Crowdfunding as alternative finance for entrepreneurs
This paper, a follow up to the previous paper that introduced alternative finances, looks at crowdfunding in the context of online alternative finance for entrepreneurs. This paper is based on a number of articles published in scientific journals some of which are cited here. Broadly defined, alternative finance refers to non-bank financial channels, which have proliferated in the last decade as part of technological advances in finance often referred to as financial technology firms or — ‘FinTech’. The advancement in technology is helping to address the imbalances between demand and supply for alternative finance.
What is crowdfunding?
Crowdfunding stands at the forefront of, and is synonymous with, alternative finance. A number of authors have viewed crowdfunding as a method of pooling small financial contributions from a potentially large group of backers, while using the internet, and often without the involvement of standard financial intermediaries. In this respect, an old fundraising method (synonymous to ‘mukando’ in Zimbabwe) receives a new boost from internet technologies towards achieving greater fundraising scale, speed and scope. Related technologies are integrated by service providers known as crowdfunding platforms, which are defined as internet applications linking fundraisers and their potential backers while facilitating the exchanges between them in accordance with prespecified conditions. Moreover, the campaign itself is also an important element of crowdfunding, and while platforms serve more as campaign management systems, their role is mostly supported by promotional capacities in the forms of social media sharing and engagements for attracting prospective backers.
Menon et al. (2018) in a published article entitled, “Analysing the Role of Crowdfunding in Entrepreneurial Ecosystems: A Social Media Event Study of Two Competing Product Launches,” argue that there are six core elements to crowdfunding and these are:
•
Crowd — refers to large group or conglomeration of individuals contributing via the internet, by financially supporting a project or cause.
•
Project owners — are project creators or entrepreneurs seeking capital.
•
Intermediaries — are crowdfunding platforms, that is, a virtual hub for the crowd and project owners.
•
Funding mechanism — are the principles or rules the intermediaries set under which funding takes place.
•
Specialisation — refers to type of projects the intermediaries support. Kickstarter and Indiegogo support projects, while equity CFP supports startups or business, for example, innovestment or invesdor.
•
Return type — is the return of investment or incentives for the crowd, for example, goodwill or thank you for donations.
Shneor Rotem (2020) in a book chapter entitled “Crowdfunding models, strategies, and choices between them,” argues that crowdfunding is an umbrella term for a wider family of fundraising models. At a basic level, these models can be differentiated between “investment models” or “non-investment models” depending on the types of compensation promised to, and expected by, the funders. Specifically, investment models refer to lending and equity crowdfunding offering financial returns to investors, while non-investment models include reward and donation crowdfunding offering non-financial returns to consumers and donors, respectively.
Accordingly, Shneor Rotem and Munim Ziaul Haque (2019) in an article entitled, “Reward crowdfunding contribution as planned behaviour: An extended framework,” published in the Journal of Business Research, found that reward crowdfunding has been a popular channel for entrepreneurs to raise funding for their ventures as of 2016, with an estimated value of EUR 191 million in Europe, US$598 m in the Americans and USD 2,08 billion in Asia-Pacific while in Africa microfinance was the leading model of alternative finance accounting for 42% (US$34,7m) of total market volume, donation-based crowdfunding accounting for 17% (US$14m) and reward-based crowdfunding accounting for 10% (US$3,17 m).
Background history
Crowdfunding is a new development in academic entrepreneurial finance research and has been the latest source of finance to enter the field. Its progress can be traced to numerous sources, such as technological progress brought by the internet, the associated social media channels, and the ongoing regulatory changes in financially savvy countries. These tools and circumstances have enabled crowdfunding to enter the alternative finance market as the youngest mechanism, with the term being coined in 2006 and research gaining traction at the beginning of the present decade.
Crowdfunding is arguably the most visible disruptive technology intermediation. In less than a decade, crowdfunding has gained traction in a number of developed economies that includes; Australia, United Kingdom, Netherlands, Italy, and United States of America. This exciting phenomenon is spreading across the developed world and is now attracting considerable interest in the developing world as well (InfoDev, 2013). Crowdfunding is an emerging channel for entrepreneurial and project funding, which has seen exponential growth in recent years, reaching a volume of EUR 262 billion in 2016, a 208% increase from EUR 130 billion in 2015 (Shneor and Munim, 2019).
Crowdfunding has been especially useful for financing unique projects, such as, creative or artistic, that generally finds it hard to get support from more traditional sources of finance. Eranti V. (2014) in a policy paper entitled, “Crowdsourcing and crowdfunding a presidential campaign,” argues that even political projects have been crowdfunded, for instance a majority of Barrack Obama’s election campaign funds in 2008 came from small financial contributions.
Through crowdfunding, smaller entrepreneurs, who traditionally have had great difficulty obtaining capital, have access to anyone in the world with a computer, internet access, and spare cash to invest. Many entrepreneurs are having difficulties in raising capital through traditional financing sources of finance.
This has affected many small and micro-businesses especially those owned by women and youth. These challenges are linked to the inherent problems associated with entrepreneurship especially at the beginning of entrepreneurial initiatives. Besides, these challenges arise due to lack of collateral and sufficient cashflows as well as the presence of significant information asymmetry with investors.
