By Rafiq Raji, PhD
Ask someone for a large donation towards a cause 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, there would probably not be much ado about it. That is the underlying wisdom behind crowdfunding. Network effects of the internet mean small donations from a vast number of people can amount to quite a lot. Now imagine if instead of a charitable course, the proposition is one of profit, naturally with some risk. There is the potential that there would be similarly 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? And one unit of a stock or bond could be less than an American cent in some instances. Well, crowdfunding avoids the regulators and transcends borders. Of course, these supposed advantages also come with inherent risks. Even so, they provide an opportunity for small- and medium-sized enterprises (SMEs) to secure alternative sources of financing in otherwise very difficult environments; especially in African countries where SMEs constitute more than 90 percent of businesses, according to the International Finance Corporation (IFC). By another account, SMEs account for about 80 percent of employment in African countries. And top among their challenges is access to credit; which even when they are able to secure, is usually at exorbitant interest rates.
Just another name
Crowdfunding, a form of so-called “alternative debt” is just one of quite a few new approaches to financing SMEs. Asset-based finance is already widely used. Other approaches other than typical plain vanilla bank debt with such fancy titles like “hybrid instruments” and “equity instruments” are beginning to be used by SMEs as well; albeit still limitedly, according to a report by the Organisation for Economic Co-operation and Development (OECD). The distinction of crowdfunding is 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 donations, nothing is expected in return, for instance; although this is usually more the forte of charitable organisations. 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, according to a 2016 report by Massolution; more than 70 percent of which was via lending. And how much of this went to Africa? A paltry $24.2 million; less than 1 percent. Most crowdfunding financing still takes place in North America ($17.25 bn) and Europe ($6.48bn); about 70 percent of the global total. Since only limited crowdfunding makes it to the African continent, what then is the potential for indigenous platforms? A sense of the potential of these would first have to be inferred from current savings in African countries of about 15 percent of GDP, according to the International Monetary Fund (IMF); which is not exactly ideal. What could probably be put to such ventures are increasingly destined for ponzi-type schemes that offer ridiculously high returns. That is not to say there is no potential at all. In Nigeria not too long ago, funds were successfully mobilized for the family of a deceased policeman’s family 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? One’s observations suggest the potential is limited – for now. (An edited version of these thoughts were first published in my Forbes Africa magazine column in March 2018)
Also published in my BusinessDay Nigeria newspaper column (Tuesdays)