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Fatih Yılmaz

Fatih Yılmaz  is an Economist at the CBRT.

Ünal Seven

Ünal Seven is an Economist at the CBRT.

Ahmet Duhan Yassa

Ahmet Duhan Yassa is an Assistant Specialist at the CBRT.

 

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Non-bank alternative financing methods are attracting more and more entrepreneurs all around the world. Considered an opportunity particularly for startups with high potential and fast-growing SMEs, these new financing types reduce firms’ dependency on classic banking and act as a stabilizer against potential financial risks. These methods, which generally rely on the principle of peer-to-peer lending or direct equity-based investment, may diminish systemic risks by providing more efficient financial diversity, and constitute a significant alternative also to the capital markets that allow limited access to small-sized firms. The leading alternative financing methods are venture capital, angel investment and crowdfunding models. Our blog post gives brief information on these methods and demonstrates their use in Turkey and in other countries based on up-to-date data.1

Venture capital refers to the method where capital owners, in general, directly buy firm equity. This method not only allows for investing through the partnership of a few number of capital owners, but also enables a good number of investors to finance firms through the funds established. Widely used in the US, this method relies on risk sharing, unlike classic borrowing methods.

The angel investment method, on the other hand, requires individuals (angel investors) to become a member of an investment network through the purchase of licenses by fulfilling certain criteria. Angel investors can individually invest in the projects or firms in need of finance that they access through such networks, or they can become partners with them. In venture investments, the investor generally does not interfere with the internal management of the firm that is bought. But in angel investments, business angels, with their knowledge and experience in addition to capital, have an active involvement in this regard, which can be considered as the key feature that distinguishes angel investment from venture capital.

The most detailed and up-to-date data on venture capital and angel investment giving both Turkey and world-based comparisons are provided by the on-line entrepreneurship platform startups.watch2. According to these data that display the total investments made as a part of venture capital and angel investments together, in 2018, the largest investment (venture capital plus angel investment) world-wide totaling USD 115 million in 2018 belonged to the US, followed by China and India (Chart 1). The OECD 2017 report also confirms this ranking

The same source reveals an increase for Turkey in both the total amount and number of venture capital and angel investments over the past decade (Chart 2). As can be seen from the figures, the total investment amount rose to USD 110.5 million in 2017, followed by a slight decline in 2018. Investments concentrated mostly on sectors such as financial technologies (fintech), cloud technologies, software, e-commerce and retail technologies.

The European Business Angel Network (EBAN)3 data indicate that approximately half of the venture capital and angel investment amounts for Turkey as consolidated in Chart 2 consisted of angel investments. Accordingly, there were 15 angel investor networks and 1,560 investors registered in Turkey as of 2017.  With its angel investments totaling EUR 52.3 million, Turkey ranked fifth among EU members or accession countries.

Crowdfunding relies on a practice that is quite different from the methods mentioned above. This method can mainly be summarized as direct funding provided by interested small-size investors to projects and companies promoted through online platforms. Crowdfunding can be made through debt and reward or donation-based methods in addition to equity-based methods. Crowdfunding acts in a sense as an online market that brings millions of potential investors together with firms in need of finance. Thus, the cost of the related financial intermediation is brought down (almost to zero levels), while procedures can be executed in a dynamic fashion.

In crowdfunding, China takes the lead by a large margin. According to the online data platform Statista.com4, the total amount of funds (USD 170 billion) that China raised in 2018 through crowdfunding was approximately seven times that of its closest successor, the US (USD 10 billion) (Chart 3). Turkey managed to raise USD 40 million in the same year. A breakdown of funds by type indicates that debt-based crowdfunding is the leading method. Additionally, equity-based crowdfunding is also widespread.

To sum up, backed by technological advancements and more common use of the Internet, alternative financing methods are improving and expanding at an increased pace. Accordingly, construction of reliable data sources will be beneficial to develop timely policies and to make analyses that can contribute to the process of policymaking.

Mutual trust is key to the development and promotion of alternative financing methods. Trust can only be built by removing the information asymmetry between firms in need of finance and potential investors. Therefore, the relevant regulations should encourage alternative financing methods by providing tax and business advantages, while, at the same time, building trust.

While regulations on angel investment and venture capital in Turkey were put into practice in 2013 and afterwards, the crowdfunding regulation took effect on 3 October 2019. This last regulatory action opened the way for equity-based crowdfunding. The relevant communique provided a legal basis for crowdfunding of innovative and technology-oriented ventures with growth potential. The already substantial fund size of the newly legalized crowdfunding demonstrates the potential and dynamic structure of these financing methods. Developing the legal infrastructure to cover also other financing methods will promote the use of those models.

Venture capital and angel investment channels are particularly important instruments to boost direct investments of foreign investors in Turkey through international networks. There are a number of firms recently purchased via these channels. Therefore, expansion of these methods is important in terms of their contribution to financial intermediation and their potential in providing high quality external financing.  

 

[1] For further information and assessments on alternative financing methods, see Financial Stability Report (May 2019) “Alternative Financing Methods” Box iii.2.i).

[2] For details, see https://startups.watch/.

[3] EBAN is an investor network working closely with the EU and EU accession countries. EBAN also publishes angel investment statistics pertaining to the relevant geography. For details, see . https://www.statista.com/statistik/suche/?q=crowdfunding For further details, see https://www.statista.com/statistik/suche/?q=crowdfunding

[4]  For further details, see. https://www.statista.com/statistik/suche/?q=crowdfunding

 

Reference:

OECD (2017) Entrepreneurship at a Glance 2017, OECD Publishing, Paris.

Ünal Seven

Ünal Seven is an Economist at the CBRT.

Fatih Yılmaz

Fatih Yılmaz  is an Economist at the CBRT.

Ahmet Duhan Yassa

Ahmet Duhan Yassa is an Assistant Specialist at the CBRT.

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* The views expressed here are those of the authors. They do not necessarily reflect the official views of the Central Bank of the Republic of Turkey.