# Developing a Sharīʿah-compliant equity-based crowdfunding framework for entrepreneurship development in Malaysia

Maya Puspa Rahman (Faculty of Economics and Management Sciences, International Islamic University Malaysia, Kuala Lumpur, Malaysia)
Mohamed Asmy Mohd Thas Thaker (Faculty of Economics and Management Sciences, International Islamic University Malaysia, Kuala Lumpur, Malaysia)
Jarita Duasa (Faculty of Economics and Management Sciences, International Islamic University Malaysia, Kuala Lumpur, Malaysia)

ISSN: 2289-4365

Publication date: 5 August 2020

## Abstract

### Purpose

Crowdfunding has become one of the preferred mechanisms to raise funds by startups and small entrepreneurs. As such, this paper aims to develop an appropriate framework for Sharīʿah-compliant equity-based crowdfunding (SEC) for entrepreneurship development in Malaysia.

### Design/methodology/approach

The research begins by analyzing the intention of 200 entrepreneurs in Kuala Lumpur and Selangor regarding the use of crowdfunding to raise capital. The analysis is based on the theory of reasoned action (TRA), which is also associated with the technology acceptance model (TAM) and is effected by using structural equation modeling (SEM).

### Findings

The entrepreneurs agree on the ease of use of crowdfunding in raising capital, although it appeared that they are quite reluctant to share their business ideas online. Subsequently, an SEC framework is proposed, to further enhance entrepreneurship development in Malaysia particularly in meeting the need for raising funds in line with Sharīʿah (Islamic law) principles.

### Practical implications

This paper aims to contribute more to the development of a blueprint for an SEC platform for market players and regulators in Malaysia.

### Social implications

This paper also aims to highlight the growing needs of entrepreneurs, particularly in Malaysia to have a Sharīʿah-compliant alternative to raise funds via crowdfunding.

### Originality/value

This paper makes two main contributions. First, it provides evidence on Malaysian entrepreneurs’ intention to use crowdfunding for fundraising through TAM and SEM analysis. Second, it proposes an SEC framework for the development of entrepreneurs in Malaysia.

## Citation

Rahman, M.P., Mohd Thas Thaker, M.A. and Duasa, J. (2020), "Developing a Sharīʿah-compliant equity-based crowdfunding framework for entrepreneurship development in Malaysia", ISRA International Journal of Islamic Finance, Vol. 12 No. 2, pp. 239-252. https://doi.org/10.1108/IJIF-07-2018-0085

## Publisher

:

Emerald Publishing Limited

Copyright © 2020, Maya Puspa Rahman, Mohamed Asmy Mohd Thas Thaker and Jarita Duasa.

## Introduction

Crowdfunding is certainly not something new in the global capital markets. Since 2012, crowdfunding has become a trendy fundraising mechanism for entrepreneurs globally. Popular crowdfunding platforms such as Kickstarter and Indiegogo exist in the United States of America (USA). Malaysia is also proud to have its own local crowdfunding platforms such as pitchIN, mystartr and Ata Plus, to name a few. In 2015, Malaysia made history by being the first country to legalize equity crowdfunding in Southeast Asia, issuing six licenses for equity crowdfunding (ECF) platforms to operate in the country (Rahman et al., 2016). Subsequently, six peer-to-peer (P2P) crowdfunding licenses were issued in November 2016, which have increased to 11 as of March 2020 (Securities Commission Malaysia, 2020, (SC)). Collectively, P2P has successfully raised RM 739m from 9,989 campaigns while ECF has raised RM 86m from 89 campaigns (SC, 2020).

