Crowdfunding is a growing phenomenon. It shows the potential of social media in building online communities based on creativity and giving. Funder and entrepreneur have been brought together to create goods and services that are beneficial to the community. This was the initial objective of Islamic finance. Rizwan Rahman explores the crowdfunding model and finds it value-driven and with lots of potential.
I want to learn Chinese. I type into Sheikh Google “Learning Chinese” – I am too lazy to go to a school or attend a course outside; plus I am impecunious! It gives me a list of options. Nothing really floats my boat. I get a little bored researching. I want to search something else. I have been hearing a lot about Kickstarter recently, a crowdfunding website. Zach Braff, an actor, producer and director, recently raised $3.1 million to produce a film through Kickstarter. 46,000 average people – not celebrities – contributed money through the website. That is approximately $67 per person. I am thinking that’s a pretty good way of earning money, let me check it out. So I go to the website and a smile crosses my face. On the main page I am confronted with “Chineasy: The easiest way to learn Chinese.” How coincidental! I click on it. Chineasy teaches Chinese through illustrations. The page is long and reads like a business plan, informing me of its pedagogical methodology, who the creator is, and how much it needs to set up this project of enabling people to learn Chinese. The page is interspersed with diagrams and videos. I am diligent; I go through it all. At the end of the day I want to learn Chinese! I am interested in the project. It needs £75,000 to set up. It has raised £37,315 and 1,049 people have contributed (known as Backers) as at the time of reading. There appears to be a time limit to when the creator needs the money by. I like the project. I like the creator. I want to donate (known as Pledges) some money so the project can come to fruition, and the website gives a list of goodies that I will receive depending on how much I donate. I register onto the website. If I donate a pound, I will get a Shout Out on its Chinese website. If I donate £10, I get the E-book to learn Chinese. If I donate £1,200, I get the whole shebang (their words, not mine). I like the idea. I donate a pound. Other people can benefit from my donation. Shame I can’t, but I am impecunious!
Crowdfunding: The People’s Revolution
Crowdfunding has become the latest fad in the social media era. Simply, an originator needs money to develop his ideas into a tangible product – it could be anything – and requests funding. He/she creates a sales pitch which they upload onto a crowdfunding website like Kickstarter. They have to calculate the amount they require to ‘kickstart’ their project. The website team assesses the idea conducting a type of due diligence. After they are satisfied, the pitch is uploaded onto the website. A person interested in the idea donates money; typically there is no minimum amount that can be donated. The donor does not get equity in the business; instead receiving some other form of gratuity. If the amount is not reached within a determined period, some websites return the donations back. Others give the option of return. The crowdfunding website typically receives about 5 – 10% of the money raised of successful projects.
Today, there are many crowdfunding platforms besides Kickstarter, which is the most popular. One report states over 450. The principles are the same in that originators go to the website to raise money. Differences lie in the type of projects that can be advertised, levels of scrutiny of project ideas, disbursement of donation times, the gratuity on offer to donors, and distribution of products after creation. Other crowdfunding sites include Indiegogo, Crowdit, and Crowd Supply.
Crowdfunding prides itself in being non-corporate. Donors are investors that do not expect to profit, but pledge money because they believe in the idea. The ideas are not limited to one specific field: they could be computer games or movies, remote patient monitoring devices or a new type of drink. Many commentators speak of an emotional attachment between the donor and the idea – individuals are more interested in seeing the idea come to fruition than benefiting themselves from the profits. So they invest little or large amounts. If there are thousands of people that also believe in the idea, accumulating funds becomes far easier.
The question is about publicity, and the internet provides the opportune avenue for instant advertising to a greater number of people. The originator does not have to shop around for funders and sacrifice a percentage share of the profits that can be made. Plus the pick of funders grows as the internet is global. One donor may not be attracted to the idea but another might be. All the originator needs is a group of interested donors.
Social media gives crowdfunding its elixir insofar as it harnesses the power of people’s consciousness in the creation of desired goods and services. Here, the individual has control in determining whether the market needs the good – a case of demand pushing supply. Not only this, the donor is contributing to a good that will be beneficial for him and the whole community. The value of most crowdfunding platforms is the nexus between donor and idea; a bottom-up model is created. Problems arise when considering the probity of the originator and the platform. An unscrupulous individual may use the platform as a means of raising capital for himself. Most platforms have a screening process where they accept or reject ideas but the due diligence is not full-proof. As for the platform itself, originators and investors have to be certain the site is genuine. Fundamentally, the model is based upon trust.
Equity Crowdfunding
The most successful crowdfunded project, so far, is Star Citizen, a multiplayer online videogame which raised over $14 million beating the previous $10,266,844 record set by Pebble Watch, a smartwatch. High investments reveal the possibility of generating profits for investors through shareholdings, effectively combining emotion with idea with the incentives of profit. Equity crowdfunding, as it has come to be known, is a new way of investment, with UK-based platforms Seedrs and Crowdcube leading the way. Investors get a share of the business and can have voting rights and dividends, similar to common equity investments. The difference is the connection between investor and idea. The bottom line for crowdfunders is not dividend or the capital gain, but the value of the idea to the community.
The problem confronting equity crowdfunding platforms is regulation. Soliciting investments from the general public when the originator has not filed with country’s financial regulators is deemed illegal. Laws are changing in many countries to capture the potential of equity crowdfunding. Italy became the first European country to publish legislation that regulated equity crowdfunding. The draft is currently being discussed. Other countries have legislation that is not specific but is encompassing. Nevertheless, to streamline and facilitate the growth of crowdfunding, European countries are looking into changing legislation.
