ABSTRACT
As per the conference paper presented at Harvard Islamic
Finance Forum, At Boston, USA in April 2014, ‘Crowdfunding as an alternative to
financing Micro Entrepreneurs, Small Enterprises, and startups exhibits the
rationale of promoting the core values of Islamic finance and thereby achieving
its targets of socio-economic development in regions of Shariah compliance.’ With
the given potential of Entrepreneurial Supply in such regions and its
limitations, the ability of redefining the crowd as a pool including small and
large investors with limited capital as well as different types of development
institutions and corporations will enrich the access to capital market without
compromising on the basic ethics of Islamic finance. This paper intends to
study the scope of Equity Crowdfunding as an alternative source of financing
small and newly established ventures that have limited access to
institutionalized financial sources. Also, the progress made in the Shariah
compliant Middle Eastern nations of the world that are digging into Equity
crowdfunding and providing bigger platforms to the young entrepreneurs to pitch
their ideas in order to make their projects financially feasible, has been
scrutinized.
INTRODUCTION
Crowdfunding is a financing alternative to conventional
financing methods that involves funding a project with relatively smaller
contributions from a large group of individuals often the common public, rather
than seeking substantial sums from a small number of Institutional investors.
The fund raising and transactions involved are typically conducted online
through special crowdfunding websites, often in conjunction with the most
popular social networking websites. Depending on the 98 Uruba Andaleeb and Dr.
A.K Mishra project, campaign contributors may be making donations, investing to
earn a fair future return on investment (ROI), or prepaying for a product or service.
According to the core ethics of Islam, all forms of Interest
(Riba) based transactions including securities offering fixed interest incomes
such as Debt instruments are prohibited and thus fall outside the purview of
Islamic Finance. Since it defeats the basic principle of avoiding all forms of
transactions involving Riba, these transactions and instruments do not receive
the approval of the Shariah Board which is a mandate before raising finance in
most of the Islamic countries. In case of a Shariah compliant Islamic financial
instrument, which is most commonly approved by the Shariah Board, any return
must be directly relatable to an asset and risk-taking in a joint enterprise
(such as partnerships). A debt security is replaced with an asset-tied security,
direct financing of an existing and real asset, accompanied by different forms
of partnerships especially equity financing.
An evaluation of Crowdfunding, as a means of alternative
financing in most of the Middle Eastern countries having a fully functional and
developed Islamic finance platform, suggests that the preference of debt over
equity in Islamic Finance is indeed a green signal for Crowdfunding
Investments. The basic nature of capital raised through crowdfunding absolutely
fits the propagations of Islamic Finance.
Financing SMEs:
Crowdfunding and other Shariah compliant fund-raising alternatives
According to the data published by World Bank on its website
in September 2015, there is a large credit gap existing between the funds
required by SMEs and the funds available from various financial institutions.
The situation is even worse in case of MSMEs. The number of MSMEs in the Middle
Eastern and North African countries including unserved & underserved MSMEs
is around 10 million. The credit gap in Middle Eastern countries exclusively
accounts for around 50%, thus facing constant threats to their survival and
growth.
On the other side, the other major challenge that the Middle
East is facing is Youth unemployment. According to recent surveys by the World
Bank, youth unemployment in the region is around 21%, one of the highest in the
world. However, the region is full of entrepreneurial talent and has had a rich
heritage of burgeoning startup ventures and SMEs. Despite this, there is lack
of availability of sufficient funds to invest in young businesses, due to some
of the following reasons:
1. Difficulties in obtaining bank financing besides bearing
the burden of debt repayment in the initial stages of development in the form
of profit sharing (Shariah Compliant banks in middle eastern countries run on
the principles of Islamic Banking, therefore, they do not charge interest on
the amounts lent. Most common practice is to share the rewards of the business
as their return on investment). Equity Crowdfunding in Shariah Compliant
Nations: an outlook in the middle-east 99
2. Obtaining a bank loan in such countries is not only time
consuming and cumbersome resulting into involvement of a lot of paperwork, but
for small firms and startup units, it also means unreasonably high rates and a
high chance of being rejected as there are huge risks involved.
3. There is a general trend of risk aversion in the region
among all investors, whether it be the retail investors, or the institutional
investors, this is especially the case after the Global Financial Crisis of
2008.
