NB Financial Innovation
NexThought Monday: The Future of Crowdfunding Depends on Avoiding Past Missteps
In the islands of Palawan, a remote area of the Philippines, nearly half of all residents live without electricity, as do 20 million people throughout the country. A small company called Hybrid Social Solutions brings clean, affordable solar energy to Palawan, distributing solar products such as lamps and mobile chargers with the support of local cooperatives. Families can afford solar products through HSSi’s partnerships with local microfinance organizations, but HSSi itself needs loans to finance the purchase of inventory to sell to the people of Palawan.
For small and growing businesses that have the potential to create social and environmental change, financing is not easy to come by. Impact investing is on the rise, but the cost of doing risky deals in faraway lands remains prohibitive for investors, especially when deal sizes are small and returns remain minimal. As investors and thought leaders wrestle with these issues, a new potential solution has arisen: crowdfunding. HSS recently received a $4,000 loan through a new crowdfunding website called SunFunder, which makes it easy for anyone to invest in solar projects in emerging markets through an online platform. Users can invest as little as $25, and receive their money back as solar companies pay back their loans. HSS was SunFunder’s pilot project, and was fully funded by just 62 people.
The still-nascent crowdfunding market is already worth over $1.5 billion in funding volume in 2011, led by early players such as Kickstarter and Lending Club. With this year’s passage of the JOBS Act, which legalizes crowdfunding for a return by non-accredited investors (anyone), crowdfunding is set to take center stage and nearly double in volume. Can social enterprises and impact start-ups in the developing world take advantage of the crowdfunding movement to solve their investment woes? A growing number of impact-oriented crowdfunding platforms seem to think so.
Kiva of course is one of the earliest impact crowdfunding sites, and is arguably the best-known. Early press coverage and strong storytelling centered around the power of microfinance lending to change lives catapulted Kiva into public recognition, and more than 825,000 people have made Kiva loans since the site launched in 2005. Start-up sites are lining up to take advantage of the coming crowdfunding boom: StartSomeGood, Microplace and 33needs all focus on social enterprise or addressing poverty in some form. Venture capitalist Skyler Fernandes, who launched the Missing Middle initiative at the World Economic Forum, delivered a TedX talk that touched on the potential of crowdfunding at Connecticut College earlier this year, and sees it as a potentially ideal way to address the mismatch between promising start-ups and venture financing that is unable to invest in deals less than $2 million.
Although crowdfunding appears to be a promising new source of capital for social start-ups, much needs to happen to really get capital flowing, and success is not guaranteed. The Hoop Fund, a site that combined fair trade shopping with crowdfunding investments, shut down earlier this year due to lack of project volume and user traffic. In order to move crowdfunding for social enterprise forward, sites need to establish a robust pipeline of projects, identify the motivations that drive the public to invest, and establish a strong trust mechanism between companies and small-scale investors.
One central question for promoters of impact crowdfunding is whether online investors want to receive returns on their investments. On Kiva’s platform, users make loans to finance microenterprises, and are paid back the full amount of their loan, but no financial return. Users can then either reinvest their money or withdraw it. Kiva’s users are clearly motivated primarily by creating impact. Impact Trader, on the other hand, envisions its site becoming an “alternative stock market,” where investors can buy and shell shares of impact stock, and withdraw profits made from this trading. Neither model has taken precedence at this point.
Investors will also need to develop trust in the companies in which they’re investing. They will need to know both that companies are financially viable, and that companies are creating genuine impact. Specialized sites like SunFunder are able to develop strong due diligence processes and a network of strong solar deals due to their narrow focus. Yuwei Shi, dean of the business school at Monterey Institute of International Studies, envisions a program where local communities become involved in assessing developing country social enterprises via social media. “Retail investors, who are located far from the company that they are putting their money into, would be able to know any local concerns about the company right away,” he explains. “This could become a cheap, transparent and reliable trust mechanism about these enterprises on crowdfunding sites.”
As both crowdfunding and social enterprise continue to grow, it seems inevitable that the two will converge, and they are already beginning to do so. Although there are potential barriers, the potential for success is significant. If impact crowdfunding takes off, it could very well provide the much-needed and most difficult to obtain “missing middle” financing for small and growing businesses in the developing world. This financing could then grow these businesses to a size more appealing to larger investors, thus providing a greater pipeline of attractive deals than currently exists and addressing one of the current major problems in the impact investing sector.