It is essential to appreciate that transparency is one of the many reasons for the ready acceptance of crowdfunding by both entrepreneurs and investors. Entrepreneurs seeking funds through the crowdfunding mechanism must disclose all related information in a short video, which is then uploaded on a specific crowdfunding platform. This video informs investors about the company’s background, the purpose of the fundraising, the fund target level and the rewards (or returns) that can be obtained. The rewards may be in monetary or non-monetary form. For example, some projects are philanthropically driven with the purpose of relieving specific issues among certain communities; hence, supporting such plans provides pure satisfaction and inner happiness to the investors. This is known as donation-based crowdfunding. On the other hand, reward-based crowdfunding offers material incentives to investors, generally in the form of items that are related to the cause of the fundraising exercise.

Another type of crowdfunding is known as P2P lending, which operates similarly to conventional lending, yielding interest as the return to the investors. Equity-based crowdfunding is another type whereby investors obtain a percentage of ownership of a company in proportion to the amount invested. The entrepreneurs raising funds through equity-based crowdfunding must convince investors that the company will grow in value over time and provide them with options to exit the investment and obtain a capital gain in the future. In addition, entrepreneurs must also be able to induce investors with the possibility of a good income stream (in the form of a dividend) over the holding period, similar to an investment in shares in the equity market. On this note, it is believed that this mechanism would encourage Muslim entrepreneurs to take part in such investments, especially with the potential development of a Sharīʿah-compliant equity crowdfunding (SEC) framework, which would allow them to grow hand-in-hand with the dedicated investors and benefit from economic prosperity.

This paper aims to shed light on how Muslim entrepreneurs can benefit from equity crowdfunding and introduces the concept of an SEC framework. Even though it is known that several crowdfunding platforms – such as Ethis and Kapital Boost, to name a few – are using the Islamic concepts for fundraising, a fundamental study on the acceptance of these models in the Malaysian market has yet to be undertaken. This study attempts to fill in this research gap. Accordingly, this study begins by gauging entrepreneurs’ general understanding and acceptance of crowdfunding by conducting a survey in the Klang Valley area and analyzing the data based on the theory of reasoned action (TRA).

This paper is organised as follows. The next section highlights the development of crowdfunding and pertinent issues associated with it. This is followed by a presentation of the survey analysis, measuring the entrepreneurs’ intention to use crowdfunding in Malaysia through structural equation modelling (SEM). Subsequently, the conceptual framework of SEC for Malaysia is discussed. The last section concludes with some recommendations for future research.

## Crowdfunding development and current issues

Raising sufficient capital has been one of the main challenges for businesses, especially start-ups. After the 2008 financial crisis, financing was further tightened, leaving minimal options for entrepreneurs and early-stage enterprises to raise funds. Nonetheless, with the advancement of technology, entrepreneurs have become more independent and innovative in raising capital, extending what was known as traditional financing by friends and family to the most significant new means of fundraising in the world, known as crowdfunding. Crowdfunding has become a practical tool to overcome the funding gap and risk implications faced by financial institutions.

The World Bank (2013) defines crowdfunding as an internet-enabled way for businesses or other organizations to raise money in the form of donations or investments from multiple individuals. Crowdfunding platforms circumvent the tedious process of raising funds from the capital market or loans from financial institutions by bridging the gap between entrepreneurs and the mass public. Kickstarter and Indiegogo are, perhaps, the most prominent examples of such platforms; however, to date, there are more than 1,000 crowdfunding platforms globally, concentrated mainly in North America, Europe and Oceanic and Asian countries (Fundly, 2020).

The recent introduction of equity-based crowdfunding in Malaysia provides more alternates for Muslim entrepreneurs to raise funds. It is believed that equity-based crowdfunding represents a significant opportunity to deliver the essential expectations from Islamic finance by combining the benefits of social development and investment opportunities for a wide range of entrepreneurs and investors. Sharīʿah-compliant crowdfunding is seen to further provide an opportunity for entrepreneurship development, especially to those focusing on offering Sharīʿah-compliant goods and services in Malaysia. Before discussing the Sharīʿah perspective on the current crowdfunding mechanisms, it would be beneficial to highlight the growth of the crowdfunding industry, thus far.

