|01 April, 2019

Better together? How to invest in crowdfunding

Crowdfunding and peer-to-peer lending are on the rise in the region as it becomes an increasingly popular way for smaller businesses to raise finance

Image used for illustrative purpose. Arab business executive chairing an important business meeting.

Image used for illustrative purpose. Arab business executive chairing an important business meeting.

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Turning to the “crowd” for funding a project or venture is becoming increasingly popular in the Middle East and in particular in the UAE. In this process, individual investors and small businesses are connected through an online platform, without the use of a conventional intermediary such as a bank.

 Many observers attribute the rise in alternative solutions of finance like crowdfunding, a branch of fintech, to the credit crisis of 2008 and the increased difficulty of start-ups or SMEs to raise funds. Recent analysis by the Khalifa Fund for Enterprise Development revealed that approximately 50-70 per cent of SME applications for funding are rejected by conventional banks in the United Arab Emirates.

“There is a developing concern of inefficient capital allocation in the UAE as banks and other established financial institutions are reluctant to provide financing solutions to SMEs. However, on the flip side, SMEs contribute approximately 60 per cent to the UAE GDP,” notes Dilantha De Silva, an investment research analyst at OBOR Invest.

“This discrepancy, which results from the conservative lending practices of established financial institutions, sets the platform for alternative financing solution providers to penetrate into the UAE financial system to cater to a growing demand for funds,” De Silva adds.

Gifts and rewards, debt and equity

There are various types of crowdfunding models, explains Rick Pudner, chairman of the Board at Beehive, the first peer-to-peer lending platform to be regulated by the Dubai Financial Services Authority (DFSA). There are “donations” models where funders donate a sum for a cause and do not expect any returns; “rewards” models where funds are asked for in exchange for a future reward; “crowd-sourced equity funding” (CSEF) where the investors receive shares in a company in exchange for the fund they provided; “debt or peer-to-peer lending” models where the lenders provide loans to borrowers and expect it to be paid back with interest at an agreed rate, or a rate fixed by the crowdsourcing platform.

“Beehive is a peer-to-peer lending platform providing an economic return to the crowdfunder through returns on the principal investment paid through monthly repayments,” Pudner says.

The main benefit from the clients’ perspective is that innovative crowdfunding technology helps to eliminate the cost and complexity of conventional finance. 

“The result is a more efficient, streamlined process that provides UAE businesses faster access to low cost loans and investors attractive monthly returns and diversified risk,” explains Pudner. The number of crowdfunding platforms in the UAE is rising. Beehive may be one of the most recognised names, but others include Eureeca, Durise and Zoomal. There are also other offering fractional investments in real estate.

Crowdfunding offers two main advantages for investors. Given that it helps to fund smaller, local businesses, it can be considered to be a ‘sustainable’ type of investment. Pudner highlights the connection between businesses and investors that crowdfunding encourages.

“Creating this connection builds brand recognition and helps support local businesses – it becomes more personal.”

De Silva agrees. “It can be challenging to pinpoint exactly what investors look for in a business, however, they do show interest in SMEs that stand out and appear unique. This is an intriguing part of the investment process and allows them to watch how the company develops and grows in the economy.”

It also gives investors more exposure to innovation. “Investors will have the option of selecting radical, innovative business concepts and ideas for funding purposes as entrepreneurs in UAE are reluctant to approach banks as these traditional lending institutions have not given any indication of being flexible toward innovative business ideas,” De Silva argues. “This underlying situation will provide angel investors with ample projects to choose from.”

A world of potential investments

There are also, of course, diversification benefits.

“Crowdfunding will allow investors to diversify their investment across a wide array of industries.

“Private equity investors in regions such as the Middle East are facing this diversification problem more than any other place due to the limited number of business opportunities available. However, a thoroughly-designed crowdfunding platform will be able to address this issue,” De Silva argues.

Finally, crowdfunding allows investors to test the depth of water with only one foot, meaning they would be able to evaluate available business opportunities in the region without committing a substantial investment amount.

“This flexibility would not be there if an investor decides to complete a private equity transaction or a venture capital investment since the regulators require you to invest a substantial (amount of) capital to gain access to business opportunities in the region,” he said.

Beehive’s Pudner cites the advantages of investing in crowdfunding as: “average annual rates of return of 10 per cent; diversified risk; monthly payments; bids from just 100 dirhams and easy access to cash”.

The regulation red flag

In terms of the “cons”, admittedly regulators in the region have been somewhat slow at catching up with the appetite for crowdfunding.

The DFSA launched its regulatory framework for loan and investment-based crowdfunding platforms in August 2017 - a first in the GCC. Abu Dhabi Global Markets launched its regulatory platform in September 2018.

As with other investments, investors face potential losses if the company they have either loaned money to, or taken a stake in, go out of business. And SMEs are a higher risk than established businesses, as failure rates are much higher – especially in the early years.

(Reporting by Charlotte Kan; Editing by Michael Fahy)

(michael.fahy@refinitiv.com)

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