Crowdfunding and other innovative fundraising platforms a new lifeline for start-ups
Craft gin and craft beer have become highly popular in SA. The fascination with these products has, however, extended beyond just drinking them. It has also led to inspiring examples of how new businesses can find alternative ways of raising capital in SA.
Sugarbird Gin, which was launched in 2017, recently ran a crowdfunding campaign through the platform Thundafund that raised more than R1m to increase its production and export its product to Europe, Asia and the US. This was followed by Drifter Brewing Company raising nearly R4m through the Uprise.Africa platform to accelerate its expansion into South Korea.
The significance of these successes is not just that exciting local products will be heading to international markets, but that they demonstrate the potential for alternative models in early-stage financing. There is a huge funding gap for new businesses in SA, and there is a real need to find innovative ways to close it.
Traditional lenders such as banks find it difficult to lend money to start-ups because of the risks involved. These businesses don’t have a track record, and rarely have the collateral to secure loans. Some entrepreneurs seek out grant funding, but it is taxing to apply for this form of funding and it generally comes in limited amounts. Given SA’s socioeconomic reality, there aren’t many who are lucky enough to get money out of their personal network of “friends, family and fools”.
Early-stage businesses therefore need to find other ways of securing finance. Increasingly, many see alternative models as genuine options.
The crowdfunding approach used by Sugarbird Gin and the Drifter Brewing Company has already shown its potential. Instead of the traditional model of one investor and one investee, it opens up the possibility to attract finance from a number of different sources. In its original form crowdfunding was a way for people to raise money for charitable causes. Often people were encouraged to make contributions by being offered some kind of reward. This model translates very easily into raising early-stage finance. Contributors can be offered interest payments, equity in the company, a profit share, or some other kind of return.
In the case of Sugarbird Gin, anyone who pledged R100,000 was guaranteed R25,000 in profit. All the people who participated in Drifter’s capital raising were granted shares in the company. People are therefore not being asked simply to give money away. They take some interest in the business’s success. The Uprise.Africa platform through which Drifter ran its crowdfunding campaign is also a member of the Southern African Venture Capital and Private Equity Association.
Crowdfunding is unlikely to ever raise enormous amounts of capital, but R1m can be a significant figure for a start-up. It can therefore play a meaningful role in the very early-stage development of an entrepreneurial idea. While the main positive of these crowdfunding models is that they open up new potential sources of funding, they still struggle to deal with the risk involved. Many platforms provide detail in terms of projections and financial statements, but information enabling contributors to assess the likelihood of actually receiving the promised rewards, remains limited.
Another nontraditional model targets this gap specifically. Appreciating the information asymmetry between investors and early-stage businesses, alternative credit scoring uses technology to determine the potential risk to investors. Drawing on big data and artificial intelligence, alternative credit scoring draws information from a range of different sources to assess an entrepreneur's behaviour. Since most start-ups are dependent on their owners, the assumption can be made that the risk associated with that individual can be extrapolated to the business as well.
In this model potential funders use machine learning algorithms rather than traditional credit scores to determine how likely they are to recover their loans. These algorithms don’t rely only on formal financial information either, but on data points such as cellphone records, transactions in mobile wallets, and social media behaviour. This means businesses and entrepreneurs do not even need to have a bank account or credit history to apply for funding. They can be assessed quickly and accurately using available data and artificial intelligence.
SA fintech company Jumo has been a pioneer in this field, lending money to individuals through mobile devices. Its model is relevant to entrepreneurs and small businesses as well. Lulalend, which styles itself as SA’s only online provider of business funding, uses a similar approach to score applicants. Since everything is handled online, it is able to deliver funding within 24 hours.
Again, the amounts involved are relatively small — Lulalend offers loans of between R20,000 and R500,000. However, for early-stage businesses having access to this funding can be critical. The Lulalend model also makes it possible for its loans to be renewed month-to-month, effectively serving as a revolving credit facility.
As technology and digitisation continue to reform the business environment, it is likely that even more such alternative funding models will be developed. This will open up additional opportunities for entrepreneurs to access early-stage finance.
Given that traditional financing is generally not an option for many entrepreneurs, the impact on business development in SA could be substantial. That means more successful businesses, more job creation and greater potential for economic development.
• Moetse and Suchecki are innovative finance & impact investing project managers at the Bertha Centre for Social Innovation and Entrepreneurship at the UCT Graduate School of Business.