### Developing a Sharīʿah-compliant equity crowdfunding framework for Malaysian entrepreneurs

By analyzing the current equity-based crowdfunding stages and procedures, a conceptual SEC framework is developed that involves three main phases as follows: the pre-funding phase, funding phase and post-funding phase. Figure 4 below presents a proposed SEC framework during the pre-funding and funding phases with the following detailed modus operandi:

• Entrepreneurs who wish to raise funds through SEC will need to establish a relationship with a dedicated equity-based crowdfunding platform operator. It is suggested that their relationship be based on the wakālah (agency) contract, as the platform will be acting as an agent or middleman for the entrepreneur in fundraising activities.

• Upon registering with an approved equity-based crowdfunding platform, the entrepreneurs will undergo an assessment process, which is standard practice in the crowdfunding industry. This will involve the screening process, due diligence and Sharīʿah-compliance assessment. In the proposed framework, Sharīʿah compliance is proposed to be undertaken by two parties, namely the equity-based crowdfunding platform, as well as an independent Sharīʿah advisor, to ensure that the business and fundraising causes are in line with the Sharīʿah. This follows the current practice of equity-based crowdfunding whereby the regulator, Securities Commission Malaysia, oversees the conduct of fundraising together with the platforms. If the assessment process gets approved, it will proceed to the funding phase (2A in Figure 4). Otherwise, the whole fundraising initiative will be halted (2B). It is important to highlight that it is at this stage that appropriate contracts are decided for the entrepreneur to use to raise the funding target. The proposed contracts could be in the form of murābaḥah, mushārakah or muḍārabah. For each of these contracts, there are some specific elements, which should be made transparent; for example, if murābaḥah contract is used, the cost and profit must be clearly disclosed.

• Once the projects are made available on the equity-based crowdfunding platform, investors can start registering themselves and evaluating the projects for the purpose of investment. It is very important to emphasize that at this stage, the equity stake, potential return, exit strategies and other benefits to be obtained by the investors are to be clearly spelled out. Progress and updates throughout the funding period, which normally ranges from 45 to 60 days, must also be made available on the SEC platform. During this stage, it is important for the entrepreneurs to keep updating the potential investors on the relevant information such as the amount of funding secured and the balance of days remaining to make an investment. Face-to-face meetings may also be arranged with investors. Should the project meet the investors’ appetite, they can commit their monies through the platform, which is normally done via the online payment mechanism (including PayPal). This proposed framework proposes the “All or Nothing” concept, whereby the contract will be executed if the fund target is met (3A); otherwise, the investors’ money will be returned (3B).

• When the funding phase is concluded and the funding target has been achieved (3A), all the necessary and legal documents must be produced such as the shareholder agreements, which clearly spell out the obligations of the entrepreneurs to their investors. A binding Sharīʿah contract between the entrepreneur and investors (mushārakah, muḍārabah or murābaḥah, as proposed earlier in the pre-funding stage) will stipulate all the details relevant to the invested project.

• The collected funds will then be transferred from the equity-based crowdfunding platform to the entrepreneurs, after deducting all related fees.

It is important to emphasize that the relationship established between the entrepreneurs and investors continues to be nourished and strengthened via periodic updates, board presentations, milestones of financing and so forth, which are categorized as the post-funding phase. This information can be published via the equity-based crowdfunding platform or the entrepreneurs’ own websites as shown in Figure 5. Nonetheless, it is noticed that communication between the entrepreneurs and investors is done via the crowdfunding platform.

It is expected that by going through these three phases meticulously, the objectives of entrepreneurs to raise funds via an alternate Sharīʿah-compliant mechanism such as SEC can be achieved. Most importantly, this could also be an additional funding mechanism that could strengthen the financial ecosystem, particularly in Malaysia.