4. Also, many investors look for collaterals before funding
in a high risk project, and for obvious reasons, it is indeed very difficult
for the SMEs to provide them the same.
Benefits of
Crowdfunding for Investors
Crowdfunding investing offers a cooperative, transparent and
economical way to invest in Shariah-compliant equity financing. Since it
requires the entrepreneur to pitch the business idea on the social networking
sites, such information comes handy to the investors thereby enabling them to
evaluate the potentials of the business soliciting funds, to arrive at
decisions regarding which businesses to invest in and the quantum of
investments to be made. Not only are the investors able to invest a subtle
amount to reduce the overall risk of losing huge amounts of their savings, but
they are also able to earn higher returns on their investment, besides having a
fair share in the stake of the SMEs that they are investing in. These returns
are, in most cases, substantially higher than the other Shariah compliant
Investments. The investors are also able to invest into a number of profitable
ventures by diversifying the portfolio of their investment and thereby hedge
against high risks of failure of Startups without compromising on the
principles of Islamic Financing.
Benefits of
Crowdfunding for Entrepreneurs
There are no hassles of obtaining a sanction from Banks for
having funds credited to the account of the Entrepreneur, thus crowdfunding
saves a lot of time, effort and money. Also, the fund raising campaign is
simple and realistic as the Entrepreneur pitches the product idea on the
Crowdfunding website and all the interested investors contribute their share of
investments. As long as the business activity is considered ‘Halal’
(permissible), obtaining fund by this mode is easily approved by the Shariah
Board. Thus, the funds can be raised from Muslim dominant regions as well as
other parts of the world, thereby providing a larger investor base to the
Entrepreneur. Besides, when an idea is introduced all around the globe via the
Internet, it does not take longer for it to go viral among the investors,
provided the right strategies follow at each step of Crowdfunding. The
entrepreneur might also gain the benefits of Market surveys just by pitching
the product development idea over the internet and soliciting the response of
its target market. It enables them to innovate and customize the product
further from all valuable feedbacks received from its target audience. It also
saves them huge sum of money to be spent on market researches before the product
launch and also shields them from product failure in the market. Thus, even 100
Uruba Andaleeb and Dr. A.K Mishra before the product is released in the market,
the potential market and the buyers are duly recognized. However, given the
size and scale of operations of Islamic Banks in regions of Middle East, the
prominent ones being located in Saudi Arabia, Kuwait, Dubai, the share of
lending to SMEs of the total lending of these banks is relatively very small.
Despite the fact that SMEs are globally recognized as economic growth boosters,
and key contributors to the National GDPs, especially in these regions, SMEs
are facing huge credit gap and a fund crisis. One of the core ethics of Islamic
Finance, being accessibility of funds to all Shariah compliant businesses,
irrespective of the size of the organization, is ruled out in these Shariah
compliant nations. Thus, Crowdfunding has been able to diligently solve the
problems of asset financing and expansion of capital base of the business due
to the very nature of the entire process of fund raiser activity. Crowdfunding
Investing has made noticeable leaps in filling the credit gap existing in the
Middle Eastern Countries’ economies pertaining to investments in SMEs. It also
broadens the scope of Islamic Financial services available to SMEs in these
regions as well as other parts of the world.
INFERENCES
From time immemorial, Islamic commercial law has strongly
favored equity instruments of raising finance over debt financing. Given the
nature of Crowdfunding and its success rate across the globe, it is inarguable
that it is apt for Muslim-majority countries that as Shariah compliant as well.
In such nations, Crowdfunding investing and Islamic financial services are
undoubtedly compatible, besides being mutually reinforcing. Both of these
concepts have similar objectives and foundations in Finance. Some of the
landmarks achieved by a few dominant crowdfunding platforms in the region include
the Indiegogo, Zoomal & Eureeca. A study of the most popular Shariah compliant
Crowdfunding regime brings us to the following sets of conclusions:
Crowdfunding & Islamic banking Despite the region having quite popular and
some of the biggest Islamic Banks that function on the Shariah principles of
avoiding all forms of Riba (Interest), there continues to be a major credit gap
between the quantum of funds required by the newly established ventures and the
actual amount of funds made available. After the Financial Crisis of 2008 and
the global meltdown, the banks have become risk averse and are not much willing
to invest in innovative business ideas that may be profitable, but weigh heavy
on the risk-scale. Even if the businesses that are able to obtain bank
financing, the entire procedure of having the funds transferred to them is cumbersome
and involves too much of paperwork and collaterals to be furnished. On the
other hand, crowdfunding is pretty simpler approach to finance the business
ideas. However, it is yet to become as popular as it is in other Shariah
compliant nations such as Malaysia, offering one of the largest crowdfunding
platforms.
