Armed with an exciting new product but operating in uncertain and demanding conditions, start-ups face a variety of obstacles. Major issues are surrounding and arising from fundraising, which hinder this decisive moment in the life of a start-up. But what are these stumbling blocks that make this crucial operation tedious?
The primary market for unlisted securities is an ecosystem-based on human execution, subject to heavy and strict regulations on financial investment. The cost of capital is such that below a certain amount, it is very difficult to access sources of funding.
There are several main types of investors who can participate in raising funds for a start-up. From public aid, through business angels and crowdfunding to venture capital funds, it becomes difficult to bring all these players together around the same round of financing given the different approaches that will have to be applied to enable the participation of the different parties.
The set of control procedures and the difficulties in managing a large number of investors are also one of the major points of difficulty. The larger the number of investors, the harder the governance and the capitalization table are to maintain. As these processes are not repeatable, each investor brings its additional workload. The use of digital tools, recognized by law, are real sources of hope to increase liquidity but to also ease the management of the administrative task before and after the raising.
It is not easy to bring together multiple investors in a single exercise, and then it is necessary to be able to apply all the legislation relating to this type of operation.
Overall, the procedures for issuing securities are particularly tedious. The lack of standardization results in a considerable loss of time. The most restrictive steps are those relating to the control of future investors.
To ensure that fundraisings are compliant, governments have put in place a binding regulatory framework that places the burden of information gathering and first-level controls on the economic agents involved in fundraising. This applies to the start-up that initiates the fundraising to control investors willing to participate. It must collect and analyze investors’ identification documents (KYC: Know Your Customer, KYB: Know Your Business) to determine whether the individual or entity is legitimated to participate in the fundraising, in the light of the specific regulations issued by its country of origin but also of the restrictions that the start-up itself has defined. As this task is purely manual, it is particularly time-consuming, a phenomenon that a start-up wants to avoid at all costs at a moment where productivity is key. At present, it takes more than a week to complete a KYC procedure for a single investor, the costs are multiplied by the number of interested investors and the banks’ back office is overwhelmed. It should be noted that this process is not reproducible, even though the European MiFID II Directive allows it to be reused for one year.
This obligation also applies to certain investors. Let’s take the example of investment funds, major players in the start-up ecosystem. These entities, which have large portfolios, have many cases to analyze and are therefore particularly affected by these constraints. They are responsible for analyzing the start-up and its members, with an obligation to identify the various beneficial owners of the start-up: “any entity or individual holding directly or indirectly 25% of the capital and voting rights or any individual who exercises control over the management, administrative or executive bodies”, Monetary and Financial Code. They must also be able, before any investment, to identify the origin and destination of the money flows of the financing round in which they are participating. In short, they must check the identity documents of all the start-up’s members and those participating in the future investment round. And this only concerns natural persons, a similar procedure is required for legal entities (Kbis, statues, etc.). Let us keep in mind that all these steps are to be considered before making any kind of investment.
Concerning the AML procedure, for payment in fiduciary money, it will take at least 5 days. These similar processes lead to errors, which are subject to sanctions by the regulators, as they allow illegal funds to be used, or investors not authorized to participate in a transaction.
All of these constraints are related to the successful completion of fundraising, but they keep going when an investor decides to resell the shares he owns.
The market for unlisted securities suffers from a lack of liquidity due to a lack of infrastructure allowing for fast, secure, and smooth trading. Shareholders often find it difficult to resell their securities and have to rely on intermediaries. Intermediaries are synonymous with costs, which reduces the capital gain made on the securities. Also, during this type of transaction, it is common for the price of these securities to be depreciated. Supply and demand meet with difficulty; shareholders are forced to lower the resale price of their securities.
At present, the “shareledger” (Registry of shareholders) of unlisted securities must be kept in paper form. Digital tools can be used to forecast its future state, but it still needs to be updated it in paper form. In the absence of access to reliable information, many errors of assessment can be made, leading to numerous round trips, slowing down the procedure. Finally, there is an obvious lack of traceability due to the numerous intermediaries, who are likely to swap or lose documents. The whole process, therefore, seems obsolete in the light of current technology.
The ecosystem for raising funds for start-ups is therefore fraught with pitfalls, from regulatory constraints to the diversity of investors and their methods to the difficulty of reselling securities in a secondary market — the gap between the listed and unlisted market is still very wide. However, the use of new technologies, recently recognized by law, will make it possible to transform the evolution of these securities throughout their life cycle. The call for blockchain technology seems to be the door open to compliant, automated, universal fundraising with a liquid secondary market.