Italy’s legislation landscape regulating innovative start-up companies encompasses a vast and diversified package of specific measures aimed at promoting not only the setup but also the development of start-ups oriented towards high-tech sectors. In particular, the intention of Italian lawmakers was to create favourable conditions for the growth of innovative enterprises, including facilitating the access to alternative sources of funding, such as equity-based crowdfunding.

Initiatives to Encourage Equity Crowdfunding

Indeed, Italy was one of the first countries in the world to regulate equity crowdfunding i.e., Italy created a systematic set of rules which specifically addressed the regulations around raising risk capital in exchange for equity through certified web funding portals and established a national registry for crowdfunding operators[1].

By encouraging the financing of companies with an innovative and high-tech content, the hope was to foster the propagation of an e-investing generation and thereby revitalise the Italian capital market.

Slow Market Take Off

However, notwithstanding regulatory developments, deal flow and investor audience remained significantly below the European area average and sadly the Italian start-up scene has fallen far behind competitor equipotential countries such as Ireland, UK, France and Germany to say nothing of the USA.

The equity crowdfunding slow market take-off in Italy has been blamed on the fact that the scope of activity for the new legal framework was narrow, referring only to equity financial instruments and, most of all, only to innovative start-ups[2]. Indeed, based on initial analysis, the intrinsic stringent restrictions set out in the newly implemented legislation were depicted by the experts as detrimental to creating a viable and healthy market for this new form of finance; in particular, it was argued that the strong limitations pertaining to the scope of potential companies in respect of a company’s purpose and age, were responsible for having compromised the “demand-side” by significantly downsizing it.

However, in the very first months following implementation of the new legislative framework for start-ups, approximately 40 new innovative companies were set up each week from Milan to Palermo and by end of 2014 there were over three thousand newly incorporated companies eligible as innovative start-ups[3]. In light of the above, it appears quite clear that the slow progress was not due (or, at least, was not only due) to the strict legal requirements start-ups required upon incorporation.

Indeed, the reasons for under par results were sought elsewhere and most likely included factors such as inadequate strategic assessments and questionable operational choices that affected the ‘supply-side’[4] i.e. the audience of funding contributors rather than the ‘demand-side’ i.e. target companies allowed to raise capital through web portals. In particular, because of the sector-specific restrictions imposed by the originally implemented legislation, capital raising through open web platforms was necessarily associated with a class of very high-risk enterprises. Actually, the novelty of business carried out by newly incorporated companies which have been operating only for a short time and are even engaged in innovative and technical sectors implies that a high percentage of these start-ups are likely to fail. Thus, while leaving out the majority of investors willing to invest in traditional and/or well-established businesses, this approach requires a range of investors inclined to understand and to be convinced by innovative and high-tech products or services[5] and, most of all, who are ready to take significantly high risks[6]. Predictably, the innovative and technological features required by law greatly reduced the palatability of the investment among the potential users of the new investment tool; therefore, both participation in equity-based funding campaigns by the crowd of investors and success rate at raising funds are adversely affected.

Poorly Designed Regulatory Framework?

Moreover, it was also argued that results were flawed by what was considered a poorly designed Consob Regulatory Framework.

The rules originally adopted by Consob aimed at ensuring that professionals or particular categories of investors subscribe for a portion of the offered financial instruments[7] (even providing for severe limitations with respect to investments by individuals[8]) received their share of criticism. In addition, the provision under which portal managers cannot directly carry out orders for underwriting the financial instruments offered on their portals (but instead must transmit them to banks or brokerage firms) was deemed incompatible with a fundraising process that should happen on-line.

Improvements to Original Crowdfunding Legislation

Eventually the Italian legislator proved very responsive and proactive and made an additional effort in pivoting towards the ecosystem of crowd investment.  

Just 18 month after having enacted the equity-based crowdfunding regulations Italy understood that crowdfunding is much larger than innovative start-ups only. The legislator improved and broadened the range of measures in favour of innovative start-ups and enlarged the pool of eligible crowdfunding target companies by assigning the greater part of measures already destined towards innovative start-ups to an even wider range of companies: the innovative SMEs (i.e., Small and Medium Enterprises operating in the field of technological innovation, regardless of their incorporation date, business sector or stage of maturity[9]). The evolution was intended to allow diversification of the portfolio and decrease risk for retail investors.

Moreover, by waiving ordinary rules and with a view to fluidification of the secondary market, the Italian legislator provided that the transfer of participations in innovative start-ups and SMEs may be dematerialized, and as such related burdens are reduced. 