Why focus on entrepreneurs?
Entrepreneurship has become the major focus for economic growth and development the world over. Marom et al. (2012) in a book titled, A framework for European Crowdfunding, point out that, 23m small and medium enterprises (SMEs) in Europe represent 99% of businesses. As such, access to capital for SMEs is critical for sparking job creation in Europe. However, crowdfunding market is in its infancy in developing countries though the potential market is significant. InfoDev (2013) in an article entitled, “Crowdfunding`s potential for the Developing World,” published by the World Bank estimates that up to 344 million households in the developing world have the ability to make small crowdfund investments in community businesses. These households have an income of at least US$10 000 a year and at least three months of savings or three months savings in equity holdings. Together, they have the ability to deploy up to US$96 billion a year by 2025 in crowdfunding investments.
The sub-Saharan Africa region is also beginning to observe donation-based crowdfunding activity and early development of equity-based platforms, including some in development, or launched in Kenya, Ghana, and South Africa (InfoDev, 2013). Research has shown a unique trend in Africa where funding flows for nonfinancial projects like donation, reward, and philanthropic online microfinance projects are primarily being funded via platforms based outside the continent, for example, in 2016 88% of total funding was from foreign-based platforms.
As of 2015, in Africa, 90% of online alternative finance was originated from platforms headquartered outside of the continent, whilst in the Middle East the reverse is true as 92,6% of online funding originated from home-grown platforms headquartered within the region. According to the Cambridge Centre for Alternative Finance [CCAF] (June 2018) report, of the total funds raised across Africa between 2013 and 2016, a large proportion of the market volume (65,41%) came from nonfinancial return models. Donation-based Crowdfunding, as the prevailing model, accounted for close to 35% of the African alternative finance market volume in 2016 and over US$94m over a four-year period.
The model has seen a tremendous yearon-year growth of 343% for 2015-2016, with US$14,26m in 2015 to US$63,11m in 2016. The Crowd-led Microfinance model is the second most prominent model in Africa for 2016, accounting for over US$34m. Yet, the model is the highest overall contributor, with US$135,07m over the fouryear period, previously accounting for close to 60% of total volume in 2014 and 42% in 2015.
The East Africa region has the largest market share of the African alternative finance market. In 2015 East Africa accounted for 41% of total African market share, while West Africa accounted for 24% and Southern Africa accounted for 19% (CCAF, February 2017).
Crowdfunding has today become one of the most promising tools to help enable economic growth, job creation and innovation. Crowdfunding has changed, since its first known citation by Michael Sullivan, on August 12, 2006. Crowdfunding is growing up quickly, and in some areas, integrating and hybridising with more conventional financing methods. Besides great innovative potential displayed by many people in developing countries, they have been great challenges in securing capital from traditional financial institutions due to some of the reasons mentioned above. Unfortunately, the majority of the previous studies on crowdfunding have concentrated mainly on America, Europe and Asia-Pacific, affording Africa little coverage, even though it has some of the world`s fast-growing and promising economies due to vast mineral resources and young growing population.
Advantages of crowdfunding
Research has shown that new online alternative finance providers have certain advantages when compared to traditional financial institutions. Such advantages include;
Streamlined online procedures that can potentially reduce funding costs, while reducing information asymmetry by incorporating insights from non-traditional sources.
Small business owners can raise capital from anywhere in the world rather than tied to local angel investors or VCs, which plugs the financing gap for startups.
Entrepreneurs can use crowdfunding to test business ideas, validate products, and support business with less than USD1 million profits. Crowd engagement is a legitimacy signal as the crowd chooses worthy enterprises to contribute their funds, with the level of backer interest gauging for a larger consumer interest.
Thanks to its anchoring in communities, crowdfunding incorporates advantages beyond the actual sums raised from interested members. Such benefits include access to valuable and timely feedback, knowledge and technology to concepts under development, demonstration of project legitimacy, as well as direct access to, and interaction with, multiple stakeholders such as prospective customers, business partners, media, existing, and future funders.
Disadvantages of crowdfunding
Despite the potential of crowdfunding, small business owners must consider challenges of using crowdfunding as alternative finance. Some of these challenges include; information asymmetries, high risk, lack of experience using the platforms, limited financial capacity, potentially higher transaction costs, stolen intellectual property, fraud, and ethical issues.
The lack of bespoke regulatory regimes and specific alternative finance policy developments is affecting alternative finance industry growth in Africa. The greatest perceived risk by the industry in Africa is ‘fraud’.
The roadblocks to equity-based crowdfunding, for example, are the cost of disclosures, costly regulatory requirements, audited financial statements, verification of all investors’ financial worth, public disclosure of all project details, lack of secondary market, and lack of analyst coverage that can positively impact stock price. In the context of global online alternative finance market which exceeded US$300 billion in 2016, the industries in Africa remain to be hugely under-developed.
This state of markets signifies both challenges and opportunities, in market creation and development, technological advancement and regulatory innovation, capacity building and consumer education.