, so I'm showing here the different forms of crowdfunding, donation, reward-based, so reward-based would be Kickstarter, profit-sharing-based, which would be like Sandau, you may know, so this is a Belgian platform on comic books, Belgians like comic books, so there you can sponsor a specific comic book, and if it gets commercialized then you participate in the profits with the author at a certain fixed percentage up to four or five years, so it's a bit different type of crowdfunding than what we're looking at today. Then you have the lending ones and then the securities ones, and there are at least three different reasons why crowdinvesting, so the securities-based crowdfunding is important to look at. First is because the risk involved is much greater, so these are investments in startups, innovative, and with promises on future cash flows. This is very different from donation-based where you don't expect anything, or reward-based where the worst that could happen is that you don't get the product back, or that with a lower quality or delayed. The amounts involved are much larger also. On Kickstarter, Indiegogo, the average amount is something like between $10,000 and $15,000. Here it's well above $100,000, the average that you see in Germany, but also in France and elsewhere, so the amounts that are involved are much larger, also the tickets are much larger, and the other part is the complexity of contracts. The contracts are much more sophisticated, more detailed in securities-based crowdfunding than the other forms. Not sure I need to spend a lot of time on this slide, but it's a slide that Lars and I have done for a working paper, so essentially the portals are there to intermediate. You have on the left-hand side, which is also on your side. On the right-hand side is the issuer, the company that either has a prospectus or not. On the right-hand side you have the investors, which are the crowd, and you have the crowd-investing portal at intermediates. Most of the money transfer is handled outside due to avoid specific regulations, and the portal proposes a template for the contract, which is then finalized with the issuer. This offer is a take-it-or-leave-it offer, so the crowd can take it or leave it, but there is no negotiation as you have in venture capitalists and business angels. The business model of the platforms is that most of the revenue they generate is a success fees. We already have a couple of success stories. One that I like to tell since I work in France is Atabio. Atabio did a 300,000 euro campaign in 2010. This is a biotech company that works for drugs that treats specific bacteria, and the exit took place about two years later, and there was a return of 44% over the two years. The exit took place through the buyout by angels. Then you also have a couple of them that have already a second and third financing round. On seed match, a nice example is Front Row Society that just closed, I think, the last third round. You have some of them that also get even larger and larger numbers, with Protonet who recently raised 3 million euros. This is exceptional. Even in France, there are no cases above 1 million euro yet, but in Germany the numbers are quite impressive. Another nice example, which is not crowd investing but crowd funding through the Kickstarter that we discussed this morning at the other conference, is Oculus Rift. Oculus Rift raised 2.5 million dollars on Kickstarter to sell its first product, and it was eventually bought 1.5 years later by Facebook for 2 billion dollars. These are nice success stories and showing that there is potential, but of course there are also failures that we already have seen, a few in Germany, a few in France that shows that of course these are risky investments. The current default rates are certainly not representative of the market because the market still needs to mature and we'll see in a few years what is the true default rate in that market. Before talking about anti-delusion protection and stage financing, let me perhaps just here very quickly mention that crowd investing is in many respects not so different from venture capital and business angel deals, and that should also highlight how risky they are, and I truly hope that the crowd understands the risk that it involves, but it also shows that many of the difficulties about anti-delusion, stage financing are exactly the same as venture capitalists, so the problems that some of the companies today face are not specific to crowd investing, they are just for the type of companies that are being financed, just that VCs and business angels tend to be knowledgeable and experienced in dealing with these problems. So first of all these are risky investments in innovative, often high-growth firms. Some fail, many fails perhaps, we don't know, only a few really succeed and we hope that they make up for the losses and that these big successes which are a few of them make a big multiple to cover the rest. So it's a bit like superstars economic where you try to, not like lottery games, but you try to pick up some successes or some very promising one, but you know that there will be many of them who fail. Most of the gain accrue at the end, so essentially after a few years at the exit, that's very important because it means that the distribution of the return comes much later and therefore the current revenues these companies have at the time of investment is just not representative. These investments are liquid, so investors need to be very impatient and also the exit stage will become very crucial and this is certainly something that will