Corporate finance Law and the age of innovation finance: Ugandan startups raised $20 million in online Crowdfunding

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Just last week, the National Payments Bill, 2019 came up to parliament for deliberation – now currently at first reading. Don’t be deceived that this bill, inadvertently or not, attempts to regulate crowdfunding. It doesn’t address platforms that outsource processing of payments like peer to peer (P2P) platforms for crowdfunding. It shouldn’t be construed as attempting to regulate the intricacies of crowdfunding.

My reading is that the Bill may only designate for P2P disbursements under the National Payments system but not crowdfunding itself.  Under clause 16, the Bill stipulates that the: “The central bank may establish a regulatory “sandbox framework for the purposes of governing the manner in which a person may obtain limited access to the payment system ecosystem to test innovative financial products or services without obtaining a license under this Act.”

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If this law intends to regulate payment systems used by major crowdfunding platforms, it’s bound to fail. Leading international crowdfunding platforms often set restrictions on who can launch campaigns and use payment systems that bar contributions from developing world contributors. Local-based platforms that use local payment systems like mobile money are better suited to be regulated by this law, but have a much smaller pool of potential contributors to crowdfunding.

Kick starter, the international platform with the largest critical mass of users, bars the raising of funds by individuals who do not have an identification card and bank account in one of the 18  Organisation for Economic Co-operation and Development (OECD) countries. Payments systems don’t define the entire crowdfunding, Capital Markets Authority should come up with some kind of regulations for crowdfunding so that when it uses payment systems, it’s not some kind of mystery.

Hitherto, peer to peer (P2P) platforms like crowdfunding financing operate on a shaky legal ground in Uganda, without a specific law dedicated to it. However it is covered piecemeal in the Tier 4 Microfinance and the Money Lenders Act (2016), The Financial Institutions Act, The Capital Markets Authority Act, The Communications Act and now the National Payments Bill, 2019 attempts to join that growing list of piece meal laws that will purport to regulate crowd funding.

If government seeks to regulate peer to peer online financing platforms, there is a need for a separate law to comprehensively regulate them, since they are not payments systems but just use them as outsourced entities. These legal gaps have left East Africa with only five platforms set up: Three in Kenya and one each in Rwanda and Uganda, compared with 10 in South Africa and 55 in the rest of Africa.

Other platforms operational in East Africa but not domiciled within East Africa include philanthropy-focused Watsi and Kangu in health and education, concessionary lenders Kiva and Zidisha in agriculture, Indiegogo and Kickstarter for creatives, GoFundMe and Global Funding for capital projects.

Crowd funding platforms could go a long way in providing the much needed finances for startup business. In 2015, a total of $7.5 million was raised through crowdfunding, with an additional $4.8 million raised in Quarter 1 (2016). The vast majority (83%) of crowdfunding activity taking place in Uganda is via donation platforms, primarily those based in developed countries. But given the competence levels and the vigilance of our regulators and ministry of finance, I absolutely guarantee you, when ministry of finance is computing the amount of foreign direct investment that comes to Uganda, they skip this figure of investment through crowdfunding.

Apart from the platform akabbo , there is little domestic platform activity, with over 80% of market activity funded via donations from foreign platforms and almost 20% coming from non-financial return-based lending. Uganda currently has no legislation that specifically provides for equity or loan-based crowdfunding. Donation and reward crowdfunding fall outside the jurisdiction of financial regulators, yet so much money is flowing into the country.

In its proper understanding, crowdfunding is the use of small amounts of capital from a large number of individuals to finance a new business venture. Crowdfunding makes use of the easy accessibility of vast networks of people through social media and crowdfunding websites to bring investors and entrepreneurs together, with the potential to increase entrepreneurship by expanding the pool of investors beyond the traditional circle of owners, relatives and venture capitalists.

This pooling of money by many individuals for equity investment in startups — and peer-to-peer (P2P) finance shows that in 2015, the nascent segment raised $22 million for investments in Kenya, $4.2 million in Tanzania and $3.5 million in Rwanda.

Having understood what crowdfunding is, here is a simple description of how it works in real life; You can have a business idea of creating a garbage disposal company in the outskirts of Kampala, collecting it from people’s houses. Your fundraising goal could be $100, but you may end up raising more than $55,000 from 6,911 backers. Investors can select from hundreds of projects and invest as little as $10. Crowdfunding sites generate revenue from a percentage of the funds raised.

The most popular crowdfunding websites are Kickstarter, and Indiegogo. They attract thousands of people. As of 2019, Kickstarter has become more popular than Indiegogo. Kickstarter since 2009 has funded more than 160,000 projects worldwide, with more than $4.2 billion pledged across all Kickstarter projects. It’s no surprise that it’s even penetrating the Ugandan market.

Much as Kickstarter is more popular than Indiegogo in terms of numbers, Indiegogo is seen as a less strict and more flexible platform than Kickstarter, as it gives backers control over whether they want fixed or flexible models—this is probably the most significant difference between the two crowdfunding platforms.

Kickstarter releases funds only after the campaign has reached its funding goal, whereas Indiegogo allows the campaigner to receive funding pro rata, or wait until their target is hit. This is an issue of internal regulation of platforms, that regulators in Uganda should pay attention to should they make up their minds to make a regulatory framework. However, in their regulations, they should not over regulate them, to the point where crowdfunding loses its purpose.

Until very recently, the opportunity to invest in young startups in western countries was not open to everyone but a few high net worth individuals. This has changed.

