In recent years, crowdfunding has gained traction as an attractive investment option in Nigeria, offering a novel approach for entrepreneurs to raise capital and for investors to diversify their portfolios. While crowdfunding presents exciting opportunities, it is essential to acknowledge the risks and pitfalls that accompany this investment avenue. In this article, we delve into the potential risks and challenges investors may encounter when participating in crowdfunding campaigns in Nigeria today.
Risks and Challenges rising by the Growth of Crowdfunding
As crowdfunding gains momentum across Nigeria, fueled by technological advancements and the growing need for alternative funding sources, the landscape is becoming increasingly complex. However, amidst the excitement of democratized access to capital, there lies a looming concern: the rising risks triggered by economic hardship and inflation.
The economic challenges facing Nigeria, including high unemployment rates, currency depreciation, and sluggish growth, have spurred interest in crowdfunding as a means of accessing funding for entrepreneurs, startups, and social causes. However, the surge in crowdfunding activity comes with its own set of risks, particularly in the current economic climate. These risks include:
- Investment failure: The biggest risk faced by investors is the risk of investment failure. By the nature of the crowdfunding system, investments in early-stage companies always involve more risk than investments in companies that have reached a certain level of maturity and have a certain level of cash flow data, have professional management, and have the appropriate structure.[1] According to global data, approximately 50% of early-stage firms and small businesses in Nigeria fail in the first five years.[2]
- Fraud and Money Laundering: The most common example of fraud is through false platforms and collecting money for counterfeit and fraudulent companies. Furthermore, at present, there are various types of financial fraud, such as investment fraud, payment fraud, or embezzlement.[3] In a country like Nigeria, where corruption is prevalent, there is a risk of funds being misused or falling into the wrong hands. This could further complicate efforts to address insecurity.[4]
- Lack of Investor Protection: The absence of robust investor protection mechanisms may undermine investor confidence and hinder the growth of crowdfunding as a viable investment option. While regulatory frameworks exist, investors should be cautious. Crowdfunding platforms have investment limits, but there is still a risk of inadequate investor protection.[5]
- Market Risk: Investments in start-ups and small businesses carry inherent risks that cannot be ignored. Returns are susceptible to market conditions, economic downturns, and industry-specific challenges, and investors should be well aware of these potential risks before making any investment decisions.[6]
- Market Saturation: With the proliferation of crowdfunding platforms and campaigns, the market may become saturated, making it challenging for entrepreneurs to stand out and attract investor attention. Competition for funding may intensify, leading to increased pressure on entrepreneurs to differentiate their offerings and effectively market their campaigns.[7]
- Liquidity Risks: Investors need to be aware that crowdfunding investments come with a high degree of liquidity risk. This means that they may not be able to easily sell their shares or recover their capital. In other words, once you invest in a crowdfunding campaign, it can be challenging to get your money back until the project is completed or sold. This is why investors must conduct thorough research and understand the terms and conditions of the investment before committing any funds.[8]
Real-life scenarios and crimes committed through Crowdfunding platforms
In mid-2021, A man named Emeka (An Alias) invested in Agropartnerships, a crowdfunding company that appeared to offer a promising opportunity to grow his hard-earned savings and yield significant returns. Eager to invest, he committed his entire N2 million savings.[9] His initial enthusiasm was shattered by a harsh reality. Months after making his investment, he anxiously awaited his first return, only to be met with disappointment as it failed to materialize. He stated that:
“It began with an excuse of a system glitch, as the company claimed. Then they shifted to manual payment processing, while still promising to pay week after week. Eventually, they stopped responding to my emails. I later found out that their office in Lekki had closed down. They blamed it on COVID-19, even though this was in January 2022 when the world had moved past the pandemic,” Emeka recounted with regret. I knew then that I had fallen victim to a scam. I can’t forgive myself for investing in this fraudulent crowdfunding scheme,”
A woman named Binta (An Alias) and her husband invested N1.74 million in a poultry farm offered by Agrilet for 20 percent returns after four months.[10] They also invested N1 million each in the Farmforte Food Valley in April, 2021. The investment was to run for a year, with 20 percent returns. In June when she got Agrilet’s email, she also got Famforte’s email that the company was unable to make repayments to those due at that time. She did not panic initially as her repayment was not due till the following year but when it became due, it was clear she and her husband were also not getting paid again.[11]
Mitigating Crowdfunding Risks
- Regulatory Compliance: It is imperative that MSMEs (Micro, Small and Medium Enterprises) strictly adhere to the Securities and Exchange Commission (SEC) rules and regulations when operating a crowdfunding platform. Failure to comply with these regulations may result in serious legal consequences. These rules include registration requirements, fees and other criteria.[12]
- Investment Limits: To ensure that individual investors are not overexposed, it would be beneficial for crowdfunding platforms to establish investment limits. This helps manage risk and ensures a diversified pool of backers.[13]
- Disclosure Requirements: When seeking funds for a project, it is vital to openly share all pertinent details with potential investors. This encompasses offering comprehensive information about the project itself, the planned allocation of funds, any associated risks, and financial forecasts.[14]
Through transparent disclosure of relevant details, trust can be fostered with potential investors, easing any uncertainties they may harbor regarding the project. Providing complete and accurate information is paramount, as any misrepresentations or omissions could result in legal ramifications[15].
