Crowdfunding: An Alternative For SME Funding

Crowdfunding as a means of alternative financing is growing around the globe and there is no reason for African SMEs to be excluded from the sweeping wave of change. Crowdfunding is broadly defined as the online practice of raising funds from a large pool of individuals handing out small monetary contributions for causes or projects they share a common interest in. The contributors’ interests vary from pure emotional attachment to the pursuit of a bountiful return on investment grounded on the hope that the business idea supported will be the next business start-up success story. The abiding principle of most crowdfunding platforms is the access they provide to average investors to participate in early-stage investing while also giving entrepreneurs access to alternative capital providers.

It is commonly acknowledged that access to financing is limited for small businesses globally but even more so in Africa. This can be attributed to their very nature which impedes their ability to obtain credit from institutions such as banks and microfinance institutions. SMEs are either start-ups with little or no tangible and valuable assets to traditional lenders or existing businesses with weak structure in terms of hierarchy and segregation of responsibilities. In addition, they operate for the most part on thin margins and are unable to produce accurate financial information on their business in a timely manner.

Crowdfunding thereby provides a breath of fresh air in the lending landscape for SMEs in the fact that access is open to all businesses regardless of their geographical location. The model rides on the advent of internet and thrives on the wings of social media. The access to capital barrier is therefore removed. Another upside for SMEs and start-ups is that the cost associated with processing is relatively low compared to the traditional medium; no management or commitment fee; limited legal fee; the sole costs to worry about are the platform fee and/or payment processing fee which generally peaks around 10% of the total contributions and is a function of the project meeting its fundraising goal or not.

There are four broad variants of crowdfunding: donation, rewards based, equity and lending. Before we look at these variants in details, let us review some basic crowdfunding terminologies and the basic crowdfunding process.

Project Creator
This is the fundraiser, the individual or company soliciting contributions or pledges for a project.

Backer
Member of the public who commits an amount of money to a project.

Pledge
Financial sum the backer has committed to give to the project if the project meets its financial goal.

Reward
A tangible gift to backers in exchange for their contribution; generally the maiden edition or early prototype of the goods or service being promoted or for which funding is sought.

Platform
Website enabling fundraisers to have access to members of the public.

Equity
Shareholding in the promoted business, which is promised to the backer in exchange for his contribution.

The Process

Project creator or entrepreneur posts a funding request on an online platform
Terms & conditions (including perks) for contributors as well as the monetary goal of the project are presented.
Project description and business plan where applicable are reviewed by members of the public.
Contributors make their pledges to the project.
If the monetary goal is met at the end of the campaign period, funds are transferred to the crowdsourcer.
If the monetary goal is not met at the end of the campaign period, funds may only be transferred to the crowdsourcer if the campaign was run on a “flexible funding” basis and not an “all or nothing” basis.

Under the donation scheme, contributors give money to a project and expect nothing in return. As crowdfunding campaigns are carried out on the web, it is generally expected that project initiators will maintain their benefactors’ interest through update reports and captivating videos. These videos can in turn be re-broadcast by enthusiasts, which will likely lead to greater online reach and ultimately greater fundraising. Backers with a keen interest in this scheme are community oriented individuals who are keen on supporting local entrepreneurship or a particular cause with a sentimental value to them.

The rewards based type of funding guarantees a promised product or service (free of charge or at a discounted price) to the backer as reward for his contribution. In this case, the initiator has effectively pre-sold the goods or service he seeks funding for in exchange for money. A sense of belonging (to a closely knit club) is a key component of the giving decision process for backers in this scheme. The thought of being among the chosen few to own a special edition of an item is also an appealing factor for members of the public to donate under such schemes.

Equity crowdfunding entails the upfront commitment by the project creator, to issue or pledge shares of the company (existing or soon to be registered) seeking funds to backers based on the quantum of their contributions to the share capital. This model generally appeals to small investors with substantial savings who wish to have control in the choice of funds in which their money is invested in.

The last type of crowdfunding is the lending scheme. Here, investors inject money in return for a handsome profit. Both principal and interest are paid on a monthly basis. Though the model is predominantly suitable for small businesses with short-term working capital needs, several venture capitalists have joined the throng of individuals in the funding pool. The result has been the recent surge in regulations, especially in the United States and France, surrounding the entire crowdfunding system. Some merely see the government’s involvement as an attempt by traditional lenders to stem the flow of funds diverted from them by an increasingly social media aware population. This position is however arguable for a number of reasons, one of which is that most businesses pursuing this alternative financing style do so for lack of a better option. They have either been unable to borrow a sufficient amount from family and friends or were denied funding by traditional lenders.

Today, crowdfunding is one of the best options for obtaining funding for your project or business idea. It has its advantages and obstacles as well.