come up the next one or two years in some of these companies. Also they require special care when drafting contracts since these are young innovative start-up with a lot of uncertainty and venture capital business angel have developed contracts that allow to solve or to mitigate much of the agency problems and information assembly problems. Funding occurs in rounds, very important. Funding by stages has a number of advantages. I'll come back to this in a few minutes, but the main reason is also that it allows to minimize risk. So you start with a small amount. You see what the entrepreneur can produce and if it goes well, you finance the next round. This limits very much the risk. There are also, of course, differences. One of the main differences is the types of securities. Venture capital, so far I know, don't buy Partial, or other types of participating notes. They buy convertible preferred shares or if they buy common shares, they bundle it with some other types of securities like warrants that allow them to get a lot of voting rights and participate in the upside but also get some protection on the downside. Essentially with preferred shares, you get to have a higher priority over the entrepreneur and if things go well, you get the upside. A few platforms offer this kind of security, which is actually convertible bonds, which I think are very promising because they solve a number of problems that we have in other securities, such as potentially those used in Germany. Also, the difference are the extent of the diligence, negotiation, and the provision of expertise beyond the investment. So this leads to one of the first main topics I would like to discuss, which are anti-delusion provisions, which has been quite contentious and a hot debate in the crowd investing arena to see to which extent the crowd should get these kind of provisions. So what is the main concern? Well, the main concern is, as I write, what happens if the firm, so the entrepreneurial firm needs to raise extra capital in the future but the firm is worth less than it is... In the future, it was less than it is worth today. So essentially, they're selling securities in the future that are at lower price than today. So the valuation did not go up in contrast to expectation but the company's worth much less than today. So this means that the investors in the first round will have paid much more for the shares than the new shareholders in the second round that come in. This, of course, makes investors in the first round very unhappy, not just because they lost money but they got highly diluted. There's, by the way, a different distinction, of course, between economic delusion and percentage delusion. So percentage delusion will always happen because if you issue new shares on the follow-up round, percentage-wise, first-round investors must be diluted. This is just by the principle of stage financing. What we talk more here is the economic delusion. So the shares that I bought in the first round at a certain price give me a certain value for my holding and the question is, is this holding worth the same thing in the next round or not? If it's worth less, then it's due to the fact that the value of the company went down. So early investors often request delusion protections. And, of course, this only makes sense if there's what we call a down-round. So the valuation went down. If the company went well, there's no reason to compensate or to give extra shares or compensation to early investors. It's only if there was a bad event that happened what we call a down-round. And then depending on the kind of securities like venture capital that they would have convertible preferred, they would get just extra shares or the conversion price would be changed so that eventually they get more shares and therefore have a larger equity stake in the firm. And they would get this in the course of the anti-delusion provision. There are a number of benefits of having these anti-delusion provisions. So let me focus on the two most important ones. One is, of course, to limit the risk of the securities holder. So this means that if things don't go as expected, they are protected, they get extra shares, so they suddenly get a larger fraction of the value. Of course, this comes at the expense of those who do not have the anti-delusion provisions. Typically, these are the founders. It's a zero-sum game, these anti-delusion provisions. It's value that is transferred from the founders who do not have such kind of protection that goes to the securities holders who have anti-delusion provisions. So the crowd holding that would benefit of it, but the one who pays for it, who bears the risk, is the founder. The other reason that makes fully sense to use anti-delusion provision is because often there are informational problems, information asymmetries, as I mentioned before, or you may just have disagreements about valuations. So very often you can see, especially in venture capital, because that's where you have negotiation. Crowd investing has no real negotiation, but you have a disagreement on the valuation. The entrepreneur may think his company is worth 10 million euros, while the investor says, well, you know, let's start with something more reasonable with 5 million. Part of this is, of course, due to the bargaining that takes place, but at the end of the day, then still there may be substantial differences in beliefs about the true potential, either because the entrepreneur has better information, better knowledge, or because they just have different beliefs. So in typical situation, you would just have