05 Crowd Finance and Social Trading Flashcards
Why is traditional IPO (raising capital) so difficult?
- requires a lot of effort for complying regulation (disclosure of financials/business information=
- involves one/several large investment banks
- entails a roadshow to institutional investors
- excludes retail investors
- is often underpriced
–>Banks may hesitate to make loans to start-ups
–>Angel funding or venture capitsal might not be accessible or not enough
What is Crowdfunding?
Crowdfunding is the process of funding a project/business or an individual by raising relatelvy small amount from a large number of investors
Charcteristics of Crowdfunding (what are the investors and how is funding coordinated
- Investors are typically retail or high net worth individuals
- funding is coordinated on online platforms that bring togehter investors and entrepreneurs
Two types of Crowdfunding?
- distinguish between profit-oriented investing and non-profit-oriented investing and donations ont the other
- ICO are a type of (more decentralized) crowdfunding
What are the JOBS?
the Jumpstart our Business Startups Act was signed in 2012, to ease the funding process of small businessess
–>Included 7 tiltes where title 3 is the most relevant
What does Title 1-2 say? (JOBS)
Title 1: makes it easier for companies to go public
* pre-ipo process with the SEC can be done confidentially
* Less stringent audit requirements
Title 2: allows firms to stay private
- companies may stay private even when advertising for outside investments
- Investors need to be “accredited”: High net Work or high income
What does title 3-4 say? (JOBS)
Title 3: Regulates crowdfunding
- limits on individual investemnts (seize, and min. holding period)
- Limits on total amount raised
- Certain disclosure requriements
Title 4: Introduced “mini IPOs”
- Shares can also be sold directly to retail investors
Motives for investing in Crowdfunding?
- Profitable for investors??
- don´t forget opportunity costs of due dilligence
- the price was simply set by the company
- was the company unsuccessful in raising funds any other wa?
- Impact investing: Investors want to have a postivie impact on society, the environmnet, and thus investing in projects they believe make a difference
- Donations: giving money to charities, artistis, provides a “warm glow” of giving
- early adopters: Reward-based campaigns often give priority access to the funded products or services
Motives for Obaining Crowdfunding? Why should is use crowdfunding ?
- Funding costs may be lower than traditional financing
- Successful campaings serve as proof of concept
- Crowdfunding process already build a network and client or fan base for the company
- company might learn from the crowd (get some idea of company valuation based on demand by investors)
- -
Risks Crowdfunding
- The project might simply fail or fall short of expectations
- Delay, the project might take longer than expected to deliver the promised reward
- Illiquidity, seeling shares during equity crowdfunding may be impossible
- Fraud, some projects were never meant to be actually realized
- Security of crowdfunding platform
What do P2P Lending, Crowdlending and Marketplace lending ?
They all describe platforms that match borrowers with lenders
- just brings them together, do not make the loans itself
- loan agreement is between the lenders/borrowers
What is Marketplace Lending?
Is a platform where Borrowers fill out a profile and the platform evaluates their credit risk and sets interest rate.
- Then borrowers can accept or reject the offer
–>THe platform make the credit decision on behalf of the investors
–>some even securitize the loans, they bundle them in special vehicles and directly sell them to institutional investors
Why do borrowers go to marketplace lending platforms?
- to pay down debt, in particular credit card debt
- other types of credit may not be available
–>Typically provide some information
- Financials and income
- Planned use of funds
Why do lenders invest on marketplace lending platforms?
- yields in other assets may be low
- better credit risk evaluation might uncover “good risks” and profitable investments
What is a Microcredit?
= Microcredit is the lending of small amount of money to typically impoverished borrowers with no access to other types of creidt
What is the promise of social trading?
The promise is to profit from the wisdom of the crowd
What is social trading?
social trading is “the interaction of investors in social networks”
What is a soical Trading platform (characteristics )
- brings together leaders and followers
- provides market data and brokerage services
- either directly executes the leader´s trades in the follower´s account or issues certificates that follower buy by subscibing to a leader
- in any case, no money flows between leaders and followers
What are signal providers?
- Signal providers share their investent ideas with the rest of the community
- execute their strategies on the platform eithe rusing
- Real money
- virtual account
- Leaers get rewarded according to the compensation scheme on the platform
What are Signal Followers?
- other screen the published investment ideas acc to their own preferences and monitor the performance of signal providers strategies
- before and after, they discuss the strategies with other users of the platform
- They become followers by subscribing to a leader and thus copying the strategy
Social Trading and Regulation
Regulation:
* executing trades on behalf of a third party requires authorization or a liscense in many jurisdicitions
* EU, UK the platform operator is genrally assumed to be the portfolio manager and not the signal provider
Transparency (Social Trading Platforms)
Transparency:
social trading platforms are relatively transparent regarding the trading history and past performance of singal providers
- however not always clear who the signal providers are and what their incentives are
Survivorship Bias and Social Trading Platforms
Survivorship bias: –>overestimation of past performanc
* past performance does not necessarily indicate future performance
Moral Hazard
Interest of signal providers may not align with those of their followers.
–>general problem of moral hazard in delegated fund management and is typically addressed by compensation schemes
How do social trading platform incentive leaders?
Social Trading platforms use diferent schemes to incentivize signal providers
* Performance fee from followers
* Number of followers
* Trading volume of followers
What are social trading platforms?
- social trading Plattforms are a form of delegated portfolio management where the platform provides a framework for investors
