On crowd-funding in Pakistan

Last Monday, SECP, Pakistan’s corporate regulator, warned public about a crowd-funding website raising funds from the public. (Internet-based crowd-funding platforms help small firms and individuals raise small donations or investment from other individuals). It also informed the public that crowd-funding schemes are not legally allowed in Pakistan. The statement also made clear that the said platform, with the name “Innovative Crowd Funding Project Pvt. Ltd Pakistan” wasn’t registered with SECP.

The press release further stated that “the public is hereby warned not to be misled by fraudulent activities, investments/deposit schemes launched by certain non-corporate entities or individuals through advertising in the electronic and print media, websites, emails, mobile text messages etc.”

More such online platforms exist in Pakistan. SECP is right to warn the public about the risk of fraudulent activities. The memory of Ponzi schemes, such as the one run by the notorious Double Shah is still fresh. Indeed, as per Pakistani law, only licensed institutions, e.g. commercial banks, microfinance banks, stock brokers and mutual funds can legally accept people’s deposits and investments.

However, given Pakistan’s demographics and economic situation, a case can be made for crowd-funding, albeit under certain restrictions.

It should be clear to the policymakers that there simply won’t be enough new jobs in the future, in both the public and private sectors, to absorb the millions of youth currently enrolled in universities and colleges. But, with a mix of initiative, ingenuity, and industry, the youth can find ways to turn their creative ideas into reality. They can start up, and in the process, not only find their passion, but go on to create more jobs.

Sadly, despite the federal and provincial governments talking a big game on promoting startups, still many barriers exist. Access to finance is one of them. Commercial banks are too risk-averse and collateral-oriented to do clean lending. The dozens of microfinance institutions are certainly more open but they offer a small-ticket loan. There is not much venture capital activity to begin with.

In that environment, crowd-funding can make it easier for individuals and startups to cut through the financial intermediaries and appeal directly to other individuals to fund their ideas and projects. But crowd-funding is more than funding. Mostly the creative and original ideas, supported by transparent disclosures, survive the online scrutiny. So there is a greater chance of disruptive innovation. And it goes beyond for-profits: for instance, artists can also pitch their creative projects online.

A regulatory framework will have to negotiate competing aspects of crowd-funding: start-up promotion and investor protection. A guarded, but incremental regulatory approach perhaps suits Pakistan’s conditions. In the first phase, the regulator can allow, under certain conditions, reward-based and donation-based crowd-funding. In those crowd-funding variants, there is less chance of fraud as individuals willfully participate to satisfy their “sense of social participation” or “sense of patronage” without expecting a return.

Once this gets going, a few years later, crowd-funding scope could be extended to equity-based crowd-funding. This variant, where startups take public money as investment, throws up risks for investor protection. So there should be stringent requirements for startups. The regulatory framework can put a ceiling on the age of startup seeking funds, number of investors, amount of investment raised, etc. To address information asymmetry, disclosure requirements have to be adequate.

Here, the buck stops chiefly at the federal government to enable the new, digital economy. And crowd-funding is just one of the many enablers that need to be looked at. It comes with its own risks, which are serious, but that is no excuse to sit back. Regulations need to be framed so that legitimate, credentialed digital platforms can become a viable funding conduit for the oft-shunned entrepreneurs.