no investment because they cannot agree on the valuation. And if they cannot agree on the valuation, they don't agree on the price. And if you don't agree on the price, well, you know, you feel that you're not getting what you deserve. So then anti-delusion provision are useful because they help investors to still make an investment, although they disagree in valuation. To give you just a very simple example, so this is not with Partziar, Shinaha and Dalin, but just shares to make the point very simple. Suppose you have a first investment round for 1 million euro, and there is a first round investment, but investors and entrepreneurs don't agree on the valuation. The entrepreneur thinks his company is worth 10 million, okay, post-money valuation, and the investor truly believes it's just worth half of it, 5 million. It still makes sense to strike a deal if you give the investor anti-delusion provision because anti-delusion provision is a mechanism that allows you to expose, make adjustments. Here's the example. So when the company started, it incorporated the entrepreneur, of course, which is 100%, so this is a seed stage. In the first round, then they need to decide how much to give to the investor. The investor can say, okay, let's work with your valuation. You're an entrepreneur, you believe really it's 10 million. Let's work with this. Then if it's worth 10 million post-money valuation, investors should get 10%. This is the 10% you have here, and the entrepreneur 90%. Then let's suppose that the investor gets the anti-delusion protection. So later on, the next round, we know whether it was 10 or 5 million because new information was revealed and you can put this valuation based on the second round, the financing. So if it really turns out that the companies were 10 million, then the investor got what he deserves. 10% of 10 million is 1 million, he ejected 1 million, he gets value for 1 million. The entrepreneur gets the rest, which is 90%, so 9 million. If, however, the entrepreneur is wrong and it's only worth 5 million, then the anti-delusion provision would enter into play and would increase the percentage share of the investor and particularly should be such a way that he again gets 1 million, which just corrects for the fact that if in the first place they would have started to work with 5 million, he should have at the beginning got 20%. So the anti-delusion provision allows you to correct exposed based on the new information that comes out and give extra shares, extra percentage to the investor so that eventually he gets 20%, 20% of 5 million is 1 million. So he gets his fair value and it's therefore a mechanism to expose just correct for the disagreement. So it typically also helps or to avoid entrepreneurs to inflate too much their valuation. Investors like to have anti-delusion provisions as a way to protect against over-optimistic entrepreneurs and it can in crowd investing also help make sure that the valuation that they are proposed by entrepreneurs on the platform to first avoid that the entrepreneur exaggerates and second that if it's wrong or it has been inflated that the crowd becomes, gets protected. The cost as I mentioned is of course excessive delusion of those who do not have such a provision and particularly it's the founder who is the person who needs to work actually. Investors are just waiting for their money. So there may be some issues about incentives in the future if there is excessive delusion. It's also going to affect the terms under which follow-up funding can be raised. Giving too much anti-delusion protection to early investors will make it much more difficult to raise funds in the future because you've got very generous term in the first round. One way that investors often introduce the anti-delusion protection venture capital and business engine that I haven't seen for crowd investing yet but that I think could be an interesting way to do it is also to link it to a pay-to-play provision. So the pay-to-play provision says that if the investor wants to have his extra shares from the anti-delusion provision in case of a down-round he needs to invest in an offer. He needs to participate in the follow-up round. By forcing the crowd to invest in the follow-up round then the crowd gives a signal that they still believe in the project and offer a strong certification of the project in later rounds. Also in terms of covenants I haven't seen much going on but exit is very important because most of the revenue comes at the exit period and I wouldn't be surprised that entrepreneurs in many of these startups will be reluctant to offer an exit venue to existing investors so quickly. One is that the most important exit route very often is the sale of the company itself. Inventure capital is the most, the two most important exit routes are IPOs, so public listing in which case all the shares are listed and investors can gradually sell their own shares. That's percentage-wise the most important one is a trade sale so the company is being sold to another competitor or a larger group. Entrepreneurs may be reluctant to sell their baby, their company and therefore not be so prone in pushing for exit and therefore giving exit possibilities to the crowd or those who invested is clearly important. I list here a number of covenants on exits but I think I'm not going to have much time discussing them but I think that's clearly something important and that in crowd investing contracts still needs to be solved is giving enough right for exits to the investors, crowd investors in the future. In terms of stage financing and that