While spending two months in Africa in early 2018 learning about the local startup ecosystem, I was exposed to the harsh reality of the lack of funding options available to African small & medium enterprises (SMEs), including technology startups. Entrepreneurs have few places to turn to fund their businesses, and investors have a difficult time assessing African companies. The time has come to introduce new and different funding models to supplement venture financing. One model in particular--equity crowdfunding--caught my attention given its applicability to emerging markets. I set out to learn more and to connect with the group of trailblazers who are working to bring equity crowdfunding to Africa, to better understand how it can boost investment and innovation within the continent.
Equity Crowdfunding: An Overview
Crowdfunding has taken off globally and has begun to gain traction in Africa, because of the new opportunities it provides individuals or businesses looking to raise awareness and funds for their ideas and products. It has increased the pool of potential idea-backers around the world from a select few investors with experience and capital, to anybody with internet access.
But, not all types of crowdfunding are created equal. Crowdfunding models include donation-based crowdfunding (in which donors are not typically granted anything in return for their donation), rewards-based crowdfunding (in which backers contribute funds in exchange for some reward--in many cases the item produced by the campaign), equity crowdfunding (in which backers contribute funds to companies in exchange for a piece of equity in the company), and debt/lending crowdfunding (in which lenders provide money and expect their loan to be paid back with interest).
Put simply, equity crowdfunding is much more demanding for businesses to pursue, and for platforms to manage, than other forms of crowdfunding. There are intensive compliance requirements to protect the financial interests of investors, and each company pitching itself through an equity crowdfunding campaign is subject to an in-depth financial and legal due diligence process. Investors must also be educated on the risks of investing in such campaigns.
Why Africa?
The potential benefits of successful equity crowdfunding are amplified within emerging markets like Africa. The primary and most obvious benefit is access to capital. In 2017, African tech startups raised US$195 million according to a recent report released by Disrupt Africa, and this figure has almost been equaled in just the first half of 2018. To put this figure in perspective, in 2017, venture deal value in the U.S. reached US$84 billion.
Capital is gradually making its way to Africa, but an infusion of investment is sorely needed given the size of the market and the severity of its developmental needs. An outside-in approach reliant on foreign investment through formal investment channels like venture capital will not accelerate growth fast enough or on a large enough scale. Even in the U.S., with its abundance of access to capital, the US$84 billion in venture capital raised was distributed across only 8,000 of the country’s 6 million businesses. Foreign investors tend to have unrealistic expectations of the timing required to scale an African businesses, and local seasoned investors tend to be risk averse.
Equity crowdfunding offers an alternative, democratizing investment, and doing so from the inside-out--offering local residents the ability to invest in locally registered businesses (and beyond if the equity crowdfunding platform complies with financial and legal requirements in other countries).
It could be particularly impactful in Africa because of the number and types of companies it could fund. In more established markets in the U.S. and Europe, equity crowdfunding is often viewed as a last resort for companies looking to raise capital. Many of the companies featured on equity crowdfunding platforms in these markets are empirically less profitable and have higher levels of debt than their peers that do not create campaigns. This makes sense--an overwhelming portion of the companies pursuing external equity financing in mature markets are those who tried and failed to secure capital internally through more traditional equity or debt financing.
By contrast, in much of Africa, access to capital for small businesses, especially early-stage capital, is nonexistent, despite the fact that SMEs (including a small yet important segment of technology startups) contribute more than 60% of total GDP and make up about 90% of all business in Sub-Saharan Africa. According to the Disrupt Africa report, nearly 75% of the capital raised by African startups in 2017 was raised by startups in 3 countries: South Africa, Nigeria, and Kenya. Companies with talented staff and viable products that fit their market are not able to try and fail to raise capital, because they don’t know where to start. They fail because they don’t have the opportunity to pitch themselves, not because their pitch fails.
Equity crowdfunding addresses these needs, introducing a model that is more inclusive and offers increased control to early-stage businesses, transferring much of the judgment of whether a company can and should try before failing from the few to the many. Although it is in its very early stages in Africa, equity crowdfunding has already produced limited results: Inge Prins, the Chief Marketing Officer of South Africa’s only equity crowdfunding platform, Uprise.Africa, shared that earlier this week, the platform paid out investment funds for the first time to local brewery Drifter Brewery. This followed a successful campaign that raised R3,889,000 (US$293,000), far exceeding its stated goal by almost R1,000,000.
Successful individual campaigns are a step in the right direction, but ultimately, equity crowdfunding is a numbers game. It prioritizes investment volume over ticket price. The big question is: will it work in Africa on a large scale?
Different Countries, Different Prospects
While Africa's economies are growing rapidly, this growth has not necessarily trickled down, and much of the population still relies on informal activities to earn a living. For the African public to buy into equity crowdfunding, supplying the micro-investments needed to support it, the equity crowdfunding model must be set up the right way. This means equity crowdfunding platforms must meet certain conditions. These conditions are standard across all markets, however their ability to be met by different African nations varies from market to market.
