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Crowd funding provides a key revenue source for expansion

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A trader counting money. FILE PHOTO | NMG

Summary

  • As corporates, small and medium sized companies explore various options of financing, the securities industry offers a viable alternative using crowd funding platforms.
  • They present investors with attractive and innovative asset classes besides traditional debt and equity plain products.
  • Crowd funding is the practice of raising money from groups, through online, mobile platforms or social networking means.

As corporates, small and medium sized companies explore various options of financing, the securities industry offers a viable alternative using crowd funding platforms. They present investors with attractive and innovative asset classes besides traditional debt and equity plain products.

Crowd funding is the practice of raising money from groups, through online, mobile platforms or social networking means. It offers small firms an alternative way to pool capital from a variety of investors, customers or lenders within a short time frame.

This form of fundraising is not just used to finance small and medium sized enterprises, it also backs social causes and creative projects among others. The investment-based crowdfunding can be undertaken through debt and/or equity or hybrid models.

The Capital Markets Authority supports market development, innovation and adoption of emerging technologies in raising finance and analytics. Steps are also being taken to facilitate adequate disclosures for platforms such as crowdfunding for participants to understand the risks involved. Evidently, alternative funding platforms have the potential to fundamentally change the capital markets financing model.

Global crowd funding market has experienced strong growth with bright prospects. According to Statista, transaction value in the segment is projected to reach $1 billion in 2021 worldwide.

Africa represents around 25 percent of the flows with potential for growth. In 2018, the region received $209 million with Zambia, Kenya and South Africa recording the largest crowd funding volumes of $40 million, $35 million and $27 million respectively.

The volumes are expected to grow as regulators lead efforts to design appropriate policies and regulation to ensure consumer/investor protection.

Globally, regulators recognise the importance of crowd funding as an alternative source of capital that can benefit businesses, individuals, and non-profit organisations, while making markets promote financial inclusion and economic development.

There are various types of crowd funding. Equity crowdfunding enables investors to finance private early-stage companies and small businesses that are not listed on bourses in exchange for equity. In doing so, investors receive shares in the company in return for cash as in a typical Initial Public Offer (IPO).

On the other hand, in debt-based crowd funding, investors are given a choice to put their money in the security of a business through debt instruments such as corporate bonds or medium-term notes, issued to finance operations or expansion plans.

Alternatively, companies can leverage this avenue by issuing such instruments through a crowd funding platform and signing a debt-based contract with interest-based returns with investors.

This debt-based crowd funding models have inbuilt data analytics, Know Your Client (KYC) and credit scoring models for investors and issuers to determine their ability to meet their interest and debt obligations when they fall due.

Equity and debt-based crowd funding have the capacity to transform access to finance by medium and small sized enterprises within the capital market not only by bringing competition to the corporate market but also widening the pool of available capital to fundraisers at a lower cost.

They also have the advantage of speedy capital deployment thus creating efficiencies and competition that reduces on-line risk.

This ensures that the beneficiary SMEs are more profitable. Besides, crowd funding provides direct access to the market and eliminates excessive costs to investors due to intermediation. It is also considered as scalable, flexible, and an efficient fund-raising solution compared to conventional methods.

In October 2020, the Authority granted a ‘No Objection’ to Pezesha Africa Limited (Pezesha) to operate its debt-based crowd funding platform in the Kenyan capital markets, after a successful one-year testing period in the CMA Regulatory Sandbox.

The Sandbox was launched in March 2019. A No Objection requires firms or licensed entities to undertake periodic reporting and compliance requirements including; effective risk management framework, transparency, capital adequacy, integrity, corporate governance, fair, orderly, and efficient conduct of business, protection of investor interest and disclosure requirements.

In line with CMA’s regulatory mandate, the emergence of these technologies that are potentially disruptive will need to be treated with caution due to the associated risks such as prudential risks which may not be fully appreciated. This also presents a new scope of market conduct risks that can put-off retail investors if not properly managed.

Viola Kilel, Senior product development officer, Capital Markets Authority