comes back to what Lars said before so stage financing here when you have a very low threshold like 100,000 euro can potentially become problematic. So again, stage financing has the nice thing is that you inject a certain amount of money that's relatively small you let the entrepreneur work and then show some progress before follow up fundraising is provided and in this graph here you can see there are some blue and green arrows so the green one is as the company evolves technological market risk goes down so that's the green one and the blue one are the stages of development of the company and the product and as you move on these stage of development typically the capital requirements go up in the case of crowd funding they invest at the very beginning which is completely here at the right which is when risk is the highest but also the capital requirements are lowest but this means the crowd takes enormous amount of risk more than follow up investors Lars mentioned before that one benefit of increasing the threshold for the exemption from 100,000 is that it allows firms to raise large amounts of money and not inefficiently low ones the other obvious benefit of increasing it is that if you increase it so you push the red line more to the right you also allow into the crowd investing platforms more advanced more developed companies companies that already solve some of its risk and you offer to the crowd investment opportunities in a bit more developed companies who require more capital but also have lower risk so it's likely by increasing the threshold that you're going to have a different composition of companies also and overall less risky I know how much time I have left but ten, no, okay, good in terms of stage financing some potential issues is also that as the funds are injected gradually new decisions need to be taken and one thing that makes venture capitalists make profit is because they are willing hopefully to pull the plug relatively early so what it means is that if they make a first round and they're not convinced they just stop can the crowd also pull the plug if needed, will they do it given that some of them make decisions that go beyond financial reasons alternatively you can also see that financing rounds taking place where the first round investors finance the second one outside investors willing to provide extra money because the company made some progress but not as much as they would have wanted so no new investor wants to come in so existing investors needs to finance it there you can again ask the question can the crowd coordinate injecting the extra funds if no new investors will want to come this is no obvious question because typically you also see venture capital deals when there are too many venture capitalists they may want to free ride and let the others provide the funding for this company that didn't do so well but that is still worth continuing the bigger the crowd the more likely some will want to free ride on the others the other part that makes a stage financing difficult for the crowd is that every stage there is a new shareholder agreement that needs to be signed and not only is this more difficult if you have a lot of people around the table but it also alters the allocation of power and control rights over time business agents often understand that they may get some control rights in the first round but in later rounds they have to give it up last mentioned and that goes back to my main topic is investor protection last mentioned a number of regulatory needs and I must say I'm very much in favor of the same initiatives but I think also that a lot of it must come from the platforms themselves so self-regulation of platforms that will affect investor protection will certainly also be very beneficial to promoting crowd investing so some form that platforms already do is for instance enforce high minimum tickets to restrict the investor access some platforms allow you to invest start investing with one or five euros but others you need to invest a minimum of a few thousand thousand euros so that eventually platform to avoid having regular crowd decides to put a very high ticket so that they only work with wealth individuals and we have actually looked last empirically on some of these platforms the composition of the crowd and clearly this is not a homogeneous group you have some regular crowds but then you have also very wealthy individuals who provide a large fraction of the deal one of the platforms I know stylized this very nicely he said on my platform 50% of the money comes from 5% of the investors so it means that 95% of the investors are so small he provides small tickets so that they only add up to 50% of the money and then you have a small 5% of individuals who provide half of it and they can provide very large tickets and many often platforms depend very much on these few wealthy individuals to make the campaign successful another self-regulation or restructuring that becomes more and more common not so much in Germany but in other countries is pooling of investments so it means that the crowd doesn't invest anymore directly in the start-up but the platform sets up a pool a company and the crowd invests in that company and the company then invests in the start-up so from the start-up perspective there's only one shareholder coming in and these can take different forms and SIMBED in the Netherlands these are cooperative that is built every time on Kampanisto it's a game Bihar which is actually a single one for all of them while on SIMBED for each separate deal there's a different cooperative on YC