How to improve the startup financing system
Creating an effective system of trading in securities of small and medium-sized enterprises may be a milestone in the development of modern technologies. It is currently one of the biggest problems that dynamically developing companies from the fintech sector have to deal with.
Investments in technology startups are very risky. However, if successful, the rates of return can be in the thousands of percent. Unfortunately, the lack of financial success of the venture is not the only risk that the investor has to take into account. One very serious potential problem is that, unlike publicly traded companies, shares in tech startups have a fairly low degree of liquidity. In other words, they cannot be sold quickly if necessary. Such a transaction usually requires finding an investor who believes in the financial success of the venture and has a vision of its development.
It would certainly be easier for startups to raise funds for development if there were institutions modeled on traditional stock exchanges, dealing with trading the shares of smaller companies. The existence of such a market would significantly reduce the risk of investment. The Advisory Committee for Small and Medium Enterprises of the American Securities and Exchange Commission (SEC), already in 2013 issued a recommendation to create regional institutions dealing with trading in such securities.
World exchanges are trying to solve the problem by creating alternative trading floors, such as Warsaw’s NewConnect or London’s AIM. However, they have consistently failed to remove very high entry barriers for issuers, and often fail to address the low liquidity problem either. There are opinions that alternative markets have advantages rather than advantages in trading on and off the stock exchange.
Slightly better solutions have been developed in several countries. For example, in New Zealand, the alternative NZX market, which had problems with low turnover and low liquidity, was replaced by the new NXT market, which specializes in trading securities issued by small and medium-sized enterprises. A similar market has been created in South Korea. KRX Startup Market, created by The Korea Exchange, specializes in trading the shares of enterprises that have raised capital for development through crowdfunding.
It seems that the optimal solution to the problem would be to allow crowdfunding platforms to deal with secondary trading. Also such a solution is already in use in New Zealand. A market called “Unlisted” has been established there, where the secondary trading of securities takes place through the crowdfunding platform Crowdsphere. However, such a solution would require the creation of appropriate regulations.
Keep in mind that securities issued by small and medium-sized enterprises will always be associated with high risk. They are also prone to price manipulations according to the pump and dump scheme. This is one of the reasons why historically many attempts to create small business stock markets have failed. This situation is a serious regulatory challenge. However, changes in the structure of the world economy, the deconcentration of many key markets as well as the increasing share of small and medium-sized enterprises in creating global GDP make it worth taking the risk of reforming and decentralizing the securities trading markets.