Equity Crowdfunding
in Shariah Compliant Nations: an outlook in the middle-east 101 Startups and
SMEs
It can also be deduced from the unemployment rate in the
region, that the problem can mostly be tackled with providing financial support
to young entrepreneurship projects, startups and SMEs. The major hurdle for a
newly established business or project is to arrange finance. In its
unavailability and access, even the most innovative projects that could have
been turned into extremely profitable and large businesses, die at its nascent
stage.
In order to help the young Arabs develop into fine
entrepreneurs and create further jobs in the Middle Eastern region, it is
required that sufficient startup funds be made available to anyone who has a
promising business model and product idea. This can easily be taken care of by
opening more crowdfunding platforms in the region.
Regulatory Framework In 2012, JOBS (Jumpstart Our Business
Startups) Act, was signed into law by the US President. The Act required the
SEC (Securities and Exchange Commission) to adopt rules and formulate laws that
will allow and provide for crowdfunding in the country. It not only led to
opening up of big and small crowdfunding platforms, but also resulted in
creation of job opportunities in the country besides bringing an inflow of
required capital or finance to the startups and SMEs.
However, an insight into the Middle Eastern countries
governed mostly by the Shariah laws for regulating their finances, shows the
absence of proper laws and regulations that would provide for financing through
Crowdfunding, let alone incentivizing the entire regime. In a recent study
conducted, it was found that although USA was the first country to have
immensely successful crowdfunding platforms such as Indiegogo and Kick starter,
however the growth rate of Crowdfunding platforms in the UK became higher than
USA.
One of the reasons being the tax benefits provided to the
investors investing in startups and SMEs using the Crowdfunding portals. They
had the liberty to deduct the amount of such investments from their total
income. Although, some of these middle eastern countries are included in the
list of Tax Havens (such as Bahrain), even then, these incentives whether in
the form of deductible investments or other tax benefits for investors might
boost the level of investments in the country. Also, existence of laws and
regulations in place and an awareness of the same shall help the economies to
allow startups to open and flourish. This would not only contribute to the GDPs
of Shariah compliant nations, but would also help them curb unemployment in the
region by creation of job opportunities and providing funds to young
entrepreneurial talent. In some of the regions such as the UAE and Oman, there
is ambiguity regarding whether the fund raised through Equity Crowdfunding
would result into issue of Capital and would be governed by the Securities and
Contracts Laws of these nations. A specified act or a law providing clear
guidelines addressing such issues and governing Crowdfunding Investing would be
truly a great step.
Uruba Andaleeb and
Dr. A.K Mishra the Arab Markets and Crowdfunding ecosystem
Many studies by organizations such as World Bank have revealed
that Crowdfunding has got untapped potentials in the markets of Shariah
compliant nations particularly in the countries of Middle East. It reaches out
to reduce the credit gap in the region despite having some of the largest
Islamic banks. Although, there has been an upsurge regarding debates and
discussions over Crowdfunding and its potentials to expand the scope of finance
for Startups and SMEs facing funding crisis, however the growth and progress
has been relatively slow paced in comparison to various developed economies of
the world.
But over the years, the Middle East’s under developed
markets are now aware of a powerful financing tool that would enable the
promising businesses and entrepreneurial talent to become some of the most
successful business projects. It is up to the regional governments to take
actions to accelerate Crowdfunding into their capital markets to be able to
reap most benefits out of its early development and surge.
REFERENCES
[1] https://www.pwc.com/gx/en/financial-services/islamic-financeprogramme/assets/shariah-compliant-funds.pdf
[2] “Handbook of Islamic Banking” (2007) by Kabir Hassan and
Mervyn K.Lewis
[3] https://www.islamicbanker.com/publications/entrepreneurial-ecosystems-oicmarkets
[4] http://www.crowdfundinsider.com/
[5] http://Blogsworldbank.org
[6] http://www.wamda.com/2015/03/crowdfunding-catapult-innovation-middleeast
[7] “Analysis of financing sources for startup
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