it's a Société Action Simplifier so a relatively simple company and on my micro-invest in Brussels it's a Société Anonyme so it must be a AG so it's a kind of company that you can also bring on the stock market also more and more there's internal selection of candidates to improve due diligence some of them have members vote so that members can vote and if they get enough votes it can become get on the platforms others build up investment committees to improve the due diligence not just for the crowd but also the platform themselves others also improve the information disclosure beyond regulation by proposing templates I think this is important because first the templates helps to improve transparency because the comparability across investment opportunities is then easier but it can also potentially reduce information as symmetry so that the crowd can make better investment opportunities from the platform perspective this is also important because if there's a lot of information as symmetry going on then good candidates good companies don't want to go to these platforms because they don't want to be bundled together with less good firms so it's also in the benefit of platforms to reduce as much as possible information as symmetry an interesting case is the case of my micro-investing in Belgium they actually mix both pooling and this due diligence improving they offer the crowd co-investment scheme where at the first step business angels commit to make part of the investment so it can be 30, 40, 50% of the amount and when the company goes to start the campaign they already say we already have commitment for x% of the money from business angels who do the due diligence on us and they're willing to invest and then the crowd then provides the rest and the rest is essentially pooled in a society anonym which is called my micro-invest finance this slide is essentially very similar as Laut just mentioned I think a small offer exemption threshold at €100,000 is potentially problematic because you're limiting the access to the most risky startups and you see that in some platforms especially in Germany that platforms end up offering securities like this Partiales, that they may not have offered in the first place if they were in an unconstrained case in France we have been pushing for light documentation so the regulation or the consultation document proposes a clear list of items that must be included and I think this will improve for the transparency and comparability further challenges for platforms but certainly also for regulators before I conclude I think there are a number of also upcoming trends that are important to consider and that are likely to impact investor protection one is that crowd investing campaigns are likely to impact also business engine networks it's quite likely that some of the business angels will migrate to platforms they may precisely be the wealthy individuals these 5% that also participate in crowd investing platforms and provide a large amounts from discussion with some of these business angel networks I know that some of them are concerned that at the end of the day crowd investing platforms offer larger deal flow than their own network and that business angel potentially need to find new services to differentiate them from crowd investing market fragmentation in Europe also currently market fragmentation is important because prospectus regulation is implemented differently but the fact that each regulation each member state in the European Union is so different as last has evidenced French regulate the platforms as well as the issuers Italians, the companies the startups others do it in a very different way in Belgium it's only the crowd this is potentially going to reinforce or even further push the market fragmentation because it will become even more difficult to make an issuance cross-border because when you go cross-border you also need to comply with their requirements another trend that I think will happen is cross-border activities some platforms are setting up to become pan-European platforms I think Campanisto has this objective but some UK platforms clearly started to do that an interesting case that I like to say since I live in Belgium and work in France is that recently two French startups rather than raising their money in France they started to raise in Belgium in Brussels so they avoided the French platforms they just raised it on the Belgian platforms so there may be an issue of startups themselves trading off the different platforms depending on their just discs and where they are and the UK several platforms have raised quite a lot of amounts of money to develop their cross-border activities finally create viable exit opportunities are very important so I think I went over time but again just to summarize this I think for Germany regulation currently does not allow my view much flexibility in the contract due to restrictive perspectives exemption and some more flexibility for platforms maybe certainly worthwhile that could be done on these exemptions however in terms of investor protection I think many of the solution will need to come from platforms themselves not just from regulation I think self-regulation is also extremely important in that area because if it gets highly regulated as much as banks or any other securities issuance there is no differentiation between banks or traditional securities issuance and this one and crowd investing can only work if it can differentiate itself and this calls for a scalable regulation that is currently also being implemented in different countries ok thanks