Introduction to Crowdfunding: An Alternative for SME Funding

The abiding principle of most crowdfunding platforms is the access they provide to average investors to participate in early-stage investing while also giving entrepreneurs access to alternative capital providers.

The first of this four-part series on Crowdfunding as an alternative for SME funding will take you through the history, basics and process of Crowdfunding. It might just be what your small business needs.  

In 2014, an estimated $16.2 billion was raised globally through crowdfunding, representing a growth of 167%, up from $6.1 billion raised in 2013, an average of $57,000 raised per hour globally, 325 projects launched per day in Q1 2014, and over 1,250 dedicated platforms worldwide. These are just but a few mind blowing statistics from the global crowdfunding phenomenon.

But what exactly is Crowdfunding? How does Crowdfunding differ from Crowdsourcing? Is all the social media buzz around it really worth it? How can small businesses and start-ups in Africa tap into this borderless and social media powered funding opportunity?

Crowdsourcing vs crowdfunding – Sometimes confused as referring to the same thing, these two words, though related, carry slightly different meaning. Crowdfunding is actually a subset of crowdsourcing as the latter refers to the process of accessing a wide group of people via the internet to benefit from their expertise, resources, knowledge or time. Crowdfunding focuses on the financial aspect of the resources. Other subsets of crowdsourcing exist, namely cloud labour, distributed knowledge, crowd creativity and open innovation. This write up focuses on crowdfunding as an alternative financing for SMEs.

The term crowdfunding emerged in the mid-2000s and is widely attributed to Michael Sullivan, a blogger. It however only became a viral phenomenon in the late 2000s with the arrival on the scene of two major funds raising platforms, namely, IndieGoGo and Kickstarter. Whereas previous platforms focused on donations to charitable organizations, the latter platforms offer ordinary individuals the opportunity to fund projects of their choice, from profit projects to non-profit oriented ventures but with no prospect of obtaining any money back.

Today, crowdfunding is broadly defined as the online practice of raising funds from a large pool of individuals handing out small monetary contributions for causes or projects they share a common interest in. The contributors’ interests vary from pure emotional attachment to the pursuit of a bountiful return on investment grounded on the hope that the business idea supported will be the next business start-up success story. The abiding principle of most crowdfunding platforms is the access they provide to average investors to participate in early-stage investing while also giving entrepreneurs access to alternative capital providers.

There are four broad variants of crowdfunding: donation, rewards based, equity and lending. But before we continue our discuss, let us review some basic crowdfunding terminologies and the basic crowdfunding process.

Pledge: Financial sum the backer has committed to give to the project if the project meets its financial goal

Reward: A tangible gift to backers in exchange for their contribution; generally the maiden edition or early prototype of the goods or service being promoted or for which funding is sought.

Platform: Website enabling fundraisers to have access to members of the public.

Equity: Shareholding in the promoted business which is promised to the backer in exchange for his contribution.

 

The Process:

  1. Project creator or entrepreneur posts a funding request on an online platform
  2. Terms & conditions (including perks) for contributors as well as the monetary goal of the project are presented.
  3. Project description and business plan where applicable are reviewed by members of the public.
  4. Contributors make their pledges to the project.
  5. If the monetary goal is met at the end of the campaign period, funds are transferred to the crowdsourcer.
  6. If the monetary goal is not met at the end of the campaign period, funds may only be transferred to the crowdsourcer if the campaign was run on a “flexible funding” basis and not an “all or nothing” basis.

Under the donation scheme, contributors give money to a project and expect nothing in return. As crowdfunding campaigns are carried out on the web, it is generally expected that project initiators will maintain their benefactors’ interest through update reports and captivating videos. These videos can in turn be re-broadcast by enthusiasts, which will likely lead to greater online reach and ultimately greater fundraising. Backers with a keen interest in this scheme are community oriented individuals who are keen on supporting local entrepreneurship or a particular cause with a sentimental value to them.

The second part of this series will show where we stand in Africa in terms of crowd funding through social media activity and the financing opportunities that it can offer entrepreneurs …