## Conclusion and recommendation

This paper evaluates the concept of crowdfunding and how it could benefit Muslim entrepreneurs, particularly in Malaysia. With the emergence of many equity crowdfunding platforms, this paper examines the current crowdfunding platforms and highlights the Sharīʿah contracts mainly used in the effort to develop an SEC framework for Malaysia. The identification of issues related to crowdfunding has led to introducing an SEC framework for an alternate method of financing.

Nonetheless, before developing a conceptual SEC framework for use by entrepreneurs, their general understanding of crowdfunding and their willingness (or intention) to use it have been assessed. To that end, a survey sample of local entrepreneurs in Malaysia has been undertaken and analyzed based on the extended TRA, which is TAM, through the use of SEM.

This paper makes two main contributions to the existing literature. First, it provides evidence on Malaysian entrepreneurs’ intention to use crowdfunding for their fundraising exercise through TRA and TAM by applying the method of SEM accordingly. Second, it proposes a conceptual SEC framework for the development of entrepreneurship in Malaysia.

For future research, there is a plan to share the proposed SEC framework with stakeholders to obtain feedback for further improvement. Apart from that, additional analysis can also be undertaken by extending the proposed framework outside Malaysia; for example, Indonesia and Singapore. It is an aspiration for this framework to become the standard operating procedure on the offering of SEC not only to entrepreneurs in Malaysia but also to the rest of the world.

## Figures

TAM

#### Figure 2.

Final measurement model

Structural model

#### Figure 4.

Proposed SEC framework – pre-funding and funding phases

#### Figure 5.

Proposed SEC framework – post-funding

## Table I.

SWOT analysis on crowdfunding

 Strengths Weaknesses Accessibility of capital Benefits to communities Rights to make a company’s decisions stay in the hands of entrepreneurs A chance to test the marketability Possibility of ideas being stolen, weaker investor protection and potential for fraud Investors might lack advice as crowdfunding is exceptionally internet-based Administrative and accounting challenges Opportunities Threats Existence of niches Positive effects are expected for the economy Information society Unsuitable legal restrictions arise Risky nature of small business

## Table II.

Description of entrepreneurs in Kuala Lumpur and Selangor

Number of respondents Total (%)
Total 200 100.0
Gender
Male 91 45.5
Female 109 54.5
Activity
Services 121 60.5
Agriculture 12 6.0
Construction 2 1.0
Others 65 32.5
Ownership
Sole proprietorship 131 65.5
Partnership 42 21.0
Private limited 27 13.5
0–5 years 112 56.0
6–10 years 47 23.5
>10 years 41 20.5
Sales turnover (RM)
10,000–50,000 101 50.5
50,001–100,000 43 21.5
100,001–150,000 26 13.0
150,001–200,000 12 6.0
200,001–300,000 8 4.0
>300,000 10 5.0

## Table III.

Final measurement model – fit indices

Model χ2 df Normed χ2 RMSEA CFI Comment
Final measurement model 76.241 39 1.955 0.069 0.968 The required level is achieved

## Table IV.

The CFA results for the measurement model

Construct Items Factor loading Cronbach’s alpha (above 0.7) CR (above 0.6) AVE (above 0.5)
PU 0.846 0.846 0.581
PU1 0.903
PU2 0.911
PU3 0.925
PU4 0.923
PEU 0.835 0.835 0.560
PEU1 0.904
PEU2 0.924
PEU3 0.902
PEU4 0.912
BI BI1 0.909 0.756 0.756 0.511
BI4 0.903
BI5 0.925

## Table V.

Results of hypothesis testing

Hypothesized path Standardized coefficient t-value p-value Decision
H1 PU → BI 0.182 1.897 0.058 PU and BI are not significant
H2 PEU → BI 0.667 5.542* 0.000 PEU and BI are significant and positively related
Note:

*p-value < 0.01

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## Acknowledgements

This research is funded by the Fundamental Research Grant Scheme 2016 (FRGS16-062–0561), Ministry of Higher Education Malaysia.

## Corresponding author

Maya Puspa Rahman can be contacted at: mayapuspa@iium.edu.my