Crowdfunding can be a cost effective way for businesses to raise funds and evidence suggests that its popularity is growing among businesses in the UAE. But exactly how does it work and what are its advantages and disadvantages? Sam Quawasmi of crowdfunding platform Eureeca explains what crowdfunding is and shares his insights on this relatively new form of fund raising:
What is crowdfunding and how does it work?
Crowdfunding is the process of raising funds from the public, or the “crowd,” for a business or project via a web-based platform.
It is an alternative source of financing to more traditional options such as bank loans and venture capital. Crowdfunding is comprised of different models that suit varying types of enterprises and target funding amounts and offers different incentives to investors in exchange for their capital.
What are the different models of crowdfunding?
There are three main crowdfunding models:
- Donation or reward based: This is the most well-known crowdfunding model. The crowd contributes capital to a campaign in exchange for perks, products, or simply the satisfaction of supporting a worthwhile endeavor. Kickstarter is the most prominent example of this model.
- Debt-based crowdfunding: Typically in the form of peer-to-peer lending, this is a highly prevalent crowdfunding model in which the crowd collectively issues a loan to a fundraiser, which is paid back over a specified period at a predetermined interest rate.
- Equity-based crowdfunding: For more developed businesses seeking significant capital, this is also known as “crowdinvesting”. Small and medium businesses (SMEs) raise capital from investors in exchange for company shares. Eureeca is the only model of this kind in the region. In its first 15 months of operation it has helped 12 regional SMEs raise a combined $2 million.
How big is crowdfunding in the UAE?
Over the past few years, the UAE has developed into one of the region’s leading crowdfunding markets. The diversity of the UAE’s crowdfunding sector means that fundraisers of all types can select the model that best suits their enterprise and capital acquisition needs.
For Eureeca, five of its 12 successfully funded SMEs were UAE-based. Of the six active campaigns currently on Eureeca, five come from the UAE.
Given the significant role that SMEs play in the UAE economy, crowdfunding is expected to grow in importance in the UAE as entrepreneurs seek alternative sources of financing.
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What are the advantages and disadvantages of crowdfunding?
Crowdfunding offers a number of advantages to both fundraisers and investors:
- Convenient and affordable access to capital for SMEs: This is crucial in ensuring growth, especially in the Middle East, where bank lending is often inaccessible to many SME’s and venture capital remains immature. It also allows entrepreneurs to expend less energy on raising capital, instead focusing on developing their business model and product.
- Allows clients and fans to share in an SME’s success: By offering ownership in the business, investors will remain loyal and serve as marketing ambassadors who spread the word about the brand among their social networks.
- A diversified investor base: Investors will not only come from the “crowd” but also can include institutional investors, who can add different types of value. It can also reduce an SME reliance on financing from a handful of large investors.
- The public relations and marketing value of a successfully funded campaign is immense as journalists covering sectors relevant to the funded business are apt to provide additional media exposure.
- Other advantages of crowdfunding for SMEs include product validation, market research, and early customer creation.
- For investors, crowdfunding platforms allow anyone with disposable income to become active investors who can contribute to social and economic growth by funding their favorite businesses, and potentially, create additional sources of income.
Some of the disadvantages of crowdfunding are:
- Many crowdfunding platforms, including Eureeca, utilize a fixed-funding model in which the entire funding target must be reached for the SME to receive the capital. If it is not, the funds are returned to the investors. In this all-or-nothing scenario, SMEs need to be realistic when setting their target amount, otherwise they may have to return any raised capital.
- While crowdfunding makes investment opportunities more accessible for investors, it also puts more distance between them and the projects in which they invest. This creates gaps in the information needed to make sound investments, leaving investors vulnerable to fraud or general incompetence on the part of the entrepreneur.
- Crowdfunding largely remains unregulated and platforms are often constrained by each country’s local laws, which can limit their geographic scope of operation. Eureeca, for example, is, for the most part, unable to accept investors from the United States because of US Securities and Exchange Commission regulations.
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How should business owners prepare for a crowdfunding campaign?
- Be fully prepared to address any would-be investors’ concerns. Ensuring that their business model and product prototype are sound is crucial.
- Prepare a solid business with proven profitability and potential to scale. A well thought out and implemented campaign will inspire confidence among investors, thus improving the chances of hitting investment targets.
Eureeca’s application process requires entrepreneurs to submit an executive summary, a business plan, financial projections and videos and images of their business. To be approved for the site, each of these must be well formulated to collectively demonstrate the proven success, viability and potential of the business. Entrepreneurs must put energy and thought into each of these prior to applying to Eureeca.
What advice would you give business owners seeking crowdfunding?
- Choose the crowdfunding model best suited to your business / project — each model attracts a “crowd” with specific expectations for the return on their investment. For example, if you’re launching a development or artistic project, or are still in the prototyping phase of product development, donation- or reward-based models are best suited. Funders using these platforms are looking for a product sample or the satisfaction of seeing your project be realized. For SMEs with a proven business model seeking significant injection of capital and access to the expertise of seasoned investors, equity-based platforms such as Eureeca are your best bet. These models attract investors who will remain interested because of their stake in the company.
- Have your business model ironed out, ready for investment — poorly designed business models without promising metrics will not inspire investors’ confidence
- Design and create a high quality campaign – one that is well put together and professional. A good product in bad packaging will not yield the desired results.
- Tap into your social networks before and after campaign launch — social networks play a pivotal role in marketing your campaign and can yield a vast web of socially connected investors and contributors with a personal interest in your business or project.
- Engage with the crowd throughout the campaign — a common pitfall for crowdfunders is to launch a campaign, tell friends, and expect the funds to come rolling in. You have to be proactive, often providing potential funders with updates and the exhibited persistence that will boost the likelihood of investment.
Sam Quawasmi is the Managing Director and Co-founder of Eureeca. A former Investment Banker, Sam worked for international investment banks in London as well as regional investment banks in Dubai. www.eureeca.com