Effective communication is key to ensuring that potential investors grasp the project and its associated risks fully. Furnishing thorough information upfront can help forestall misunderstandings or disputes later on. In essence, transparency and clear communication with potential investors lay the groundwork for a successful project and enduring investor relationships[16].
- Robust Risk Management: MSMEs are to implement effective risk management practices. Assess and mitigate risks associated with the project, market conditions, and external factors.[17]
- Investor Education: It is imperative to educate investors thoroughly about the potential risks and rewards associated with crowdfunding to enable them to make informed decisions. [18]The rights and responsibilities of investors must be clearly outlined. They must be aware of their role and obligations throughout the crowdfunding process.[19]
- Monitoring and Reporting: It is important to regularly update investors on the progress of funded projects, especially if there are any significant developments or changes. Transparency builds confidence.[20]
- Data Protection and Privacy: All necessary measures must be taken to safeguard any sensitive information pertaining to investors and the project owner. No compromises should be made in this regard. Compliance with data protection laws is essential.[21]
Safe Codes and Strategies for Investors
Crowdfunding risks require a multi-faceted approach aimed at addressing various potential vulnerabilities. Here are some strategies for investors to consider:
- Conduct Due Diligence: Thoroughly research and evaluate crowdfunding platforms before participating. Look into the platform’s track record, reputation, and regulatory compliance. Choose platforms with transparent processes and a history of successful projects.[22]
- Diversify Investments: Spread your investments across multiple projects or platforms to reduce exposure to any single risk. Diversification can help mitigate the impact of potential failures or losses on individual investments.[23]
- Assess Project Viability: Evaluate the viability and credibility of projects seeking funding. Scrutinize project details, business plans, financial projections, and the team’s experience and qualifications. Avoid projects with unrealistic goals or insufficient information.[24]
- Set Investment Limits: Establish personal investment limits based on your risk tolerance and financial capacity. Avoid investing more than you can afford to lose in any single project or platform.[25]
- Monitor Investments: Stay vigilant and regularly monitor the progress and performance of investments. Keep track of project updates, financial reports, and any red flags that may indicate potential issues or concerns.[26]
- Understand Risks: Educate yourself about the inherent risks associated with crowdfunding, including project failure, fraud, and regulatory uncertainty. Be aware of common pitfalls and scams, and exercise caution when evaluating investment opportunities.[27]
- Engage Legal and Financial Advisors: Seek guidance from legal and financial professionals with expertise in crowdfunding and investment management. Consult with advisors to assess the legal and financial implications of crowdfunding investments and mitigate potential risks.[28]
- Participate in Regulated Platforms: Preferably, invest through platforms that operate within regulated frameworks and adhere to established industry standards. Regulatory oversight can provide additional safeguards and protections for investors.[29]
- Review Terms and Conditions: Carefully review the terms and conditions, as well as the investment agreements, associated with crowdfunding campaigns. Understand your rights, obligations, and recourse options in case of disputes or disagreements.[30]
- Stay Informed: Stay informed about developments in the crowdfunding industry, regulatory changes, and emerging best practices. Keep abreast of news and updates related to crowdfunding platforms, projects, and regulatory developments to make informed investment decisions.[31]
Conclusion
In conclusion, while crowdfunding offers exciting prospects for investment in Nigeria, it is essential for investors to remain vigilant and informed about the potential risks and pitfalls. By understanding the challenges associated with crowdfunding investment and implementing risk mitigation strategies, investors can position themselves for success in this evolving investment landscape.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
[1] Sanction Scanner “ Crowdfunding: Fraud and Money Laundering Risks “ file:///C:/Users/HPUSER/Downloads/Crowdfunding_%20Fraud%20and%20Money%20Laundering%20Risks%20-%20Sanction%20Scanner.html Accessed 12/03/2024
[2] Securities and Exchange Commission “Overview and Regulatory Framework on Crowdfunding in Nigeria” Accessed 13/03/2024
[3] Sanction Scanner “ Crowdfunding: Fraud and Money Laundering Risks “ file:///C:/Users/HPUSER/Downloads/Crowdfunding_%20Fraud%20and%20Money%20Laundering%20Risks%20-%20Sanction%20Scanner.html Accessed 12/03/2024
[4] Oluwaseyi Ajjibade and Muzha Kucha (1st March, 2024) “Risks of Crowdfunding ransom for kidnapped persons”RADIO NIGERIA Risks of crowdfunding ransom for kidnapped persons – FRCN HQ (radionigeria.gov.ng) Accessed 13/03/2024
[5] Olubusola Oyeyosola Diya (14th July, 2021) “The Nigerian Securities and Exchange Commission Crowdfunding Rules- Its Impact on Startups and SMEs” <The Nigerian Securities And Exchange Commission Crowdfunding Rules – Its Impact On Startups And SMEs – Securities – Nigeria (mondaq.com)> Accessed 13/03/2024
[6] Ibid.
