At first glance, the Middle East and in particular the GCC, seems like an ideal market for a robust crowdfunding economy. But the growth of this peer-to-peer form of financing has been sluggish, blamed in part by slow-moving regulations.

Having a great idea is only the first step for an entrepreneur and it can be difficult to attract and convince the right investors to support the vision. It requires networking, pitching one’s idea and picking out the smart money if one is lucky enough to attract the investment. For young startups that may not be ready to take on large, single source investments, alternative financing models may provide an answer.

The alternative finance market is worth billions globally, and chief among them is crowdfunding where businesses can finance themselves or their projects by requesting small amounts of money from a large group of people.

In theory, this way of raising investment is not new, most businesses essentially “crowdfund” from friends and family in the early stages. However, the internet’s ability to address millions of potential investors at once has brought crowdfunding to the forefront of alternative financing and a promising aspect of financial technology (fintech). According to Statista, the worldwide transaction value in the crowdfunding segment currently amounts to $6.9 billion.

With open online platforms, crowdfunding makes raising capital and investing more accessible, efficient and transparent than other traditional sources of capital. Rather than replacing angel investors and venture capitalists (VC), the model serves as a vehicle for them to invest in small to medium sized enterprises (SME), along with other, perhaps smaller investors.  

From an investor’s point of view, it allows individuals to become involved in a project, without risking large sums. This opens up the possibility of investing to a larger demographic. According to Eureeca, a Dubai-based equity crowdfunding platform, up to 50 per cent of the investments come from the entrepreneur’s own network.

“Crowdfunding gives small investors access to something they wouldn't necessarily have access to before as it required significant capital. It allows them to diversify their investment better rather than increasing concentration risk by allocating too much capital to one investment,” says Siddiq Farid, chief executive officer (CEO) at UAE-based real estate crowd-investing platform Smart Crowd.

Credit Gap

Following the 2008 global financial crisis, banks tightened their lending policies and traditional investors became more risk averse. This has created a credit gap of $260 billion for SMEs across the Middle East and North Africa (Mena) with just one in five having access to bank loans or other forms of credit. According to the World Economic Forum (WEF), SMEs represent 96 per cent of registered companies in the region and about half of employment, but they account for just 7 per cent of total bank lending – the lowest level in the world.

This shortage has opened up the opportunity for companies like Liwa in Jordan and Dubai’s Ureeca and Smart Crowd to offer an alternative for SMEs seeking capital, but the uptake of crowdfunding in the region has been slow, partly due to local banking and financial regulations. As a startup itself, Smart Crowd has successfully navigated complex regulation red tape both from real estate regulatory bodies and the financial entities governing crowdsourcing. On region-wide delays in adopting crowdfunding platforms, Farid points to risk aversion and lack of awareness.

“Crowdfunding is a retail-focused product, hence the regulators have been slow to adapt to it,” he says. “Second, lack of understanding has led to delays and falling behind from global peers. The regulators here are a little more risk averse.”

The low credit-card penetration and banking penetration rate is also a barrier. World Bank data suggests that 69 per cent of the region’s population remains unbanked – transferring money online for the unbanked individual therefore, is a challenge. Egypt’s MoneyFellows, a rotating savings and credit association (ROSCA), another form of peer to peer lending where a small community of people contribute a fixed amount of money and take it in turns to receive the whole sum every month physically collects the cash from some its customers to overcome this issue. But this is costly and near impossible for crowdfunding campaigns that attract investors beyond one city.

“A lack of regulatory innovation, awareness and infrastructure play a role, even though the alternative finance market is worth over $300 billion around the globe. Mena and other emerging markets are not even close to harnessing this opportunity,” says Leila Mroueh, acting CEO of Zoomaal, a creative economy focused crowdfunding platform.  

Regulatory Hurdles

As the startup economy in the Middle East continues to grow, and more entrepreneurs turn to alternative investement, financial authorities throughout the region are tasked with putting into place appropriate regulations that protect both the investors and recipients alike. Existing crowdfunding platforms are taking it upon themselves to work with authorities, providing guidance in the development of crowdfunding regulations.

“The industry needs to develop in a safe and sound manner and countries need to adapt their regulatory, supervisory and consumer protection framework to address the unique risks of equity crowdfunding,” says Quawasmi.

But it is not just regulatory challenges that has held back crowdfunding. Some startups have been put off by the slow pay-out timings and concerns for their fundraising efforts in the future. If, and when a VC does come along to invest in a project, the concern is that they may be turned off by too many investors already on the capitalisation table. Sam Quawasmi, co-CEO and co-founder at Eureeca thinks that this mindset may be on its way out.

“While it is true that some VCs did have concerns about messy capitalisation tables, this is less the case now as crowdfunding has become more commonplace,” he says. “A large crowd of investors can be viewed as extremely positive because they are likely to be some of your best customers and advocates going forward. This is particularly true for B2C [business to consumer] businesses.”

Eureeca has recently seen a rise in the uptake of the alternative financing model, with 24,413 active investors on its platform and an average investment size of $5,800. The majority of its business comes from the UAE, but it has seen growth from Kuwait, Jordan and several European countries, such as the UK and Netherlands, as well as Malaysia. Of the 18 investments listed on Eureeca’s platform last year, 13 were successful. In 2017, the company listed 12 investments.

“The crowdfunding industry in the Middle East is now at a turning point. With the first deals funded by platforms now reaching the point in the cycle (three to five years) where we would expect to be seeing returns and exits to the crowd,” says Quawasmi. “We can anticipate the emergence of transparent and quantifiable statistics about the industry.”

Jobedu, a Jordanian streetwear startup that promotes Arab designers, successfully raised $220,000 using crowdfunding in only six months. In addition to raising the funds that the company required, it enabled the startup to engage with its customer base in a completely new way.

“Being a very public brand, we always want our community to own a piece of Jobedu and crowdfunding helped us facilitate that,” says Tamer AlMasri, co-founder at Jobedu. “Some of our crowd investors are now mentors to our team in their area of expertise and others have joined the board. Our most engaged investors are active with us on promoting the brand on a regional and international scale which is great.”

For now, crowdfunding may be the right solution for B2C startups with a strong customer base, while ROSCAs could provide an answer for founders in need of small cash injections every so often, but the only way alternative investments can grow is with the introduction of better regulations.