Passing crowdfunding legislation in the USA has not been a smooth process. In April 2012, President Obama signed in the Jumpstart Our Business Startups (JOBS) Act, intended to “increase American job creation and economic growth by improving access to the public capital markets for emerging growth companies.” However, not all parts of the act are in legislation. It was only in July that the SEC lifted the ban on public solicitation allowing companies to freely advertise that they are fundraising to the general public. This was a positive step forward but quicker progress is needed. In the end, the extent of the USA’s adoption of crowdfunding will have an influence throughout the world.
What Makes Crowdfunding Successful?
The success of crowdfunding has shown the potential of donations to build companies. The move into equity crowdfunding and peer-to-peer lending reveals that a lot can be done with the basic model. But what has been stressed thus far is that crowdfunding is very much a collaborative endeavour linking investor, entrepreneur and agent. It creates a social economy, one not entirely based on self-interest and derivation of profits. Rather the focus is on building ideas. This is why many of the projects that have been funded are artistic, because the investor feels a visceral connection with the idea. Both commercial and civic projects can be (and have been) funded with crowdfunding platforms.
The internet provides a perfect marketing platform, not only for the originator, but for the investor. The previously mentioned Zach Braff leveraged off his celebrity status, inadvertently, to generate investment. Individuals were pulled in by his celebrity status. If a project has well-known backers, and many backers, this will increase interest.
So what makes crowfunding successful?
1. It is about the idea. The idea could be original or mundane but the originator must believe the idea is beneficial for the community in some way, whether it is to entertain, teach or provide.
2. The donor must have an ‘emotional connection’ to the idea. Without this connection, he/she is unlikely to donate.
3. The internet brings together individuals from around the world immediately and in an instant. The difficulty for entrepreneurs has always been to find finance. It involves searching, networking, begging! The internet eases this process. Originators can instantly pitch; donors (and many of them) can instantly receive.
4. Awareness of the crowdfunding platform is necessary. This is obvious, but how does Kickstarter and Indiegogo gather interest? A few successful projects and media interest gives impetus.
5. You do not have to be a millionaire to invest. Micro-investments from many people can do the trick.
6. Acknowledgement goes a long way. Backers typically receive a gratuity for their investment. It is not money. It is a token of thanks. That is enough to make the donor feel involved.
7. Trust the originator to execute and the platform to disburse the funds. Trust goes a long way. Without donor trust crowdfunding would crumble especially as regulation is minimal. The donors have to trust the platform first to distribute the funds, and then the originator to execute.
These principles attract originators and would-be donors alike. Through crowdfunding platforms, there is a greater pool of individuals from which a group may be interested.
Is Crowdfunding Islamic?
As mentioned, there are over 450 crowdfunding platforms, one of which is Shekra. Set up in Egypt in 2012 by Shehab Marzban and Adeb Boseli, Shekra blends Islamic finance with crowdfunding. Principally, the focus is on small and medium-sized businesses in the Middle East in order to engender and galvanise entrepreneurship in a region noted for high youth unemployment. The model follows the basic crowdfunding model with a few tweaks. There is a closed group of investors, Shekra provides a score judging the potential of the idea and suitability of the investment, and Shekra acts as an equity partner rather than a recipient of a fixed percentage fee.
The model prides itself in sharing the risk and reward following the tenets of shirka (partnership) contracts. The projects will have to be Shari’a compliant, a key difference with other crowdfunding platforms. Importantly, there is a consulting team from Shekra that helps the originator set up their company and offers advice in terms of market pitching and promotion. Once again, a collaboration between different parties ensures a social economy: ideas, investors and entrepreneurs are connected together.
In many ways, crowdfunding resembles the economic relationships in pre-modern Islamic countries in that trust was a mainstay of business relationships. Merchants would often send their agents to sell their wares in distant markets, occasionally for little to no profits. Agents would trek into markets and sell the products, returning back to the merchant with the profits earned. To sustain and maintain this relationship trust was crucial. Anyone who broke the trust would be ostracised from the community.
Similarly, crowdfunding relies on trust. Without regulation, crowdfunding is risky as the donor does not know the originator. But the internet has created online communities that bring people from around the world together. It is difficult to oversee each member but the platform knows that it will cease to have an impact if the originator does not bring to fruition the pitched idea. It is upon the platform to ensure that the originator is honest and hardworking. The originator looking for money knows that to receive money, the idea has to be original and well thought out. This shows effort. If he has gone this far, he is likely he will execute the idea and donors will be likely to donate. This is not full proof and there have been instances where patents have been breached or funds have not been adequately spent. Nevertheless, instances are few.
For the Islamic financial industry, crowdfunding offers opportunities for the industry to return to its original goals. The original ideals of the industry were to share profit and risk and to be egalitarian. The industry has moved more towards debt finance in which the bottom line is not the idea or the end product, but the potential to profit. Crowdfunding brings the social aspect of finance as it draws individuals together to essentially judge the importance of an idea and its impact of society. Donors, by donating, are not buying a product they need or to enhance their lives, they are donating because they believe of its value. This is value maximisation and not profit maximisation. This is where the masses know what they want and are not swayed by the insinuations of advertising and excessive investments. This is a value-driven, bottom-up model. And we are only seeing the beginnings of its potential.
