The emergence of crowdfunding in South African financial markets

By Daniel Makina, University of South Africa

Introduction

Innovation has given rise to fast growing forms of alternative financial markets outside the regulated traditional markets, now commonly referred to alternative finance, also known as disruptive finance or distributed finance. Crowdsourcing, which means seeking ideas and resources from crowds, has resulted in one form of alternative finance known as crowdfunding. In essence, crowdfunding is a model of microfinance that dates back to the 18^th century when Ireland experienced a famine. In response, an Irish nationalist and author of Gulliver’s Travels, Jonathan Swift, started a £500 fund to lend money to poor tradesmen whereby they would pay in small weekly instalments without interest. Over the years more schemes mushroomed throughout the world to cater for the rural and urban poor leading to the establishment of microfinance institutions such as ACCION International in Venezuela and Grameen Bank in Bangladesh in the 1960s and 1970s. The internet revolution of the 2000s gave rise to new models of microfinance now commonly known as crowdfunding. Thus modern day crowdfunding is facilitated by the internet and its definition now refers to the use of this platform. Professor Ethan Mollick of the Wharton School of the University of Pennsylvania in the USA attempts an all embracing definition as follows: “Crowdfunding refers to the efforts by entrepreneurial individuals and groups –cultural, social, and for-profit – to fund their ventures by drawing on relatively small contributions from a relatively large number of individuals using the internet, without standard financial intermediaries.” However, crowdfunding cannot only be defined by the use of internet as it has been there from time immemorial.

Although crowdfunding exists in many various forms, there are four main forms, viz: (i) donations-based, (ii) reward-based, (iii) peer-to-peer (P2P) lending and (iv) equity crowdfunding. Donations-based crowdfunding is where the crowd funds a cause without expectation of compensation whereas in reward-based crowdfunding they would be expecting a token gift. In the USA crowdfunding platforms such as Kickstarter and IndieGoGo are active in this space. P2P lending pairs individuals looking for small loans and people willing to lend money in small increments. Lending Club is a popular P2P crowdfunding site in the USA. Equity crowdfunding is where investors purchase equity in private companies in small increments. OurCrowd is one equity crowdfunding platform that connects venture capitalists, angel investors and accredited investors.

Social media such Facebook, Twitter and the like, has facilitated crowdfunding because of its ability to enable the creation and exchange of user generated content. Social networking sites allow users to create personal pages, provide other users with access, and exchange with them instant messages and emails. Facebook and Twitter which have a wider reach and interactivity are considered suitable channels for most crowdfunding campaigns. For instance, studies have shown that 51% of Facebook users are said to be more likely to buy a product after becoming a fan of the product’s Facebook page. Hence getting followers from the beginning is a crucial part of getting your project funded. Command Partners, the world’s top crowdfunding marketing agency, aptly puts it as follows: “People are more likely to give money to a project they feel a connection with rather than a total stranger, so developing relationships and interacting helps establish your project on a personal level, and not just as a corporate placeholder that’s easy to ignore.”

Global crowdfunding market

In recent times the global crowdfunding market has had a phenomenal growth. This is evident from the Crowdfunding Industry Report released in 2015 by a research firm, Massolution, which specializes in crowdsourcing and crowdfunding industries. Massolution collected data on 1,250 active crowdfunding platforms worldwide and reported significant findings. It reported that crowdfunding platforms raised $16.2 billion in 2014, an amount that was a 167% increase over the amount raised in 2013. Furthermore, Massolution estimated that the global crowdfunding market grew to $34.4 billion in 2015, more than doubling the 2014 figure. The market was dominated by lending which accounted for $25.1 billion, or 73% of the market, followed by donation ($2.9 billion, 8.3%), reward ($2.7 billion, 7.8%%), equity ($2.6 billion, 7.4%) and other types of funding ($1.2, 3.5%). While growth in volumes are primarily being driven by lending-based crowdfunding, the coming into force of the US JOBS (Jumpstart Our Business Startups) Act on 16 May, 2016, which enables small businesses to sell securities to non-accredited investors, will propel  equity crowdfunding to greater heights in the coming years.

