The UAE’s Recent Crowdfunding Law Advances Opportunities for SMEs
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The UAE’s Recent Crowdfunding Law Advances Opportunities for SMEs
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By Saniya Fatima, Research Analyst, Botho Emerging Markets Group
June 29, 2022
In 1997, a British rock band raising funds from their fans to finance their reunion concert was amongst the earliest success stories of modern crowdfunding. Today, the global crowdfunding market is expected to grow from $12.2 billion in 2021 to $25.8 billion by 2027. Yet, the MENA region contributed only $150 million by 2020, accounting for a negligible portion of the global crowdfunding pie. However, the UAE's new crowdfunding regulation is a significant step toward closing this gap and utilizing crowdfunding to promote the local small and mid-size enterprise (SME) sector and strengthen the UAE's position as a regional startup hub.
In recent years, the UAE has seen an upward trend both in terms of existing platforms like Dubai Next, Eureeca, and Beehive, which offer reward-based, equity-based, and peer-to-peer loan crowdfunding; and the emergence of crowdfunding regulations. Yet, until March 2022, there was no regulatory framework in the UAE that specifically addressed or permitted crowdfunding across the country, aside from the existing jurisdiction-centered regulations, like in the DIFC. In this context, the UAE's newly approved crowdfunding law, System for Crowdfunding Platform Operators, empowers the Securities and Commodities Authority (SCA) to govern regional crowdfunding platforms, removing regulatory ambiguities and streamlining the governing process across the country, thus opening up a multitude of opportunities for the entrepreneurship sector in the UAE.
Opportunities for SMEs and Investors
The foremost value of crowdfunding lies in the financing opportunities it offers to startups and SMEs in the country. SMEs account for 95% of companies in the UAE. However, they face challenges in accessing finance—conventional banks reject 50% to 70% of funding applications from SMEs. Furthermore, the total percentage of loans to SMEs currently stands at 4%, well below the MENA average of 9.3%, demonstrating a major gap in debt financing of startups in the country. The new crowdfunding law, which regulates debt financing, is expected to close this gap by opening new debt-financing avenues for SMEs and startups in the region, assisting entrepreneurs in emerging industries. It is expected to boost startups from creative industries, such as art and entertainment, as well as emerging technologies, such as NFTs and SpaceTech, which have a harder time accessing traditional finance due to their unconventional and relatively untested business models.
Beyond bolstering SMEs, crowdfunding systems benefit investors, especially angel investors, who want to spend minimal time and resources on due diligence. Due to mandated baseline due diligence requirements, crowdfunding platforms can significantly reduce the typical due diligence period of 45-180 days even before the deal is available to investors. Eureeka, for example, has a due diligence process that takes 7–11 weeks before a campaign goes live. This process ensures the legitimacy of investment opportunities on crowdfunding sites, thereby increasing investor confidence.
The Challenges of Crowdfunding
However, while crowdfunding offers myriad opportunities, it also comes with risks and challenges. For one, the inflated capital table connected with a crowdfunded project prevents businesses from receiving follow-on funding due to the complicated equity governance. This governance challenge is amplified further when equity holders include novice investors with limited corporate governance know-how, as they are often found to restrict efficient governance. For crowdfunding platforms, due to the operational costs of conducting investor due diligence, estimated to be around $600 per unique investor, small ticket transactions become expensive. While many crowdfunding platforms have imposed minimum investment sizes to combat this issue, higher minimum investment requirements discourage smaller investors, in turn limiting access to crowdfunding for entrepreneurs. Additionally, many of the crowdfunding platforms have stipulated an "all or nothing" policy wherein funds are returned to investors if a funding-seeker fails to hit their fundraising target. While this measure protects investors, the policy is indicative of the limitations of crowdfunding for entrepreneurs.
Strengthening the UAE as the Go-To Startup Hub of the Region & Opportunities Moving Forward
The new regulations go a long way towards promoting the UAE’s role as a startup and SME hub in the region, one that offers a diverse range of financing opportunities. Crowdfunding capitalizes on the recent increase in investment activity from within the UAE over the years, with family offices also looking for investment opportunities in start-ups and VCs, as pointed out by experts. Additionally, while crowdfunding is slowly gaining momentum across the Gulf, the UAE’s advanced business environment ensures that its crowdfunding platforms have an edge in attracting investors from neighboring countries. The new regulation also put the UAE ahead of its regional peers in terms of providing regulatory support for crowdfunding platforms, as many of the Gulf countries are still in the process of formalizing equity crowdfunding regulations into law.
However, there are even more opportunities in crowdfunding that the UAE can capitalize on. Adopting regulations that designate distinct class sizes for small-ticket investors and provide more governance flexibility to entrepreneurs and sophisticated shareholders is one way to address some of the existing governance challenges faced by entrepreneurs. Another opportunity includes more aggressively tapping into the Islamic crowdfunding market, taking a cue from Bahrain. By exploring newer niches within the emerging crowdfunding segment, the UAE government has the opportunity to widen the alternative financing options for its SMEs.
This article has been written by Mariam Mumtaz and Saniya Fatima, Analyst, Botho Emerging Market Group, with special insights from multiple Dubai experts. We would like to send a special thanks to Hans Christensen, Senior Director, Technology and Entrepreneurship, Dubai Integrated Economic Zones Authority.