US investors are buzzing over crowdfunding, would it work in South Africa?
Among the many things that the internet has made possible is what experts call “many-to-many” communication – that is, sites where a large number of individuals can individually and collectively communicate directly with a large number of other individuals. This innovation is what underlies the idea of crowdfunding.
For those of you who aren’t aware of it, crowdfunding is a sexy idea that has gained prominence and popularity over the last few years. In its original form, crowdfunding involves sites where seekers of funding – micro-businesses, charities, or individual artists and writers with a project in mind – post descriptions of and information about their projects/plans/business models. People with money to invest or donate browse these posts, and pick ones that they find appealing to fund, usually with relatively small amounts of money. The idea is that by aggregating lots of small contributions, big sums can be raised to fund worthy ventures.
Generally speaking, old-school crowdfunding sites treat the money that they raise as donations – in other words, donors don’t buy equity in the things that they fund; rather they are rewarded with small gifts or honourable mentions, and a warm, fuzzy feeling of doing good. In the USA, prominent crowdfunding sites that primarily raise money for creative projects like documentary films or dance troupes include Kickstarter, ArtistShare, and Indiegogo. On these sites, you can find and fund cash-strapped but worthy community projects, bands raising money to produce albums, and even micro-businesses looking for seed money.
Of more interest to investors, however, is the advent of crowdfund investing. The idea here is pretty much identical to the classic idea of venture capital, but with an internet angle – start-ups or people with ideas for start-ups post the details of their ideas and plans on crowdfund investing sites, and investors browse these, identify ideas they think have potential, and fund them, buying equity (that is, a small ownership stake and an interest in future profits) in return for their usually-modest investments.
Now, you may be asking yourself, what exactly, besides a sexy name, is the difference between this and regular investing? The answer, at least in the USA, is accessibility and regulation.
Traditional venture capital is pretty much a game reserved for wealthy and highly informed investors. Start-ups seeking venture capital usually identify a few big-money investors, and negotiate complex contracts with them under the jurisdiction of a host of securities laws and regulations. This excludes small investors, who lack the sophistication and contacts to find and take advantage of attractive (and potentially high growth) start-up opportunities. It also means that small businesses have basically three options for raising funds: bank loans, friends and family, or attracting the attention of venture capitalists (no easy task).
For years, people have wondered why there couldn’t be a better way and as crowdfunding models developed in other domains, people started asking if such models could be used to open up start-up investing to small investors. The idea caught on, and last year America’s Congress passed the Jumpstart Our Business Startups Act (JOBS Act), following similar legislation in the UK and elsewhere in Europe.
Among many other things, the JOBS Act makes it possible for start-ups to source up to $1m a year from online funding portals without having to register with the Securities and Exchange Commission (SEC) and file a stack of complex financial reports. This reduces the regulatory burden on small companies and expands their fundraising field, as well as offering investors new ways to invest in high-growth start-ups.
Of course, observers worry that crowdfund investing will mean ill-informed and vulnerable investors end up being scammed. Because companies seeking crowdfunds don’t have to compile financial statements or comply with SEC rules, there is certainly a danger that some will take advantage of the “loophole”. However, given that the highly regulated Enron ended up being a Ponzi scheme, and the well-overseen Bernie Madoff made off with billions, it’s hard to get too worked up about the risks. Investing is a dangerous business, and as always, caveat emptor should be the watchword.
So far, there has been no significant move to get crowdfund investing up and running in South Africa. However, in many ways SA is a great environment for it. The country desperately needs to get more small businesses up and running, and South African banks and venture capitalists are slow to dole out the rands. The country’s financial infrastructure is solid, and by leveraging this technology, massive opportunities could be created.