[7] Ibid.
[8] Ibid.
[9] Samson Akintaro (July, 2024) “ The Dark twisted of Nigeria”s agro Crowdfunding industry” https://nairametrics.com/2023/07/23/big-read-the-dark-twisted-world-of-nigerias-agro-crowdfunding-industry/ Accessed 13/03/2024
[10] Caleb Ojewale (30th November, 2023) “ In Nigeria, Agriculture became fraud. Tech was the enabler”
https://businessday.ng/backpage/article/in-nigeria-agriculture-became-fraud-tech-was-the-enabler/ Accessed 13/03/2024
[11] Ibid.
[12] Christine Ngene (8th June, 2021) “ The SEC Nigeria rules on Crowdfunding- an overview” AFRICA REINVENTED The SEC Nigeria rules on crowdfunding – an overview (africareinvented.com) Accessed 13/03/2024
[13] Nnaemeka Emmanuel (30th April, 2023) “ The Future of Regulated Crowdfunding In Nigeria” Connectnigeria Articles Accessed 13/03/2024
[14] Ibid.
[15] Ibid.
[16] Ibid.
[17] Ibid.
[18] Ibid.
[19] Ibid.
[20] Christine Ngene (8th June, 2021) “ The SEC Nigeria rules on Crowdfunding- an overview” AFRICA REINVENTED The SEC Nigeria rules on crowdfunding – an overview (africareinvented.com) Accessed 13/03/2024
[21] Ibid.
[22] Investopedia. “How to Assess the Viability of a Crowdfunding Project.” https://www.investopedia.com/articles/investing/082615/how-assess-viability-crowdfunding-project.asp Accessed 13/03/2024
[23] Forbes. “Why Diversification Is Important in Crowdfunding.” https://www.forbes.com/sites/forbestechcouncil/2021/09/17/why-diversification-is-important-in-crowdfunding/?sh=5b9bb13f5b23 Accessed 13/03/2024
[24] Crowdsourcing.org. “How to Choose a Crowdfunding Platform: 10 Key Considerations.” https://www.crowdsourcing.org/editorial/how-to-choose-a-crowdfunding-platform-10-key-considerations/34267 Accessed 13/03/2024
[25] Ibid.
[26] SmartAsset. “How to Monitor Your Crowdfunding Investments.” https://smartasset.com/investing/crowdfunding-investments-are-they-worth-the-risk Accessed 13/03/2024
[27] Ibid.
[28] Crowdfunding Insider. “How to Stay Informed as a Crowdfunding Investor.” https://www.crowdfundinsider.com/2019/07/149250-how-to-stay-informed-as-a-crowdfunding-investor/ Accessed 13/03/2024
[29] [29] Crowdsourcing.org. “How to Choose a Crowdfunding Platform: 10 Key Considerations.” https://www.crowdsourcing.org/editorial/how-to-choose-a-crowdfunding-platform-10-key-considerations/34267 Accessed 13/03/2024
[30] Ibid.
[31] Crowdfunding Insider. “How to Stay Informed as a Crowdfunding Investor.” https://www.crowdfundinsider.com/2019/07/149250-how-to-stay-informed-as-a-crowdfunding-investor/ Accessed 13/03/2024