There are 3 main types of crowdfunding. These are; reward crowdfunding, equity crowdfunding and debt.

You can find reward crowd funding on sites like indiegogo and kickstarter. In reward crowdfunding, you are essentially donating money to a project for instance, app development. You aren’t investing but donating to the business. In return you get some kind of gift from that project. However, most people wouldn’t be interested in such a type of crowdfunding. Most people prefer shares in a company.

The second type, debt crowdfunding, you are essentially lending money to a business, could be a conventional loan, or issuing a bond from the business to investors you connect with online. The best website that deals with this type of crowdfunding is funding circle, they have decent interest rates in return.

The most important is equity crowdfunding where you invest money in a young business and you get real shares in return, in the hope that that business is a unicorn that could become the next facebook or amazon. However remember very few businesses become global superstars.

According to general ugandan securities law, under Section 90 (a), (b) (c)(d) and (e) of the Capital Markets Authority, Act, equity and debt based crowdfunding could be interpreted as offering of securities to the public, and may necessitate filling a prospectus with the Capital Markets Authority because it could be a form of “advertisement” that is “made to a person in Uganda which contains or refers to an invitation or inducement to subscribe for or purchase a form of investment.”

However, since crowdfunding could be peer to peer kind of investing, it’s hard to interpret it as a private placement that does not require the issue of a prospectus. In equity crowdfunding, you can make a decent return if you have some luck and you go about it the right way.

There was a report done some 2 years ago called: siding with the angels, that looked at 1080 businesses that started in the UK between 1998 and 2008. It found that if you had invested in all 1080 companies, you could have got an annual return of 22%.

The trick here was to diversify and invest across a wide spectrum of businesses because it is inevitable that a lot of these businesses will go burst and then a few of them will do well and then overall you make a profit.

These are the websites that are equity-crowdfunding based -Crowdcube, seedrs,sydicate room and investing zone .

Crowdcube is the site with entrepreneurs that have raised the biggest sums of money. For sydicateroom, the minimum amount of money you can invest in a business is 1000 pounds.

Personally, I find seedrs’ equity crowdfunding legal structure intriguing and commendable. Its nominee structure is really great.

For instance, if you are an entrepreneur, and you raise money on the seedrs platform, lets say, the new shareholders own 10% of the business you founded, seedrs will manage that structure as the nominee of all the individual shareholders who you raised money from on their platform. This is good for the entrepreneur because he only deals with one person, which is seedrs as the nominee for the individual investors.

It is also good news for the investors because it means seedrs keeps an eye on things to make sure that the interests of these early stage individual investors are properly protected.

For instance, if you are an investor and you raise 100,000 dollars on the platform, and a year later you come back to raise another 100,000, the business valuation could grow prompting you a year later to get additional money from a venture capital firm to raise a million dollars.

The venture capital firm will get a sizable shareholding in the business and the early stage investors’ stake that invested via seedrs will get diluted. In that, instead of owing 10% of the company they end up holding, say 5%. Dilution is fine and should be expected.

Seedrs also provides clarity on whether the early stage investors via a seedrs platform will not get badly treated through an unreasonably large dilution. They make you trust the platform that your interests will be specifically looked after. Seedrs are very aware of this issue.

The way equity crowdfunding works is very simple. If you are an entrepreneur and you want to start a business, you just have to get onto one of those sites and you put your business up on the site and stipulate, you are looking for 50,000 dollars, let’s say, you have a time period of 60 days and your looking for people to invest in your business during those 60 days.

Anyone can invest as little as 20 dollars in your business. If it reaches the 50,000 dollars target, then everyone that has put money in your startup would have successfully invested in the business. However, if it doesn’t reach the 50,000 target, after the 60 day period, that target is over and the investors get a refund of their money.

If you are to invest via crowdfunding, unlike buying shares on the stock market, it is high-risk. First, there is a risk of insolvency where you invest in startup companies that eventually go burst.

Secondly, if you invest via equity crowdfunding, even if the investments go well and you feel you are making a decent return, it could be hard to exit. You may be unable to sell your shares for a while because there is no secondary market or a stock market where you call your broker to implore them to sell your shares.

Then there is a risk of dilution where the percentage stake that you own might over time reduce as new people buy into the business. overime during the target period.

Most of these crowdfund platforms I have mentioned are governed by English law. If you are not targeting investors in Uganda but UK or America, the definition of offering securities in the Capital Markets Authority Act, under Section 90( a) may be irrelevant.

Therefore, because of all these risks, the UK regulator, The Financial Conducts Authority (FCA) stipulates that the only people who should invest in equity crowdfunding are sophisticated investors or high net worth investors, or those who commit not to put more than 10% of their investable assets into crowdfunding.

What investable assets could mean is all your assets excluding your main home. Personally, I am still inclined to the view that 10% is still too much because crowdfunding is high-risk stuff.

Crowdfunding is a new reality, therefore Capital Markets Authority and Bank of Uganda should live with it by making favourable regulations. It’s not going away.

They should only mitigate its risks. I have told Keith Kalyegira, the Capital Markets Authority CEO, of the opportunities in crowdfunding so that they put in place regulations, but he seems not to take it seriously.



Crowdfunding raised $34 billion globally last year. The World Bank estimates that crowdfunding activities globally will raise $96 billion by 2025.

I think Capital Markets Authority needs to go retooling in light of this new age of corporate finance. I need not say more.


 

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Louis Kizito is General Counsel at Pixan Technologies

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