When market share is analysed by region, North America accounts for more than half (50.1%) of the crowdfunding market, followed by Asia (30.6%), Europe (18.8%) and other regions (0.5%) which include South America, Oceania and Africa. Notwithstanding the low market share for Africa, crowdfunding in the region is fast growing. It was reported as having achieved an annual growth rate of 101% in 2014.

Crowdfunding in South Africa

GeoPoll, the world’s largest mobile survey platform with a network of 200 million users in Africa and Asia, conducted the African Entrepreneurship Survey in 2015. They sampled five African countries –the DRC, Ghana, Kenya, Nigeria and South Africa- from which 200 entrepreneurs in each country were interviewed. One of the questions asked was for the entrepreneurs to indicate which of the online resources –blogs, crowdfunding, social media, general websites and other – they find useful in supporting business growth. The responses are shown in Table 1 below.

Table 1

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Source: GeoPoll African Enterpreneurship Survey 2015

The survey shows a significant increase in the use of crowdfunding in African countries with the DRC leading among countries surveyed. In fact the usefulness of crowdfunding reported by entrepreneurs in the DRC elicited 25% of responses.

However, it is in South Africa where the crowdfunding market is leading in terms of both the mushrooming of crowdfunding platforms and possibly volumes of funds being raised. Crowdfunding is not entirely a new phenomenon in South Africa. For many years communities used it in the form of stokvels, whereby members contribute small equal amounts to a pool fund every month from which a member is allocated cash in turns. What is new is crowdfunding that now utilizes the internet and social media. In recent years crowdfunding platforms have emerged in South Africa whose objective is to raise funds  for various causes that include funding small businesses, charities, artists, musicians, ideas, studies and many other causes. Table 2 below lists some prominent local crowdfunding platforms that have sprouted in South Africa recently and causes they support. Notably, the majority of these platforms fund small business and hence fosters economic growth and employment.

Table 2

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The size of the crowdfunding market in South Africa is not known. However, from a survey of how much is stated as being raised on various crowdfunding websites, I would estimate the annual volume being raised to be not less than R100 million so far.

Notwithstanding its phenomenal growth, the crowdfunding model is not well understood by many people, including the regulators. Currently, there is no specific law that regulates it. Writing for Creamer Media, Portia Mashinini and Lerato Lamola at Webber Wentzel law firm provide us with useful insights with regard to potential risks posed by crowdfunding and challenges for regulators. They observe that the challenge faced by the Financial Services Board is striking a balance between encouraging crowdfunding, which facilitates easy access to capital for small businesses and hence promote growth, and protecting investors from potential risks. These potential risks include, among others, fraud, money laundering, platform failure, lack of due diligence and proper disclosure. Since the risks largely relate to market conduct, it is envisaged that future crowdfunding regulation will fall under the Financial Conduct Authority when the Twin Peak model of regulation is adopted in South Africa, in which regulators will supervise market conduct to protect financial consumers.

Looking ahead

Crowdfunding is a fast growing form of alternative finance benefiting from web-based technologies such as social media. The World Bank estimates that globally crowdfunding would raise $93 billion annually by 2025. In South Africa the crowdfunding industry is fast growing and one hopes future regulation will not stifle its growth. Evidence shows that official regulation stifles innovation because of lack of expertise by regulators with respect to innovative emerging markets. In South Africa we cannot say crowdfunding is entirely unregulated. While there is no specific legislation for it, different aspects of the industry are regulated via various acts such the Companies Act, the Banks Act, National Credit Act, Financial Advisory and Intermediary Services Act, Financial Markets Act and the Collective Investment Schemes Control Act. Going forward, I would recommend letting the industry self-regulate first before enacting a specific law to regulate crowdfunding.