Where the crowd goes, others follow

A lack of liquidity coupled with the boom in social networks is fuelling the growth of crowd-funding platforms. But it’s not just an American phenomenon; several websites have set up in the region in recent months looking to tap into the Middle East’s deep pockets
Where the crowd goes, others follow
By Claire Valdini
Sun 29 Jul 2012 09:18 AM

When Dubai-based singer-songwriter Gayathri Krishnan was looking for investment for her first album she didn’t think twice about how she would raise the money. Having been forced to cancel a collaborative project with other UAE artists after a series of corporations and sponsors pulled out at the last minute, she logged onto the crowd-funding platform, Indiegogo.

“My goal was to reach $20,000 and I raised that in the first ten days. I had 30 days in which to raise the target and in that time I raised a total of $23,130 from 90 investors from all around the world including the UAE, Australia, Canada, India and even China,” she tells Arabian Business.

Krishnan is just one of a growing number of individuals turning to crowd-funding platforms, a capital-raising strategy that allows investors to buy small stakes in ventures amid a shortage of liquidity following the global economic crisis.

Once the reserve of the creative arts industry, crowd-funding is now mainstream. US-based Pebble Technology Corp, which is developing a smart wristwatch that connects to Apple’s iPhone and Google’s Android phones, raised $10.27m from 68,929 individuals in May, making it the most crowd-funded start-up ever in dollar terms, according to website Kickstarter and investors.

Pebble is unlikely to hold its crown for very long. Research firm Massolution forecasts that $2bn will be raised worldwide this year, up from just $530m in 2009. There are currently over 450 crowd-funding platforms, up from 100 in 2007.

So how does it work? While the concept has been around for years — fans of the British rock group, Marillion, raised $60,000 in donations, underwriting its entire US tour in 1997 — the concept has been gaining steady momentum following the onset of the global economic downturn and the boom in social network sites such as Facebook and Twitter.

Companies and individuals looking for capital have an allotted period of time to raise their target via crowd-funding platforms. Would-be investors are then able to quiz the companies using social media. “The crowd — the investors — are there to review and critique the business plan online; they can vote, share, ‘like’ with their friends,” explains Chris Thomas, of Dubai-based crowd-funding website, Eureeca.

“If within three months you have hit 100 percent of your funding objective, the [money] is transferred to your company account. Crucially, it’s an opportunity for investors to invest as little as $100 — because that’s our minimum ticket rate — in a new business in exchange for equity.”

Investors are also offered incentives for each price point. Krishnan, for example, offered her financial backers eleven different packages based on a range of donations from $10 to $5,000. Investors that donated $10 were promised a signed digital copy of the album and artwork two weeks prior to its launch while those that paid $5,000 were given executive producer credit. “The $300 package, which included sending me a sound-bite to include in a song, was the most popular,” she says.

Crucial to the industry’s growth in recent months has been the US Jumpstart Our Business Startups Act — or JOBS Act — which was signed into law in April and enables small businesses to sell securities through crowd-funding websites, subject to certain procedures.

The provision, which the Securities & Exchange Commission will finalise before implementing the act early next year, means companies will be able to sell up to $1m of stock per year to an unlimited number of investors. Individuals who earn less than $100,000 a year can invest up to $2,000 per company per year; wealthier folks can invest ten percent of their income up to $100,000.

“What this will allow people to do is for those that have money and those that need money is democratise the access to capital so that they can launch businesses. What you are going to find is that people with money are going to be following the crowd to see where the people and ideas are that are getting thousands of followers are going and they are going to deploy more capital,” says Sherwood Neiss, one of the chief architects behind the JOBS Act.

The introduction of legislation will not only boost entrepreneurship but also increase political and economic stability, adds Jason Best, who worked with Neiss to co-author the framework. “Crowd-funding is going to increase political stability because to create new jobs and to employ more people who are investors emotionally and financially in existing power structures and existing organisations of companies makes for a much more stable political environment,” he explains.

While the majority of the industry’s growth is coming from western markets — of the $1.5bn raised last year, $837m came from North American investors, according to Massolution — it is gaining popularity in the rest of the world. Massolution expects the number of crowd-funding platforms to increase to 530 by the end of the year, up from 452 in April.

In the last month, two Dubai-based firms, Eureeca and Aflamnah, have launched operations. In the week since Eureeca launched, the website, which is founded by former investment bankers Chris Thomas and Sam Quawasmi, received more than 65 inquires from companies seeking funding and as many from investors looking to help kick-start local companies.

“The market is very ripe for this; if you are a business owner looking to raise funds, it’s very difficult to find an outlet now; banks aren’t lending, venture capitalists have moved to much larger deals so there is a very large funding gap that Eureeca fills,” says Thomas.

Eureeca expects to help 100 businesses reach their funding targets within the first year of operation, says Quawasmi. “We are looking to launch the site with around ten businesses and we would expect that once we hit critical mass over the first year we hope to get around fifteen businesses per month.

“Of that we are expecting around half (40-50 percent) to get funded so in terms of the opportunities we would hope in our first year to help 100 businesses reach their funding,” he adds.

While Eureeca aims to appeal to a wide range of start-ups and companies that are already operating across a wide range of sectors, Aflamnah says it will concentrate on the region’s creative community. The website already has four confirmed projects, all seeking funding for a variety of film-based projects, which launched their campaign on 1 July. The firm, which charges a flat rate of $100 for registration and stipulates that the project must have some form of link to the region, says it is currently receiving two new enquiries daily.

“There seems to be a movement at the moment that is very supportive of talent, at a grass roots level as well as other levels but it’s just finding them, people don’t know how to go. It is as much as a marketing tool for these ideas as it will be a funding tool. It will take a little bit of time to take off in a big way but we’re seeding it and the response so far has been great,” says Vida Rizq, a founding partner.

In spite of its rapid growth, crowd-funding is not without its critics. US state regulators and several high-profile commentators have voiced concerns about the threat of potential con artists, claiming to be crowd-funding brokers or to represent online portals through which future deals must be conducted, while others claim it is a misleading way in which to raise capital.

While the JOBS Act will provide regulation in the US, other regions are still lagging behind. The lack of legislation in the Arab world is likely to limit the number of Middle Eastern investors, says Jordanian entrepreneur and founder of Aramex, Fadi Ghandour.

“Crowd-funding will have lots of challenges, mostly legal. It requires hybrid commercial laws to allow for such a democratic funding process and I do not see how it can be done,” he explains.

“I am certainly not sure how this could happen in the Arab world where current laws are barely keeping up with the changes happening in technology and the possibility virtual investors which is what crowd funding is.”

Ghandour adds that it is only when the legal hurdles are ironed out will it enable start-ups to benefit.

Quawasmi from Eureeca argues that it is difficult to mislead hundreds of investors. “The process of validation is actually the crowd themselves so the terms and conditions have been clearly highlighted on any business plan. We expect investors that are going to invest money, especially large amounts, to do their due diligence and to ask these entrepreneurs questions transparently online,” he says.

“The all-or-nothing financing… forces entrepreneurs to think of milestones, otherwise called start-up methodology, so it’s going help entrepreneurs think more strategically about capital and make them smarter business people,” adds Sherwood.

Legislation aside, it looks like crowd-funding is here to stay.

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