Last year Leen Sadder of Beruit, Lebanon had an idea to create an organic and biodegradable alternative to Western-style teeth cleansing. Called Miswak, this twig of the Salvadora persica tree has been used for teeth cleaning throughout the Middle East and Asia for millennia. Leen recognized the sustainability of eliminating both the toothbrush and paste and its application for the developing world. She created a crowdfunding campaign on Lebanon-based crowdfunding platform Zoomaal and within weeks raised over $18,000 from 301 backers — 104 percent of her target — along with 4,400 likes on Facebook and 573 tweets. This bought her money, market validation, and media attention. She is now in production. This idea that would never have seen “likes” or funding from banks or venture capitalists. Enter the alternative world of startup and small business financing, called crowdfunding.
Crowdfunding is a simple but transformative concept. An entrepreneur proposes a business, charitable, or creative project on a crowdfunding website. If convinced, tens, hundreds or even thousands of individuals commit relatively small amounts of capital to support the idea. Taken together, these contributions may be significant enough to turn the idea into a commercial reality. This industry is still in its infancy, but it topped $3 billion in transactions in 2012 and may top $5 billion by the end of this year.
In the World Bank report we authored called Crowdfunding’s Potential for the Developing World, we provide a detailed explanation of crowdfunding, its different forms, the opportunities and risks for debt and equity based crowdfunding, variables for success, ways to mitigate risk, and how to craft enabling policy. It includes a self-assessment tool for policymakers and regulators to decide if they have the right technological, social, cultural, and regulatory variables in place for crowdfunding to thrive in their jurisdiction.
In investment-based crowdfunding campaigns, funders receive equity in the business. Their capital is not guaranteed, but if the business is a hit funders have the potential of realizing significant financial rewards. Because equity-based campaigns entail the issuance of securities, it requires forward-leaning regulation. Debt-based crowdfunding campaigns also offer the ability for small businesses with customers and cash flow to borrow money from the crowd at more attractive rates than the banks. And current data shows the default rate of crowdfunders is lower than average. With the passage of the JOBS Act in the United States, a path forward for securities-based crowdfunding was created for governments globally to potentially follow.
Crowdfund investing is a valuable tool for individual and institutional investors, for policy makers and for public sector SME funds through efficiency, transparency, and market validation.
Efficiency: By consolidating a standard set of applicant data on one platform, crowdfund investing sites speed up the process of investigating and comparing different project ideas, companies, and management teams. Democratic access to this data speeds up and simplifies decision-making.
Transparency: With open data and social decision-making also comes greater transparency. Users of crowdfunding websites quickly expose fraudulent campaigns and vigorously hold fundraisers to account for their promises. According to Wharton professor Ethan Mollick, less than 0.1 percent of the funds raised on crowdfunding websites are raised by people with no intention of delivering on the promises they make.
Market validation: When a particular idea proves a hit with individual investors, it can also enhance its attractiveness for institutional investors to act as lead investors or co-investors. In similar fashion, crowdfunding can be a neat selection mechanism for public sector SME funds—some of which have more funds for entrepreneurship than they do the ability to disburse them.
Crowdfunding isn’t just the latest fad—it’s a powerful new tool. It can be employed at various parts of the entrepreneurial process. It may unlock a new class of entrepreneurs and investors. It may create novel partnership opportunities for institutional investors and for governments to have a wider impact with existing funds. But it comes with its own set of challenges and risks. Given the daunting challenge of creating jobs, though, and the short-term success of crowdfunding to date, perhaps this is something more governments should consider?
Sherwood Neiss is Principal at Crowdfund Capital Advisors LLC (CCA). CCA works with governments, multilateral organizations, investors and entrepreneurial stakeholders on creating enabling crowdfunding ecosystems. Sherwood Neiss and Jason Best created the framework to legalize debt and equity crowdfunding in the USA, have testified in front of the US Congress four times and were at the White House as President Obama signed their bill into law.