On the other hand, other measures not directly arising from the original package of regulations have enriched the framework of governmental initiatives currently in place to support innovative start-ups and their ecosystem. In particular, since there was a widespread sentiment in Italy that too much regulation might have been implemented, Consob updated its Regulation, adding to the aforementioned measures new procedural simplifications[10]. The verification of adequacy of the investment can now be carried out by the managers of the portals themselves, and not exclusively by banks as required before, bringing the entire procedure on-line. Moreover, with a view to broadening the definition of “professional investors” to satisfy the 5% rule for capital subscription, two new categories of professional investors have been added, besides banks and investment funds: “professional investors on request”[11], identified according the EU directive “Markets in Financial Services” (MiFid), and “investors in support of innovation”[12], which includes business angels.

Challenges to Overcome

However, despite the great efforts made (showing slightly encouraging signs[13]), many challenges persist and the impact of the tool for raising venture capital is still limited both in terms of capital raised and companies involved.

So why is the Italian equity-based crowdfunding persistently struggling to take-off and which measures may be adopted to narrow the gap between the Italian scene and that of comparable countries?

In the first place; by expanding the possibility to raise capital through equity crowdfunding to SMEs the Italian legislator did not overrule one of the original detrimental factors, which is still a necessity, namely, technological innovation. It is known that innovative and technology-based firms face more difficulties in attracting external funds as compared to firms operating in traditional sectors.

The market is now ripe and is awaiting public action to strengthen the innovation ecosystem by achieving the most significant breakthrough: the expected opening of crowdfunding to all business – such as manufacturing and trade – which currently make Italy one of the world’s top economies. Undeniably, among the issuing candidates most attractive to the crowd are also those businesses that are engaged in popular and traditional activities such as real estate, fashion, restaurants and food.

Another fact for analysis, notwithstanding the impressive number of newly incorporated start-ups registered in the specific section of the Companies Register, is that crowdfunding audiences remained small (less than 1% of those entitled to funding through online portals opted for it). Indeed, according to survey results conducted in 2015, the reasons for below average results are in part the backwardness of Italian financial knowledge and digital background: by end of2015, only 65% of Italians were fit for the definition of "internet user" and only 30% of Italian individuals were familiar with digital culture. Moreover, it appeared that crowdfunding was still a relatively little-known phenomena, given that only 26% of individuals claimed to have heard of it. 58% of respondents stated that they were not willing to invest through a crowdfunding platform mainly due to concerns about online financial frauds.

With respect to the above, the development of crowdfunding postulates that consumers have appropriate digital skills, are aware of the new options available and are willing to engage with them. In this respect, while the number of Italian Internet users is increasing (along with those classifiable as high digital literate), crowdfunding must become the subject of extensive information and raising awareness campaigns. It should also be noted that notwithstanding Italy’s alleged weak rule of law, up to date crowdfunding ecosystems has been characterized by high professional standards of crowdfunding operators and Italy proudly stands out for its creation of a reliable and safe environment for investors operating in the crowd investment field.

Another factor may have played a decisive role. According to the “long tail” principle[14],  compared to traditional forms of financing (business angels, venture capitalists, banks and other financial institutions) in which few actors mobilize great deals of money per capita, crowdfunding should leverage a large number of relatively small amounts of money.

This has not happened in Italy, where to date - instead of characterizing itself as an unconventional economic activity involving large “crowds of non-specialists” - the instrument of equity-based crowdfunding has been used by sophisticated investors as an investment diversification tool; the model that emerges from the initial data collected has been described using the image of "private equity online" or "club deal online", i.e., a small number of shareholders making offers of substantial amounts[15]. Obviously, a Club deal is usually characterised by elements that renders it not entirely comparable to the dynamics of crowdfunding; this aspect (along with the fact that subscribers often do not adhere to those envisaged when the new regulations were introduced) might have been detrimental to the physiological development of equity-based crowdfunding in Italy. In particular, the equivalence between the contributors of both the crowdfunding and the venture capital scene (and/or the private equity scene) implies that very different valuation and decision-maker parameters are taken into account in Italy as compared to those that would typically apply to an investment performed through web portals in other European countries.

Conclusions

In order for the market to find a way to ensure meaningful development, Italy needs to allow all businesses to accept crowdfunding in exchange for equity and it must implement new initiatives to raise the level of knowledge and awareness; moreover, both funders and target companies should cease to look to logics and methods shaped by the industry of venture capital and should conform to more typical crowdfunding patterns[16].

Hopefully, Italy will be up for the task and both public and private proactivity in favour of the national ecosystem of innovative business ventures will aid the tool for raising venture capital in gaining further strength and effectiveness. Despite the slow take-off, we remain optimistic that the equity-based crowdfunding market will eventually flourish in Italy and figures will rise to the similar levels found in large industrialised countries.