Harnessing the crowd's power

Tapping the masses could potentially get your business off the ground or take your operations to new heights

Image used for illustrative purpose. Convincing potential investors through crowdfunding may involve a lot of a start-up owner’s time and effort, but it is one of the risks that go with the SME territory.

Image used for illustrative purpose. Convincing potential investors through crowdfunding may involve a lot of a start-up owner’s time and effort, but it is one of the risks that go with the SME territory.

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When Mouna Abbassy and her husband decided to give up their day jobs and set up IZIL, a Dubai-based start-up that manufactures and distributes beauty products made from natural Argan oil, a trip to the bank was never an option. Instead, they relied on their savings to jumpstart their business plan.

“We did not consider banks for personal reasons; non-Islamic bank debt is not an option for us because of our values and Islamic beliefs,” she said. “Plus, we know all too well that as a small business, [the] chances of obtaining a bank loan are nearly impossible.  Banks look for businesses [that are] at least two years into the business cycle, [are already] generating cash and have assets they can guarantee the loan with.”

From the very start, the Moroccan entrepreneurs were looking for alternative funding sources, which would not interfere with the operational and strategic vision they have for their brand. As IZIL gathered steam, the couple turned to crowdfunding platform Eureeca.com to raise the USD 152,625 they required.

“Thirty-two days [after we launched our campaign], we raised the capital we needed from 20 investors,” she said.

By the time IZIL’s campaign closed, the company was 104% overfunded at a total of USD 159,675 from 29 investors, representing equity of 6.6%, according to the Eureeca website.

Abbassy’s story is becoming more and more common in the Middle East and North Africa (MENA) region, home to a thriving, yet underserved, SME market.

The allure of crowdfunding

What makes crowdfunding a viable alternative to bank lending is the fact that it is a simple, innovative way of raising capital by asking a large number of people for a small amount of money, said Austin Rudman, partner and head of financial services for UAE and Oman at KPMG.

“[It] is revolutionising the finance industry, using platform technology to provide smart, flexible and timely finance by offering a marketplace that directly connects businesses with investors,” he said. “[It provides] businesses with faster access to lower cost finance and provide investors with better returns and managed risk by diversifying their investments.”

Rudman said crowdfunding has become a very successful practice in the United Kingdom and the United States where LendingClub, which pioneered the industry, exceeded expectations and raised around USD 870 million on its initial public offering debut in 2014. In the Middle East, particularly the UAE, some of the crowdfunding models available include equity-based crowdfunding and peer-to-peer (P2P) lending.

“For start-up SMEs looking to establish their business, equity-based crowdfunding is the best option. For established SMEs looking for capital, the P2P lending model is a more cost-effective option,” Rudman suggested.

Narrowing the funding gap

Crowdfunding’s popularity in the MENA region results from a distinct funding gap in the market, said Sam Quawasmi, managing director and co-founder of Eureeca.com.

“Only 20% of SMEs in MENA have a loan or a line of credit, the lowest percentage of any region in the world; and the average share of SME lending on total loans is only 8%, which is the lowest ratio among all the regions,” he said.

“With regard to equity institutional investors, the region’s financial enablers are merely a handful. In particular, the network of equity investors, a critical source for early stage capital in the West, is still nascent in the MENA region.”

Quawasmi said the strong demand for alternative funding sources was evident when Eureeca managed to list 26 companies and fund 12 firms, one year after it was launched in 2013.

While based in the UAE, Eureeca offers a cross-border crowdinvesting platform that spans Jordan, Lebanon, Egypt and Kuwait. It is also fully licensed in the UK, and is regulated in The Netherlands and Malaysia.

Pitfalls of crowdfunding

Rudman of KPMG said entrepreneurs should know that the equity-based crowdfunding model exposes their project details to potential investors and funders, potentially giving their competitors inside information about their business.

“They should also be aware of exactly how much equity they are giving up to establish their business and will it still be profitable to them after giving away equity,” he cautioned. “On the other hand for peer-to-peer lending model, it involves a rigorous review to ensure that businesses are creditworthy.”

Despite this, Rudman believes that crowdfunding – as well as P2P lending – is still, by far, faster and more flexible than seeking bank financing.

“To balance the positive reaction to this new phenomenon, there is some scepticism around the lack of traditional banking regulation to protect lenders, borrowers and investors alike.

“The challenges will be educating the market as to the benefits and transparency to drive volume adoption as well as providing comfort to regulators that crowdfunding companies have the necessary investor protection measures in place,” he said.

Convincing potential investors through crowdfunding may involve a lot of a start-up owner’s time and effort, but it is one of the risks that go with the SME territory.

Note: This article was originally published on Accelerate SME and it has been republished on Zawya with full copyright permission.

Disclaimer: This article is provided for informational purposes only. The content does not provide tax, legal or investment advice or opinion regarding the suitability, value or profitability of any particular security, portfolio or investment strategy. Read our full disclaimer policy here.

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