Ask someone for a large donation and the person is likely to balk. If considerate, a polite plea to mull it for a while might be made. Ask for something smaller, akin to pocket change, and there probably would not be much resistance to it. That is the underlying wisdom behind crowdfunding.
The network effect of the internet means small donations from a vast number of people can amount to a lot. Now imagine if, instead of a charitable course, the proposition is one of profit, naturally with some risk. It has the potential to attract many takers.
But how is that any different from the normal stock or bond issuance process? Do interested investors not similarly take as many units of a share or bond sale as they want or can afford? Well, crowdfunding avoids the regulators and transcends borders. Of course, these supposed advantages also come with risks. Even so, they provide an opportunity for small- and medium-sized enterprises (SMEs) to secure alternative sources of financing in difficult environments; especially in African countries where SMEs constitute more than 90% of businesses, according to the International Finance Corporation (IFC). SMEs also account for about 80% of employment in Africa. Top among their challenges is access to credit; which even when they are able to secure, is usually at exorbitant interest rates.
Crowdfunding, a form of so-called “alternative debt”, is just one of a few new approaches to financing SMEs. Asset-based finance is already widely used. Approaches other than the typical bank debt are beginning to be used, with fancy titles like hybrid instruments and equity instruments, albeit limitedly, according to a report by the Organisation for Economic Co-operation and Development (OECD).
Crowdfunding is different in that it is mostly project-focused, as opposed to financing the entire business. Although still mostly debt financing, equity type financing is beginning to evolve. Whether it is via donations, reward or sponsorship, pre-selling or pre-ordering, lending or equity, not needing an intermediary other than the platform through which the financing is facilitated is a key attraction. And potential returns to backers need not be financial. For the reward or sponshorship type, an acknowledgement, service or token of appreciation suffices.
As the name implies, investors who back a venture in the pre-selling or pre-ordering format sometimes expect no more than the product they backed before it gets to the mass market; and may be at a much lower price. In the lending format, it is the typical payment of interest and principal that one finds in other credit environments that prevails. Alternatively, the parties could agree to share revenue and thus partake in the risk of the venture. And the equity form is no more than the investors buying into the venture via shares.
Global crowdfunding financing was $34.4 billion in 2015 and more than 70% of it was through lending, according to a 2016 report by research firm Massolution. How much of this went to Africa? A paltry $24.2 million, which is less than 1%. Most crowdfunding financing still takes place in North America ($17.25 billion) and Europe ($6.48 billion); about 70% of the global total.
Since crowdfunding has so far been limited in Africa, what is the potential for indigenous platforms? A sense of this potential would first have to be inferred from current savings in African countries of about 15% of GDP, according to the International Monetary Fund (IMF). This is not ideal. What funds could potentially be put into such ventures are increasingly destined for ponzi-type schemes that offer ridiculously high returns. That is not to say there is no potential. In Nigeria recently, funds were successfully raised for the family of a deceased policeman via crowdfunding. But if the object is a business venture, without the sentimentality of a supposed noble cause, how easy would it be to similarly mobilize funds?
It seems the potential is limited – for now at least. – Written by Victor Mamora