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Out Of The Box: Crowdfunding Startups To Prevent Economic Collapse

Given the COVID-19 led economic crisis, government support for small and medium enterprises becomes imperative wherein crowdfunding startups appears to be an effective policy measure. However, there are some bottlenecks which need to be addressed on urgent basis.

While it has been ascertained that nothing short of a complete lockdown can control the outbreak, such measures would appreciably debilitate the financing muscle in our economy. The Ministry of Planning says the economy is to sustain Rs2.5tr losses due to severe shocks from coronavirus outbreak. In this scenario, startups provide a potential area of growth, and therefore should not be ignored. The country was named one of the fastest-growing economies in Asia in McKinsey & Co’s latest report on the Pakistani ecosystem. The same report revealed that 720 startups had been created since 2010, indicating that there has been an exponential growth of startups in Pakistan. 

Although the government has announced a relief package, to disrupt the economic contagion, that is not enough to save an economy which now faces an existential threat. In such times, the development of small to medium businesses can be an urgent shot in the arm as it fosters job creation and economic growth, and helps countries recover from economic recession. But there is no welcoming news from our government for startups as the credit facilities have been dramatically limited for them. According to a report recently published by Germany’s public news broadcaster Deutsche Welle, Pakistan could become Asia’s next big tech startup market, but the central problem it faces is access to finance.

Currently, small to medium businesses have limited options for financing, which include debt financing and venture capitalism. One prerequisite is an asset to borrow money from financial institutions which is improbable for many startups at an early stage. Therefore, the absence of collateral rules out the option of debt financing for most of the people.

This restraint is more pronounced in case of tech startups, where basic asset is intangible, since financial institutions haven’t yet made a cultural switch to recognize such an asset as valuable collateral. Moreover, paying interest means that a reliance on bank financing reduces cash flow, which can impact the ability of a business to grow while at the same time, hinder its capacity to withstand economic downturns.

Also, the existing legal landscape is skewed towards the banks, for example, Section 27A of the Banking Companies Ordinance 1962 bars any person, company, etc. from inviting deposits of money from the public for investment in their businesses.The section not only prohibits crowdfunding indirectly but gives an edge to the existing players in the market. Hence, startups turn to pitch their ideas to venture capitalists, but given the risks associated with investing in young companies, fewer startups are able to secure their loans.

Furthermore, Public Offering Regulation permits only those companies to raise finance from public which have been in business for at least three years and have a profitable track record of two and half years. Such regulation naturally excludes cash-hungry startups. To be fair, these concomitant restrictions are in place to prevent investors from fraud, however, this is being done at the cost of economic growth. In such a context, the search for alternative-financing sources is a priority need for business and research developments.

Surely, there are ways around this, as for example, the USA following 2008 economic recession enacted Jumpstart Our Business Startups (JOBS) Act in 2012 that allowed small businesses to raise capital through “crowdfunding,” the acquisition of small amounts of money from a large number of investors, for the first time. To eliminate the risk of fraud, the law places the burden on an intermediary which runs background checks on the companies and provides complete disclosure of information to the public.

Interestingly, crowdfunding is energizing many economies across the world – including some developing countries. Unfortunately, Pakistan has not followed the trend so far. However, this is a challenging time; growing everyday for government which needs to dismantle regulatory roadblocks the startups face to raise capital. To be fair, steps have been taken to ease the regulatory environment for businesses, and the measures taken seem to be effective as Pakistan’s position mentioned in the World Bank’s Ease of Doing Business Index report, jumped from 136th place in 2018 to 108th place in 2019.

The inevitable demise of businesses due to disruption from coronavirus can lead to significant job losses (about 18.5 million estimated) which may impact the social cohesion of society, resulting in political upheaval with government finding itself under pressure to generate solutions to tackle unemployment. Rather than resorting to protection of traditional industries, the executive, with the help of the parliament, should immediately put a concerted effort to rework securities regulation to encourage the funding of startup industry through crowdfunding.

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