Friday, September 26, 2014

Crowdfunding in China: Three key issues

Given different financial environments, legal systems and cultural practices, Chinese crowdfunding is a totally different phenomenon. For example, in the United States, after passage of the JOBS ACT, crowdfunding has legal validation and subsequent protection. In this environment, a crowdfunding platform is free to move toward perfection. With equity crowdfunding on the horizon, investment and return is soon to be a factor in crowdfunding.

But, in China, the crowdfunding environment is still not sound. Compared to the United States, the development of crowdfunding in China is differentiated by three factors. First, innovative projects are harder to find in China than in the United States. Secondly, people in China seem to lack confidence in crowdfunding. Third, the legal basis for crowdfunding is uncertain. The following article discusses each of the issues in detail.

1. Supply Side: Lack of innovative projects

“Innovative ideas (in China), especially in the technology category, trails far behind the United States in terms of both quality and quantity. The situation is sometimes likened to be too many ships chasing for too few fish in the river,” the authors of a study on crowdfunding published by the World Bank wrote.

Actually, given cultural and historical differences, Chinese people seem to be more focused on the traditional. Therefor, the ability to innovate seems lower currently than in the US. This is bound to change, however.

Since crowdfunding is a powerful tool that lets innovative businesses attract funds, the number of good crowdfunding campaigns is limited in China.

2. Demand Side: Lack of confidence

The key issue in Chinese crowdfunding is the problem of "donating money to a stranger." This has reduced confidence in crowdfunding. The supply of willing sponsors is not so as high as in the US. People do not want to donate money to crowdfunding projects because people in China may not have as much confidence in small business as people in the US have. Since most crowdfunding campaigns end in failure, some people do not want to take the risk of putting money into such high probability of failure projects. Moreover, because the Chinese still have limited knowledge of crowdfunding, they cannot accurately assess the value of helping a crowdfunding project succeed. Even if they find a very attractive project, they think, “oh, while
this idea is not bad, I will buy one after they have produced it.” They do not realize that without supporters, the business may find it impossible to produce the product.

As a result, Chinese crowdfunders must make an extra effort to advertise and promote their campaign. This increases the cost of crowdfunding and, at the margin, makes it less likely to succeed. Since crowdfunding is a totally new idea in China, we need to introduce the concept to the public, giving them confidence in crowdfunding and showing them the importance of contributors. We must let the public know clearly that, if you like an idea, you must donate now, or you may never see this product in the market! In my opinion, only when this idea is imbedded can crowdfunding succeed in China

3. Lack of law and regulation

China’s weak intellectual property laws do not provide adequate protection for entrepreneurs. Without a legal system that protects new ideas, the financial incentive behind innovation is effectively eliminated. Entrepreneurial ventures already incur plenty of risk; when competitors or market dominators can steal ideas with little to no retribution, the viability of new ventures is degraded.

In equity crowdfunding, Chinese property law has clearly forbidden private financing for small businesses, so key legal issues must be resolved as soon as possible. These issues include: what is the difference between
equity crowdfunding and illegal private financing, and, most importantly, is equity crowdfunding legal in China? Therefor, it is urgent that the Chinese government release a law that takes specific aim at crowdfunding activities and clearly define standards and rules.

Even though there are many problems and obstacles of crowdfunding in China, the World Bank has a high expectation on China market. The most recent World Bank report predicts that by the year of 2025, the total amount of crowdfunding worldwide will be US $90-$96 billion per year and that the greatest potential lies in China, which accounts for US $46 to US $50 billion of that figure. Given the sheer size of the population, this prediction makes sense. China has the largest number of people and one of the largest markets in the world, so there is no reason why crowdfunding cannot be popular in China.

If Chinese crowdfunders resolve the three issues cited above, we are certain that crowdfunding will boom in China.

Posting by Jing Chen & Jianning Zhang, Masters Candidates in Accounting, Smith School of Business, University of Maryland. They are both Crowdfunding Research and Development Interns, NCS, Fall, 2014. 

Edited by William Michael Cunningham.