Crowdfunding, the practice of pooling resources in small amounts by a large number of people to support a cause, idea or venture over the Internet, has emerged as a new and exciting branch of entrepreneurial and social finance. While still nascent in development, it is gaining traction in many parts of the world as a viable source of financing for small and medium enterprises (SMEs) and start-up businesses.
Crowdfunding opens up fresh possibilities for SMEs to access funding from a larger audience of individual investors, vastly expanding their choices beyond traditional providers of finance. SMEs can potentially attain more reasonable cost of finance by “banking” on their overall reputation to present their trustworthiness to prospective investors, instead of being restricted by the checklists of traditional financiers.
A World Bank report estimated the global crowdfunding market to grow to US$93 billion (S$121 billion) by 2025, or 1.8 times the total 2012 global venture capital figure. The additional capital that start-ups and small businesses can potentially tap from crowdfunding is significant.
Crowdfunding can be grouped into four broad categories: Donation-based, reward-based, equity-based and debt-based.
Donation-based and reward-based crowdfunding are popularised by platforms such as Kickstarter. These platforms are used by early-stage start-ups. A successful campaign not only helps provide funding to kick-start a venture, but also gives the entrepreneur a proof of concept through crowd validation. Funders on such platforms are either motivated by receiving a tangible reward such as a new product or they simply believe in the project and want to help. While the occasional million-dollar hits make the headlines, most successful campaigns on donation- and reward-based platforms average under US$50,000.
With equity- and debt-based platforms, crowdfunding enters adolescence to crowd-investing. It is used by businesses that have already demonstrated minimum viability, in the midst of executing their plans, acquiring customers and showing revenue traction. Funders either invest in the shares of the company with the potential to benefit from the profitability of the business or enter into a contractual arrangement to lend for a determined rate of return, in the form of interest.
ADDRESSING THE FUNDING VOID FOR SMEs
SMEs make up 99 per cent of enterprises, employ more than 70 per cent of the workforce and contribute more than 50 per cent to Singapore’s gross domestic product, comparable to most parts of the world. But the share of loans allocated to SMEs by the mainstream financial sector is only around 20 per cent, nowhere proportional to the significance they have on the economy.
To be sure, it is a global phenomenon. A survey on Organisation for Economic Co-operation and Development (OECD) countries found that SMEs face tougher credit conditions in the form of shortened maturities and increased demand for collateral, compared with larger firms; and increased interest rate differentials between SMEs and large firms.
Inadequate financing prolongs the “hunger game” for small businesses. Consequently, the funding void has been aptly termed “the valley of death” for many small firms. Crowdfunding can help address this shortfall.
In the United Kingdom, for example, peer-to-peer business financing platforms are setting a precedent in offering small businesses an alternative avenue to access finance. One such platform, the Funding Circle, has facilitated more than £400 million (S$818 million) of loans to more than 5,500 UK SMEs, funded by more than 33,000 individual non-accredited investors.
The UK government, through the British Business Bank (the equivalent of statutory board SPRING Singapore) further recognises the viability of such platforms by channelling matching funds to SMEs that have successfully crowdfunded.
Other than expanding the sources of capital for small firms, crowdfunding’s benefit lies in its grassroots-driven process of financing. Unlike traditional finance, the funding relationship is one-to-many. An entrepreneur has the opportunity to expand his network and forge lasting relationships with funders, who will take a vested interest in the success of his business.
Crowdfunding enables a small business to build trust. With trust, businesses gain access to a resilient source of funding and enrol a community of supporters as their natural brand ambassadors.
On the flip side, crowdfunding information can be asymmetric. Investors may become susceptible to fraud or scams. Some form of controls would be necessary to prevent crowdfunding turning into the next Wild West.
The Monetary Authority of Singapore and SPRING Singapore are currently evaluating an appropriate regulatory framework for crowdfunding to strike a balance between investor protection and enabling such innovative grassroots-driven modes of business financing to flourish.
Still, money does not come easy. To orchestrate a campaign requires deliberate and careful planning.
Entrepreneurs looking to secure crowd finance need to do extra homework to effectively engage prospective investors. Other than gathering the financials and working out the business case for the funding request, the campaign will also require the business to deliberate and clarify its vision, mission and values, so as to present a compelling growth story for prospective investors to support.
While the work does exceed that of form-filing, business owners often find validation and gratification from successful campaigns. The journey to entrepreneurship used to be a lonely one, but not any more with crowdfunding.