As economies around the world battle through various stages of the economic crunch, small and medium enterprises (SMEs) are a saving grace. They’ve been identified as compelling catalysts of broad-ranging economic growth and development, research shows that, in South Africa, an estimated 91% of formalised businesses are that of SMEs. These businesses provide employment opportunities for approximately 60% of the labour force and their total economic output accounts for approximately 34% of GDP.
Yet, despite significant contributions to the economy, existing financial institutions have failed in their mission to provide capital to those entities that need it most.
One of the most unique aspects of SMEs is their ability to delve into new and unsaturated sectors of the economy and develop exciting and innovative opportunities. Yet the significant risks attached to this means banks are less likely to lend money and more likely to give the cold shoulder, hindering the ability of a market-based economy to function efficiently. The few that are successful in obtaining some capital, stumble, thanks to the inability of financial institutions to take into account important SMEs specific products like immediate cash for invoicing, financial leasing and lower borrowing costs. As a result, a large proportion of start-ups and promising businesses begin to eat their way through their overdraft and, after seeing no way out, many completely fall to the wayside and shut up shop in the first two years of existence.
Admittedly, banks are slowly but surely waking up to the importance of SMEs, but, for some, the damage has already been done; future entrepreneurs of generation tomorrow are left feeling and thinking that banks just don’t support small enterprises! Yet, where there is a will, there is a way.
Queue crowdfunding – pioneering companies that are stepping in and filling the massive financial void and uplifting despondent youth. Taking inspiration from old school practices of money lending from friends, family and peers, these forward-thinking firms focus on helping small companies and entrepreneurs acquire funding for a business venture by raising monetary contributions from a large number of investors, usually via the internet. Last year alone, a report released by UK-based The Crowdfunding Centre showed that more than US$60, 000 was raised on an hourly basis via global crowdfunding initiatives and 442 global crowdfunding campaigns were launched each day.
Crowdfunding has many plusses, the main being expertise. Unlike banking professionals, who have usually only ever worked in the industry and have no real understanding of how different SMEs function on a daily basis, crowdfunding investors possess sector-specific insight into the environment in which the business trades and have deep and enriching experience that helps to widen the reach of a niche business and increases their capacity to find bigger and stronger audiences. Companies from highly specialised sectors that address highly complex business and social problems, like those entrenched in renewable energy and new technologies, for example, continue to successfully attract investment through alternative finance as they receive the knowledge and expertise not necessarily available from a high street bank manager.
Plus, unlike a bank, the crowdfunding process allows funds to be allocated on the viability of an idea as opposed a decision that is based on credit records and the need for individuals to show financial stability. All or nothing crowdfunding platforms create a safety net for investors and business owners, as funds are only allocated once the entire anticipated funding goal has been reached. If an entrepreneur sets a goal and doesn’t reach it, there is no penalty or loses, as all the funds are returned to each contributor, whilst a successful fundraising project results in wins all around – the entrepreneur gets his or her funding and the investor receives a small percentage commission.
Entrepreneurs also have the opportunity to pre-sell a product or concept that they haven’t yet taken to market, so are able to test consumer reactions and create encouraging networks for global marketing and advertising opportunities. An idea that might need some work can help inspire other ideas and drive even more business opportunities. There is never a cost to apply, the process is less painful and extensive than going to the bank and an international portfolio of investors establishes a great foundation to spread and limit risk.
In essence, crowdfunding is to the rest of the world what stokvels have been to South Africa for so many years – an alternative way of obtaining financial support. As the banks continue to do battle with the negative reputations that continue to overshadow them, the alternative financing sector continues to evolve and transform the way SMEs verify, execute and grow their business ventures. What started out as a social experiment several years ago is now becoming an exciting way of life and an interesting way to do business.