Unlisted & Unlimited: Alternative financing for SMEs

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CROWDFUNDING has democratised fundraising for businesses since its mainstream appearance on the Internet in 2008. While still popular as an alternative form of financing, it has also evolved into something new — equity crowdfunding.

Crowdfunding platforms were initially dominated by start-ups seeking seed funding to kick-start their businesses or by individuals looking to raise funds for charity and other social purposes. They make their case for why they need the money on a crowdfunding website and then rely on public donations to reach the targeted sum.

Equity crowdfunding is where an entrepreneur raises capital by allocating a share of his business to the crowd that funds him. This is different from conventional crowdfunding as the business owners do not give up any equity in exchange for funds.

Equity crowdfunding has become an increasingly popular way for SMEs to raise funds in the two to three years since it emerged. In the UK, for example, it has taken off in such a way that it might displace banks as the primary source of funding for SMEs.

Despite the UK government’s encouragement for banks to drive SME lending and the available tax breaks for investors, the number of loans taken by SMEs in the UK has contracted on an annual basis since 2009, decreasing 25% between 2011 and 2013.

According to news reports, the emergence of equity crowdfunding platforms, such as Crowdcube, Seedrs, Funding Circle and Thin Cats, are quickly filling in the gaps in the UK’s SME funding landscape.

“Previously, [crowdfunding] was for relatively smaller, early-stage companies to raise small amounts of money. But now, much larger businesses are looking to top up their round,” Kieran Garvey, business development manager at Crowdcube, tells The Edge. “They’ve already secured some investments, perhaps even [from] institutional [investors], but are just looking [for the] additional 30% to 40%.”

Since its inception in 2011, Crowdcube has raised over £40 million (RM212.6 million) from an investor crowd of 90,645. The average amount raised for the platform’s successfully funded businesses is £230,990. The smallest amount raised to date is £12,000 while the largest is £1.9 million, with an average of 104 investors per pitch (investors can go in with as little as £10).

Crowdcube funded 54 businesses last year, and this year it helped Stelios Haji-Ioannou, the founder of listed British airline easyJet, raise £1.4 million for his next venture, easyProperty, adding to the £6 million he had already obtained.

Getting a business onto Crowdcube’s platform, however, is a selective process. Most of them are based in the UK and can offer equity stakes or issue mini-bonds to investors in exchange for funding.

“We accept international investors, but a lot of investment comes from people within your first, second or third degree of connection, and they tend to be people from your own country,” says Garvey, adding that Crowdcube partners universities, venture capital firms and corporate finance houses that refer businesses to them.

“There’s a filtering system through our partners, we then turn down over 80% of the businesses that apply to us. Of the 20% that get on the site, 5% get funded,” he continues.

“[Of this 5%,] 25% are start-ups that raise £50,000 to £150,000 and sell 20% [of their business], compared with early-stage businesses, which give out 15% and raise £150,000 to £500,000. These businesses would have been around for a couple of years, have some traction and a bit of a track record already.

“Growth businesses take up a quarter of our funded applicants. They are well established, have been around for a few years, have a proven business model, are revenue generating and are here to stay. They typically give out 10% and look for £750,000 [and beyond].”

To sceptics of equity crowdfunding, proponents have this to say: A platform isn’t just a vehicle to get money, it is also a marketing tool businesses can use for publicity during the fundraising campaign period. On top of that, it’s a much faster way to raise capital. A project on a crowdfunding platform usually gets 30 to 60 days to raise funds, while the traditional channel of bank loans takes months.

If the amount of capital raised from equity crowdfunding increases, having an adequate regulatory framework will become necessary. Though there isn’t a secondary market on which investors can sell their equity stakes, Garvey anticipates its appearance in the next 6 to 12 months.

“Inevitably, there will be a market for that. There are companies trying to do that at the moment, not just for crowdfunding investors, but to help any private investor sell his shares,” he says. “There’s a whole ecosystem and infrastructure that’s merging to enable that.”

On the home front, the Securities Commission Malaysia (SC) proposed a regulatory framework for equity crowdfunding in August, seeking public feedback before revising it (see box below). The regulator also organised the Securities Commission Synergy and Crowdfunding Forum (SCxSC) on Sept 19 to raise awareness of equity crowdfunding as an alternative channel of fundraising. Only a handful of countries are trying to establish a framework that recognises and regulates this market.

“Two areas of financial innovation using disruptive technologies that have seen strong growth in recent years are peer-to-peer lending and equity crowdfunding. Regulators view such alternative online venues as a viable market-based financing and investment option, providing a means to not only seek funding but also to crowdsource ideas and innovations for underserved segments of the real economy,” said SC chairman Datuk Ranjit Ajit Singh at the SCxSC Forum.

“At the SC, we strongly believe the future of finance is market-based, therefore enabling the means for these funding channels to thrive in an environment that promotes confident and informed participation is a key imperative.”

According to Ranjit, 2013 saw more than 600 crowdfunding platforms worldwide raising some US$5 billion (RM16.4 billion). Crowdfunding’s total market potential is estimated to grow to between US$90 billion and US$96 billion by 2025, with China and East Asia accounting for 57% of the global funds raised. While it is still relatively small in the wider equity and debt capital markets, the SC says crowdfunding is an important channel for capital formation that will impact the financial landscape.

“As part of this innovative ecosystem, the SC will provide a regulatory framework that ensures an orderly market with adequate oversight to facilitate small businesses raising equity capital.”

The SCxSC Forum drew a crowd of 600, comprising entrepreneurs, angel investors, students and business leaders, and contemplated issues such as how the web can enhance capital raising, technopreneurship and angel investing via equity crowdfunding at the panel sessions.

Regulatory framework aside, the next critical factor in ensuring equity crowdfunding’s success is investor confidence. Thus, strong investor education initiatives to help investors make informed financial decisions will be a key component, says Ranjit.

“Equity crowdfunding lets investors ‘get in on the deal’, allowing everyone who understands the risks to have the opportunity to invest in early-stage companies … thereby strengthening the inclusiveness of finance,” he adds.

“Everyone has a role to play in advancing the crowdfunding phenomenon. There is still a lot of work ahead to make this happen … requiring collective and concerted effort on the part of policymakers, technology providers, market participants, businesses and investors alike.”

This article first appeared in Unlisted & Unlimited, The Edge Malaysia Weekly, on October 13 - 19, 2014.