Crowdfunding is becoming an increasingly popular alternative for small to medium enterprises (SMEs) to raise capital. Now entrepreneurs no longer have to rely on banks or public funding institutions, they can now bank on the kindness and business savvy of strangers.
How it works is a group of individuals are able to raise funding, typically via the Internet, for a business idea or project.
Although this concept is not a new one globally, in South Africa it is still relatively new. There have, however been some new players that have entered this market such as Jumpstart Africa, Thundafund and Startme who provide a platform from projects ranging from anything from creative to agricultural ventures.
We talk to Phillip Lewis, Private Equity Portfolio Manager at Raizcorp, who explains the concept and the crowdfunding opportunities available for SMEs.
Can you give us an outline of what exactly crowdfunding is and how it works?
Crowdfunding started in 2008 with the launch of Indiegogo and has grown into a $6.4 billion industry in 2013, with a reach of 27 countries, while it is expected to grow to more than $90 billion by 2025.
“The risk is spread across any investors and the high risk is accepted in the crowdfunding space for an expected higher return”
Basically, it refers to a large number of peer-to-peer funding by individuals or organisations that are managed through an online platform. The capital is raised to fund anything from a business to a project or even a personal loan. This being said there is additional diversity coming through in the model where specialised focus is being put on such things as donations and social fundraising.
In a very short period of time the crowdfunding model has evolved into three areas of financing for businesses, namely donations, peer-to-peer (debt) and equity-based transactions.
Is crowdfunding becoming more favourable for SMEs?
The working paper for the International Organisation of Securities Commissions noted that peer-to-peer lending only contributed 0.01 % ($2.8 billion) of global lending in 2013. As highlighted by a USAID report in 2010, the lower the business turnover the lower the chance of attaining finance – this resulted in crowdfunding gaining great traction amongst SME’s as it is another source of funding, with many of the risk mitigation of larger financing organisations becoming less relevant in the crowdfunding space.
As a consequence of less red tape, raising equity finance takes approximately 25% of the time of traditional means.
This tolerance for risk in the crowdfunding space could be explained by several factors, namely the size of the investments by the investors is a lot smaller so the risk is spread across any investors and the high risk is accepted in the crowdfunding space for an expected higher return.
From the investor’s point of view, the benefits include sourcing deals more easily and more efficiently while allowing them to diversify their investments, and gaining more insights with greater transparency and data.
“There has been a slow uptake in South Africa as this is a new concept that has to gain traction and be proven in the local market”
What are the disadvantages of crowdfunding?
The industry is growing substantially so there is a lot of pitching going on and how the pitch is positioned and the quality thereof becomes even more relevant in the clutter.
When referring to the debt option, the investor’s risk is high and there is an expected higher return requirement for them. For a business, it becomes critical that they can maintain profitability and manage cash flows to repay the obligations.
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There are newly emerging fraud issues that are causing some concerns in the industry and resulting in tighter regulations governing the transactions being put in place. Keeping abreast of these changes would only protect your interests.
How does the ownership structure work? Do you still own 100% of your company?
With equity crowdfunding, like the normal sale of equity, there is a small share exchange (or stake in the business or projects) for money. As per normal shares, when the value of the business shifts, so will your share value.
Are there any successful ventures you know of that are a result of crowdfunding?
The company that comes to mind is Ouya, an open-source gaming console based on the Android system that comes with free game trials. The company raised about $8.6 million through Kickstarter between 2012 and 2013 and according to its website has sold more than 890 units.
What are the three things every business owner should look out for before pursuing crowdfunding?
Some considerations would include:
- Intellectual property (IP) protection – the possibility of communicating your idea on the World Wide Web and ensuring adequate protection will be costly and risks hard to mitigate, this forces the offering to have a well-defined USP (unique selling point) that is difficult to reproduce.
- Limitations on the use of funds – this means that the money raised can only be used for a specific purpose while many platforms have a clause controlling the distribution of funds until certain conditions have been met, such as if the target hasn’t been attained then the transactions will not be processed and no investments or loans or attained.
- Accounting and compliance considerations – because the industry is relatively new and it is experiencing large amounts of growth, there are continuously new regulations and rules that are being implemented, which depending on your business type and location may have negative implications for your ability to raise funds. This is also compounded by the lack of clarity by many professionals regarding the crowdfunding industry.
Do you think the crowdfunding concept is suited to the African/South African context?
Most definitely yes, there is a clear need from many of the businesses in South Africa for funding. The fact that this offers an investment platform linking both investors and investees, combined with the size of the African population, there are great opportunities.
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This is evident in many options starting to appear both locally such as StartMe, FundFind and ThundaFund, and on the rest of the continent like StartCrunch in Nigeria to name just a few.
However, there has been a slow uptake in South Africa as this is a new concept that has to gain traction and be proven in the local market.
When the model of community stokvels success is taken into account then it is clear that once the technology platform, the process and jargon are understood by the community at large there is a good chance of Crowd Fundings success in South Africa.
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