Regulatory bottlenecks denying local start-ups opportunities offered by alternative finance. FILE PHOTO | NMG
What you need to know:
Crowdfunding methods have played huge role in western economies in solving funding dilemma on startups, thus triggering innovations and consequently boosting development efforts.
During the just-ended elections, President Uhuru Kenyatta and activist Boniface Mwangi explored different strategies to raise campaign funds.
Whereas Mr Kenyatta raised money by holding a private dinner with a coterie of high-net-worth supporters, Mr Mwangi carried out a passionate social media fundraiser from the general public to aid his cause.
The contrasting fundraising scenarios the two politicians faced equally reflects in funding of businesses. Start-ups always struggle to raise capital even where they have sound collateral.
Established entities, on the other hand, are able to easily raise capital by taking credit facilities or tapping capital markets.
It is this funding gap that financial technologies have tried to bridge. This has led to the rise of alternative finance and shadow banking fundraising methods which are mostly modelled on trust and technology.
In the digital era, financial institutions have lost the monopoly of financial intermediation.
One such alternative finance model that has shown huge potential is crowdfunding. This is the practice of raising money from a large number of people to fund projects.
Unfortunately, Kenya has lagged behind in tapping this model. For crowdfunding methods have played huge role in western economies in solving funding dilemma on startups, thus triggering innovations and consequently boosting development efforts.
Crowdfunding methods may generally take four forms.
First is the equity crowdfunding, where capital is raised by calling the ‘crowd’ to invest in a venture in exchange for shares.
Second is the reward-based crowdfunding, where backers of the project receive rewards such as free software based on their contribution after the venture becomes afloat.
Third is debt-based crowdfunding, where investors offer unsecured loans to an enterprise which would be refunded.
Lastly, there is charity-based crowdfunding, where contributors to a cause expect no returns. This has been relatively common in the country, with Kenyans often called to lend a hand in various worthy causes, including settling medical bills.
We have seen campaigns such as #Kenyans4Kenya, #WeAreOne, #1MilliForJadudi, among others. Platforms such as M-Changa have been started to facilitate the processes.
However, equity and debt-based crowdfunding has not taken root. Unlike their western counterparts, local tech-savvy entrepreneurs have not been able to utilise these funding models due to an outdated legal framework and unsupportive regulators.
For instance, the Capital Markets Authority (CMA) states in its 2016 annual report that it carried out enforcement actions by terminating a crowdfunding attempt by an entity called Propertyzote Crowdfund Pty Limited by issuing a “Cease and Desist.” Propertyzote had intended to crowdfund for real estate venture.
The action by the CMA was unfortunate. The regulators should encourage and not strangle innovations through formulaic interpretation of the laws that are visibly outdated.
There are numerous case studies of successful crowdfunding initiatives. As early as 1885, when US government sources failed to provide funding to build a monumental base for the Statue of Liberty, the public crowdfunded through a newspaper-led campaign. This enabled the shipping of the Statue from France to the US.
In 2012, Palmer Luckey founded Oculus VR, a virtual reality firm, by crowdfunding through Kickstarter platform. Oculus VR was later acquired by Facebook for a whopping $2 billion.
These examples clearly illustrate the power of crowdfunding in financing entrepreneurial ventures and creative projects, which traditional financiers will ordinarily give a wide berth.
In having facilitative regulatory framework, the US has set the pace by enacting the Jumpstart Our Business Start-ups Act (JOBS Act), which provides initial parameters for crowdfunding activities.
Kenya should follow suit and enact a legal framework to facilitate crowdfunding efforts. Alternatively, business ventures seeking to crowdfund could be allowed to operate without triggering legal repercussions, in what is called ‘regulatory sandboxes’ but under watchful eye of regulators to protect the public.
Adopting crowdfunding would certainly open new possibilities for funding emerging enterprises, some of which would have huge impact on society.
It would equally open avenues for entrepreneurs to utilise social media, the web, and network effects to offer rewards, or equity stakes to potential investors in exchange for funds.
It is noteworthy that start-ups of yesterday, such as Facebook, are some of the world’s most valuable companies today.
A crowdfunding mechanism would also facilitate such budding ventures to engage investors anywhere in the world.
This would ensure start-ups achieve a greater purpose of connecting creators and entrepreneurs directly with customers and funders, enabling creators refine their ideas and further spur demand for new innovations, and improving sales when the innovations are commercialised.
Nevertheless, businesses should only be allowed to crowdfund on authorised platforms to avoid duping members of the public.
