HomeAnalysisEquity-based crowdfunding

Equity-based crowdfunding

Alexander Maune
AS the world is entangled in a nasty global war that is being fought from different fronts, that is, military, financial, electronic, and diplomatic with Russia and Ukraine at the centre stage, the implications on the financial flows are going to be serious.

The United States and European Union have imposed sanctions on Russia. They have disconnected some Russian banks as well as the Russian central bank from the Society for Worldwide Interbank Financial Telecommunication (Swift) among other measures.

This came as a shocker to many financial experts, who are calculating the global consequences of sanctioning a central bank of a Group of 20 countries (G20) and United Nations Security Council member (P5) country, a superpower for that matter.

Currently, the impact of these sanctions has reached every corner of the world due to Russia’s position in the global economy. Russia is a global gas and petroleum producer and exporter.

It exports about 45% of its gas to the European Union (EU) and 8% of its crude oil and petroleum products to the US besides other commodities.

Global energy and financial experts are asking who is going to be the biggest loser in this war. To some, these sanctions will act as a boomerang.

These measures have also strengthened the Eastern bloc, especially the China-Russia relationship. As for the EU, it seems as if they did not think through their actions, emotions were at play.

But what can be expected from politicians, they do what suits them at that moment at all costs.

From the way the current global financial architecture is framed, it is going to be more difficult for capital to cross borders unless there are some changes to the current structure and setup. The world is likely to see changes to the global monetary framework coming from the East with Russia and China at the centre stage.

Nobody is going to be spared from this. The only fall-back for entrepreneurs will be domestic investments and the diaspora community through equity-based crowdfunding.

Besides, countries will forge strategic alliances with trusted partners. This can be seen in the current conflict between Russia and Ukraine. Countries are aligning to blocs in which they feel safe in the long run.

This conflict is beginning to have serious negative implications on investments as investors seek safe havens for their assets.

Entrepreneurs are not spared as their source of finance is becoming less and less each day.  Globally, equity-based crowdfunding (EBCF), especially in developed countries has been leading as alternative finance for entrepreneurs. EBCF model accounts for the vast majority of activity, which is concentrated in a few countries notably China, the US and the UK.

However, its performance is not that much in developing countries of Africa where donation-based crowdfunding is taking the lead. EBCF is only in its very earliest stages in Africa. But what is EBCF?

For this paper, EBCF refers to a mechanism that enables broad groups of investors to fund start-up companies and small businesses in return for equity (Agrawal, Ajay; Catalini, Christian; Goldfarb, Avi, 2016).

The main motivation of investors is to get a return on their investment, with other rewards or tangible benefits. The equity-based model is considered an investment model.

In EBCF, individuals or institutional funders buy an ownership stake in a company or organisation. If the business succeeds, then its value goes up, as well as the value of a share in that business and vice versa.

The term equity crowdfunding is often used to describe crowd-investing into both debt and equity-based instruments when they are offered on an equity crowdfunding platform.

According to Kislov Sergey (2000), the first known baseline design of EBCF was proposed in the year 2000 in Russia. The first known EBCF platform was launched in 2007 in Australia, called the Australian Small Scale Offerings Board (ASSOB) (Raymond Sam; Lambkin, Anthony; Swart, Richard; Neiss, Sherwood; Best, Jason, 2013).  ASSOB now trades as Enable Funding that has raised over US$150 million for 176 private companies as of 2017.

In 2011 Crowdcube, launched its first EBCF platform in the UK. According to Crowdfundinsider (2013), there were 77 EBCF against 175 donation-based, 127 reward-based, and 36 lending-based crowdfunding platforms in 2013.

In an article entitled, Reward Crowdfunding contribution as Planned Behaviour: An extended Framework, Shneor and Munim (2019) identified three clusters of investors, as defined by their motivation to back EBCF campaigns in Finland.

The clusters included donation-oriented supporters, who are predominantly motivated by the opportunity to participate and help; return-oriented supporters, who are motivated by both financial returns and opportunity to participate and help; and pure investors, who are motivated predominantly by financial returns.

Because EBCF involves investment into a commercial enterprise, it is often subject to securities and financial regulation. Thus the reason why its adoption is limited since securities regulations in most jurisdictions are still pending or non-existent

In his 2014 book entitled, Crowdfunding: A Guide to Raising Capital on the Internet, Steven Dresner states that the Business and Entrepreneurship category is the most active, followed by Social Causes, which is less active on EBCF campaigns when compared to other models.

The emerging model of EBCF is found on platforms such as Seedrs, Exorot.com, and Crowdcube.

Small-and-medium-sized businesses actively utilise online alternative finance channels and instruments for their funding needs.

Since 2015, alternative finance firms have increasingly serviced SME clients, with discussions around SME-focused FinTech activity serving as a key priority for policymakers globally.

The utility of alternative finance for SME clients is undeniable. With data suggesting that volumes going to entrepreneurs, start-ups, and small-and medium-sized businesses globally are on the rise and proving to be a viable and long-lasting funding source, which may be even more critical during pandemics such as Covid-19 (Cambridge Centre for Alternative Finance [CCAF], 2021).

In 2015 EBCF had the highest average number of funders (279) in Africa.

Equity-based models contributed US$1,5 billion in 2019 and US$2,2 billion in 2020 (3% in 2019 and 4% in 2020). As equity-based models have advanced, subsets of the model like real estate and property-based crowdfunding have flourished, with investors able to acquire full or partial ownership of a property asset via the purchase of property shares, and Revenue/Profit Sharing.

In terms of global volume by alternative finance models, EBCF ranked 10 out of 18 in 2019 and 2020. EBCF total volume by region in 2019 and 2020 were as follows: APAC (US$450m andUS$737m); China (US$70 000and US$40 000); Europe (US$968m andUS$1,13bn); LAC (US$49m andUS$37m); MENA (US$13m andUS$12m); SSA (US$16m andUS$8m); UK (US$624m andUS$656m); US and Canada (US$1,96bn and US$1,8bn).

Besides some promising prospects of EBCF globally, there are some associated risks.

The following are some of the main risks associated with EBCF globally: default, malpractice, changes to current regulation, fraud, cyber security breaches, incompetence or mismanagement on the part of platforms, lack of regulatory clarity for platforms, and project risks.

These risks are strengthened by the great asymmetry of information in EBCF and may lead to market failures such as adverse selection, moral hazards, and collective action. Uncertainty regarding the fairness and proper use of the collected funds is another critical aspect affecting EBCF.

Another risk factor includes creators of crowdfunding platforms who are inexperienced and who cannot complete funded projects by agreed deadlines.

Furthermore, amateur investors are susceptible to fraud when they fail to verify projects and “free-ride” on other investors` funding histories. Above all, there is an overall risk of failure in early, platform-driven projects.

Creators of investment-based crowdfunding platforms such as EBCF face regulatory hurdles in some jurisdictions. In most SSA countries, EBCF platforms need to have a stockbroker licence, which is a high burden for small platforms.

In some jurisdictions, EBCF regulations have been amended to further strengthen investor protection, with conflict of interest rules and regulation of information sheets for investors as the key changes.

In summary, EBCF will be an exciting and rewarding way to increase access to capital for businesses and investment firms, especially in Africa, but the rules must be followed carefully to ensure compliance and investor protection.

  • Maune is a Talmudic scholar, researcher, and consultant as well as a member of IoDZ. Mailto: alexandermaune6@gmail.com.

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