Crowdfunding: How this alternative financing route is helping SMEs ignored by banks to raise capital

Updated: November 13, 2019 12:27:40 PM

Credit and Finance for MSMEs: Crowdfunding platforms partner with the SME support system to help optimize processes and amplify the efficiency of SMEs.

From the available options of alternative financing, crowdfunding has emerged as a front-runner.
  • By Chet Jainn

When Sukarma Foundation, an Indian non-profit SME, wanted to set-up a manufacturing unit to produce eco-friendly sanitary napkins, it chose to raise the business funds through the alternative financing route rather than raising a loan through a bank or an institution. Why? Small businesses, until recently, struggled with getting finance for business due to limited financing options and the related barriers. But the advent of alternative financing is bringing a welcome change to this situation. Alternative financing refers to a range of financing sources that have emerged externally to the traditional financing system comprising regulated banks and capital markets. 

Some new age alternative financing sources are through online market platforms like crowdfunding, equity crowdfunding, revenue-based financing, online lenders, peer-to-peer consumers and business lending, and invoice trading third party payment platforms. These sources diametrically differ from the traditional ones as they are technology-enabled disintermediation platforms. However, the micro and SME sector still largely remains in the dark about the now available range and potential of non-traditional fundraising methods which make it easier for organizations to raise funds for the business.

India has a growing startup and SME sectors with approximately 42.50 million registered and unregistered SMEs and 23,742 DPIIT recognized startups. Most of them being in a growing phase, their need for business finance is frequent and alternative financing can soon be their preferred route for financing. From the available options of alternative financing, crowdfunding has emerged as a front-runner.

Crowdfunding platforms even partner with the SME support system to help optimize processes and amplify the efficiency of SMEs. They not only support small businesses and startups by helping them crowdfund but also in terms of strategic support, mentoring and grant funding amounting to a few crores from their own resources or through their global partners.

Also read: Credit card for startups, SMEs: Small businesses can now manage expenses, payments; enjoy rewards

Crowdfunding through a technology portal connects three main parties – the entrepreneur or SME looking for funds, the contributors interested in supporting the cause or project, and a moderating organization that enables the engagement between fund seeker and the contributors. The role of the moderating organization is to facilitate the contributors be able to access information about different initiatives and funding opportunities available for the development of products/services. Crowdfunding offers three popular business models which SMEs and Startups can choose from:

Rewards-based crowdfunding: It has emerged as an attractive fundraising option for thousands of small businesses and creative projects as the proposal and campaign are easier to prepare, launch, and manage compared to traditional business finance. It is easily accessible too. A reward-based model facilitates both non-exempt donations or contributions and rewards or perks based fundraising. The fundraiser sets the rewards that he/she is comfortable with for a certain amount of contribution and also specifies the time period for the delivery of the reward.

Equity-based crowdfunding: In Equity-based crowdfunding, in consideration of funds solicited from investors, equity shares of the company are issued. However, solicitation is done at an earlier stage by raising funds with the help of a business and offering equity interests in the business to investors online. Businesses seeking to raise capital through this mode typically advertise online through a crowdfunding platform website, which serves as an intermediary between investors and the start-up companies. Traditionally, start-ups are funded through private equity, angel investor or loan arrangements with a financial institution. Any offering of public equity takes place only after the product or business becomes commercially viable. Some examples of equity crowdfunding platforms are Wefunder, Fundable, Syndicate Room, Crowdcube and Seedrs. 

Some platforms offer private fundraising where startup equity fundraising is possible, provided startups to follow the security trading rules of respective countries. Such platforms offer private fundraising software to protect fundraising information from unknown people. This software is primarily aimed at startups wanting to raise money without breaking any regulations while leveraging the power of fundraising technology.

Donation-based crowdfunding: This third kind of crowdfunding is a way to source money for a charity project or any cause-driven project by asking donors to contribute money to it. The donations can be tax-exempt depending on the tax-exemption status of the fundraiser in their respective country. Gofundme, Crowdera, Letzchange, (now GiveIndia Fundraisers), Milaap, Ketto are some of the leading platforms active in India. Some SMEs with a social mission can also leverage such donation platforms.

Alternative financing is already creating a tangible impact on the SME sector. With more individuals lending to one another, the increased availability of affordable credit stimulates greater financial activity and drives business growth. As a result, consumer segments such as MSMEs – until now either completely ignored or significantly underserved by the traditional banking and financial services segment – now have unparalleled access to finance and credit.

(Chet Jainn is the Founder & CEO at Crowdera. Views expressed are the author’s own.)

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