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Equity-based crowdfunding platforms’ transaction value in Latin America is expected to reach more than $270 million, with six million users by 2020. (Image by IDB)
Monday, May 23, 2016
Perspectives

Latin America Crowdfunding: Strong Potential


Crowdfunding is growing rapidly in Latin America, experts say.

BY LATIN AMERICA ADVISOR
Inter-American Dialogue

Latin America’s largest crowdfunding platform, Idea.me, on April 14 announced that it was expanding into Miami in an effort to raise funding from entrepreneurs focused on creating social, urban or community impact in the area. The platform was previously only available in six Latin American countries. How big a trend is crowdfunding in Latin America? To what extent does “collective finance” threaten the business of traditional lenders? What benefits and drawbacks do entrepreneurs experience with crowdfunding that they do not experience when seeking loans from banks?

Gerardo Puelles, advisor at the SME division of the Chilean Ministry of Economy, Development and Tourism: Crowdfunding is becoming a mainstream financing source in many countries in Latin America, especially in economies such as Mexico and Chile where a strong entrepreneurial ecosystem has developed in the last few years. Entrepreneurs have faced the need to tap alternative financing sources as they usually do not have access to traditional bank loans since they do not have collateral to offer nor a track record to show. It is important to note the differences in the financing models. Idea.me, for instance, is a rewards/ presale platform on which backers provide small amounts of money and receive a prototype, perks or just the satisfaction of supporting a new business idea. There are other financial crowdfunding schemes such as equity (in Latin America a pioneering platform is Broota), as well as credit-based crowdfunding. Although crowdfunding might reduce to some extent the margin banks make on loans, crowdfunding is rather complementary to the traditional banking industry. Disruptive technologies in fintech bring opportunities to better serve bank customers. Major banking institutions around the world have also been investing heavily in technology and are teaming up with online lenders. In Latin America, consumers often seem unhappy about the interest rates they pay on loans; and savers are unsatisfied with the average return they get on traditional bank deposits. Online lenders are bridging this gap by offering higher returns for investors and better credit conditions for borrowers. Crowdfunding makes use of the so called ‘Wisdom of the Crowd.’ If a project does not get support in a funding campaign, it is very likely that the project would have failed if it had been launched in the market. Therefore, crowdfunding helps entrepreneurs to validate of business ideas. Crowdfunding also has a positive effect on the community since it creates opportunities to support local businesses. Crowdfunding requires more responsibility and effort by entrepreneurs to deliver on their promises and to address investors’ doubts and concerns.

Kai Schmitz, leader of FinTech Investment for Latin America at the IFC Global FinTech Investment Group: Crowdfunding is an appealing concept since it democratizes investments, helps entrepreneurs, lets ordinary people vote with their money on new ideas and eliminates the middle man institutional fund investor who takes a large portion out of the return. However, recent experience has reminded us that the risks are fundamental. Illicit crowdfunding platforms have created fake investment opportunities and operated Ponzi schemes. Crowdfunding also suffers from conceptual issues: entrepreneurs often are not just looking for money, but also for other added value from their investors, in particular at an early stage. This includes experience with operating a startup, industry knowledge and an ability to help with an exit. Crowdfunding platforms to date mostly do not offer these benefits, and as a result, the entrepreneurs using them are sometimes those who were unable to raise funding from institutional investors, arguably creating adverse selection. The concept is therefore evolving, and crowdfunding platforms are increasingly run by investment professionals with sector expertise who can select attractive investment opportunities and add the value entrepreneurs are seeking. There is hence a competition for good investment professionals between funds and crowdfunding platforms. Those who can offer better benefits get the best investment managers, and these are until now usually the funds, so the problem is simply moved to another level. This shows that crowdfunding creates a serious risk for small investors to be left with suboptimal investment opportunities, in addition to the risk of fraud. Retail investors should carefully analyze if and how the investment opportunities are screened and selected. They should also check the quality and integrity of the managers of the crowdfunding platform. Regulators in the region are catching up and are creating criteria for crowdfunding platforms that address these and other risks. Until that happens, crowdfunding is better suited for experienced investors rather than the broad public.

Keisuke Nakamura, special advisor at the Multilateral Investment Fund of the Inter-American Development Bank: Crowdfunding has great potential as a source of funding for startups and emerging businesses in Latin America. According to a market forecast, equity-based crowdfunding platforms’ transaction value in the region is expected to show exponential growth by reaching a total of more than $270 million, with six million users by 2020. Crowdfunding platforms and banks are beginning to form partnerships to support funding entrepreneurial activity in developed economies. This trend is coming to Latin America soon as demand for funding entrepreneurial growth increases. Most countries in Latin America have a void for SME financing that governments, commercial banks, angel investors and venture capital have not been able to fill. Crowdfunding is one of the promising tools to fill it. Crowdfunding is more advantageous for startup or early-stage entrepreneurs as lending decisions are made based on business ideas or products, not by assets or collateral. Also, crowdfunding campaign pitches could be an effective marketing tool for products and services. Regarding potential drawbacks, entrepreneurs must invest more time and effort than anticipated for running a crowdfunding campaign, which may compromise their time for taking care of their nascent businesses. Also, in spite of the time and effort, if the threshold set by entrepreneur cannot be achieved, all the funds collected to that point might have to be returned to contributors.

Nicolás Mariscal, member of the Advisor board and chairman of Grupo Marhnos in Mexico City: Crowdfunding is part of Latin American culture. The difference is that long ago, projects became known via word of mouth; today, social networks, different platforms and technological tools are used. The tendency of this practice is increasing, and technology plays an important role. It is part of the P2P, or people-to-people, economic activity and the growing collaborative economy. Thus, it positively challenges the traditional credit mechanisms for innovation. For example, Britain has ‘mini-bonds,’ which permit the issuers to microfinance this type of debt at competitive rates. However, crowdfunding covers a much wider niche, ranging from mere donations to contributions for ventures. Unlike traditional methods of money lending, however, where profit is expected, participants in crowdfunding have other motivations. In the majority of cases, they contribute due to the sheer pleasure of helping or seeing their money invested in a project that they support, regardless of the rewards. Thus, technology platforms become facilitators of the collaborative economy.

Enrique Jacob, president of Mexico’s National Entrepreneurship Institute (INADEM): In Mexico, financial penetration is lower than in other Latin American countries (credit as a proportion of GDP is lower than 35 percent). Thus, there is still huge potential to expand credit in different forms, and crowdfunding is certainly an attractive possibility. Crowdfunding in Mexico is in the early stages. However, a study carried out by the Multilateral Investment Fund points out that there is an adequate foundation upon which a robust crowdfunding industry may be built. Rapidly expanding access to the Internet and related technologies, combined with strong economic conditions, will enable more Mexicans to engage in crowdfunding. Progressive reforms enacted under the current administration, in addition to emerging leadership from INADEM and a growing culture of local entrepreneurship demonstrate the practicality of driving additional reforms addressing digital commerce and finance. Following this study in 2014, the Multilateral Investment Fund granted the Mexican government $1.5 million to develop its crowdfunding ecosystem. Mexico is the first country in Latin America in which such a project has been carried out.

Republished with permission from the Inter-American Dialogue's daily Latin America Advisor


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