1. Regulation. Equity Crowdfunding is just now starting to be seriously discussed in Africa, and is currently not regulated in any African countries. Regulation is what catalyzed the growth of equity crowdfunding platforms like Republic and StartEngine in the U.S., with the implementation of Title III of the JOBS Act in May 2016. This piece of legislation governs every aspect of equity crowdfunding in the U.S., from fundraising limits to company filing and financial disclosure requirements.
Similar legislation for equity crowdfunding in Africa is needed if it is to be a sustainable and scalable investment option for both companies and investors. The current cost structure and the legal requirements involved in setting up and managing an equity crowdfunding platform are prohibitive for many would-be platforms. Prins noted that Uprise.Africa, which launched in late 2017, assumes the costs of managing a specific category of license and adhering to all rules enacted by South Africa’s financial regulatory body, the Financial Services Board (FSB), even though the platform is not technically regulated as an equity crowdfunding platform.
Regulation also benefits investors by providing them protection, and sometimes further benefits. In the U.K., investors are incentivized to invest via equity crowdfunding platforms by receiving tax breaks on their investments.
The equity crowdfunding regulation process in Africa is in different stages of development depending on the country. In Morocco, there is a drafted crowdfunding legal framework on the Secretary General’s desk that will be voted on by parliament in the coming months. Instrumental in the process of getting this framework drafted and voted on are Arnaud Pinier and Eric Asmar. Pinier launched Smala & Co, the first donation-based crowdfunding platform in Morocco, 4 years ago. He and Asmar have been working to update Morocco’s crowdfunding legislation across the various types of crowdfunding, including equity crowdfunding, with the eventual goal of consolidating all types on the Smala & Co platform. However, as Pinier explained, Morocco also has a particularly complex financial regulatory structure to navigate. Each type of crowdfunding is overseen by a different regulatory body, and all regulatory bodies must validate the proposed updated framework or else it cannot be implemented. Other countries, such as South Africa, Ghana, and Kenya, are in much earlier stages of discussions with their respective regulatory bodies.
In the absence of regulation, equity crowdfunding platforms cannot succeed on a large scale in Africa. But can current platforms survive or better yet grow in any meaningful way until this point comes? The answer to this question depends not on formal regulation, but on informal regulatory interpretation, and how regulatory bodies treat unregulated financial products that operate in the gray area between legality and illegality. For instance, in Nigeria, the Securities & Exchange Commission explicitly issued a ban on equity crowdfunding in August 2016, leading the country’s only equity crowdfunding platform, Malaik, to shut down. Smala & Co in Morocco also had to suspend its crowdfunding operations (including donation-based crowdfunding) as it could not comply with current Moroccan regulations. On the other hand, as mentioned above, South Africa’s Uprise.Africa has operated successful equity crowdfunding campaigns without violating its country’s investment regulations.
Smala & Co’s Asmar suggested the divide between countries in which something unregulated is acceptable versus forbidden dates back to colonial ties to the continent. In countries previously colonized by the French (mostly in North and West Africa), the general regulatory attitude is: ‘if something is not expressly permitted, it is forbidden.’ Conversely, in countries with Anglo-Saxon roots (mostly in South and East Africa), there is more leeway to operate in a legal gray area. Causation aside, this attitudinal divide, whether historical in basis or not, will dictate the ability of equity crowdfunding platforms to exist in Africa until regulation is in place.
2. Quality control. Trust is a massive issue for African consumers and investors, and especially in the case of a high-risk investment scenario like an equity crowdfunding campaign, platforms must work to build investor trust. This means carefully vetting and curating the companies listed on the platform. Uprise.Africa requires all entrepreneurs to submit a business plan and investor pitch deck. The team then prompts the entrepreneurs to complete a due diligence questionnaire, after which an investment analyst generates a report on the business that is sent to a review committee to assess. If the business is successful in the review, the Uprise.Africa team begins its extensive legal and financial due diligence process, and only once a business makes it through is a pitch developed to go live on the platform.
Platforms must also play a more active role in supporting their featured companies, acting as a partner rather than merely a forum, and overseeing campaigns from a creative and business perspective. And crucially, platforms must play an active role in promoting financial education and clearly educating potential investors about the risks as well as the upside of equity crowdfunding, acting as an intermediate between investor and company.
3. Online payments. There must be an online mechanism for investors to easily transfer funds to companies on the platform. This has proven to be a barrier in complex regulatory environments like Tunisia and Morocco, whose only payment gateways are banks, and whose currency is non-convertible, meaning it can’t be exchanged for an international currency such as the U.S. dollar or the euro outside of Morocco. This has translated to a lack of digital payment options in such markets. Furthermore, the general lack of trust in the region extends to digital payments. On the other hand, countries like Kenya, Zimbabwe, and South Africa have embraced digital payments and money transfer technology. Without a strong online payments infrastructure, equity crowdfunding platforms cannot function.
It's too early to tell whether equity crowdfunding will take hold in Africa. If these conditions are not met, equity crowdfunding will never scale. But if they are met, equity crowdfunding platforms have the potential to pave the way for impactful growth in African markets, attracting public investment to unlock a new viable model for funding innovation for the continent’s many small businesses and startups.
