Crowdfunding as a way of attracting investments into start-ups

Crowdfunding is a popular way to lure investment into start-ups from investors from all over the world. Although crowdfunding itself appeared back in 1997, as a separate instrument for attracting investments it became widespread much later, since 2006.

Many people identify the term “crowdfunding” with one of the most well-known platforms — Kickstarter, however, this platform is not the only one that helps effectively attract investments into start-ups.

Crowdfunding is a method of generating investments through contributions from many people (a crowd) who might not be connected to the project or professional business investment.

As we highlighted in our last article, the culture of investing in start-ups in Ukraine is still in its infancy. Meanwhile, increasing the country’s investment attractiveness will be a determining factor in restoring economic stability. That is why the issue of establishing crowdfunding to attract investments into Ukrainian start-ups is still very relevant even as the war rages on.

In general, crowdfunding platforms can be divided into three main types, which differ by the end result for the investor:

1. Donation (reward) crowdfunding is a type of campaign which doesn’t provide a financial return to investors or contributors. The reward for an investor can have both a tangible form (the end product of the company at a more attractive price) and an intangible form (public gratitude, advertising in the media, etc.). Kickstarter is a striking example of a donation crowdfunding platform;
2. Equity crowdfunding offers individuals real investments with acquisition shares in start-ups. WeFunder is a striking example of an equity crowdfunding platform;
3. Debt crowdfunding is a type of campaign that involves providing a loan to a company in exchange for receiving a financial reward in the future. Crowd2Fung is a striking example of a debt crowdfunding platform.

The WeFunder and SeedInvest platforms, which enable start-ups to get the required capital and provide an opportunity for everyone to become a professional investor without accreditation, are two of the most well-known equity crowdfunding platforms.

Let’s start with the analysis of the WeFunder platform.

WeFunder is a Kickstarter for start-ups, a platform that allows start-ups to attract investments from anyone: from FFF (friends, family, and fools) to venture funds.

Key features of the platform include:

• minimum investment is USD 100;
• platform team will help a start-up with the drafting of necessary documents and submission of Form C to the SEC;
• balanced platform fee: startup pays 7,5% of the amount of attracted investments only in case of successful closure of the investment round;
• advanced level of funds security raised by the start-up due to the use of a special purpose vehicle (SPV), on the balance of which investments from the crowdfunding platform are accumulated, and then these funds are invested in the shares of the start-up;
• opportunity to raise money from non-accredited investors.

SeedInvest differs from its competitor (WeFunder) by the higher cost of platform services and more rigorous checks of unaccredited investors.

Key features of the platform include:

• minimum investment is USD 1000, which significantly limits the number of persons from whom investments may be attracted;
• the platform fee is higher — 7.5% and a 5% convertible note or equity fee, both taken on the amount of capital raised via SeedInvest;
• the platform does not use SPVs, which can affect how attractive start-ups are for venture capital investors;
• opportunity to raise money from non-accredited investors while conducting an additional assessment of their financial data;
• the platform offers a separate Auto Invest product that allows non-accredited investors to develop their own investment portfolio and diversify risks. The minimum deposit is USD 1000, and it will be automatically distributed between five start-ups in accordance with the investor’s request.

Crowdfunding development in Ukraine.

Crowdfunding has grown commonplace in Ukraine since the start of a full-scale military invasion, making it possible to quickly raise significant sums of money for the nation’s military and humanitarian needs.

Meanwhile, there is a certain degree of skepticism about the use of crowdfunding in Ukraine to raise money for start-ups, not least because of the lack of transparent legislative regulation of such activity.

The vast majority of the projects offered on well-known Ukrainian platforms are social and charitable.

The following are Ukraine’s primary crowdfunding models:

1. “Take all or nothing” in which the author of the project receives funds only if he/she has managed to collect the necessary amount;
2. The proportional model is in which the money is transferred to the author of the project in case a certain part of the total amount of the fee is collected (most often it is 50% of the total amount).

In order to raise funds for innovative projects, Ukrainians apply to both national platforms (“Спільнокошт”, RazomGo, GoFundEd, StartEra, Ulule) and international platforms (Kickstarter). The use of the latter is complicated by the need to involve intermediaries — residents of countries who can register the project on the platform and start a fundraising company.

Let us remind you that only citizens of the following countries can register a project for fundraising on Kickstarter: Australia, Austria, Belgium, Great Britain, Canada, Denmark, France, Germany, Greece, Hong Kong, Ireland, Italy, Japan, Luxembourg, Mexico, Netherlands, New Zealand, Norway, Poland, Singapore, Slovenia, USA, Spain, Sweden, and Switzerland.

Legislative gaps that prevent equity crowdfunding in Ukraine include:

• lack of legislative regulation of crowdfunding;
• the necessity of progressively developing adopted legal instruments of attraction of investments, such as Convertible Loan and SAFE.

Conclusions:

To sum it up, we can say that crowdfunding is an effective mechanism for attracting investments to start-ups and is quite widespread across global venture funds.

Ukraine is undoubtedly progressing toward creating a robust IT community and establishing specific legal frameworks that will make the country’s enterprises and the entire state more attractive to foreign investors.

One of the key stages toward enhancing the investment climate and the growth of Ukrainian technology start-ups, in our opinion, is closing the aforementioned legal gaps.

Maksym Saievskyi

Partner at Digilaw

Yaroslav Barvenko

Lawyer at Digilaw