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CROWDFUNDING IN MEXICO

The Power of Digital Technologies to Transform Innovation, Entrepreneurship & Economic Inclusion

MULtILAtErAL INVEStmENt FUNd Inter-American Development Bank 1300 New York Avenue NW Washington, DC 20005 www.fomin.org mifcontact@iadb.org All rights reserved

Disclaimers The findings, interpretations and conclusions expressed herein are entirely those of the author(s) and do not necessarily reflect the view of the Multilateral Investment Fund, its donors, the Inter-American Development Bank and its affiliated organizations, the Board of Executive Directors of the Inter-American Development Bank or the governments they represent. The Inter-American Development Bank cannot guarantee the accuracy of the data included in this work. The boundaries, colors, denominations, and other information shown on any map in this work do not imply on the part of the InterAmerican Development Bank any judgment of the legal status of any territory or the endorsement or acceptance of such boundaries. Rights and Permissions The material in this publication is copyrighted. Copying and/or transmitting portions or all of this work without permission may be a violation of applicable law. The Inter-American Development Bank encourages dissemination of its work and will normally grant permission to reproduce portions of the work promptly. To cite this publication: Crowdfunding in Mexico: The Power of Digital Technologies to Transform Innovation, Entrepreneurship & Economic Inclusion. 2014. Multilateral Investment Fund, Access to Markets and Skills. Washington, DC: Inter-American Development Bank.

Table of Contents

About MIF

5 5 10 16 20 24 27 32 36 38 46 51 54 57 60 64 68 102 104 106 108

1. Executive Summary 2. Introduction 3. Research Methodology 4. Crowdfunding Overview


About Massolution

5. Analysis of the Mexican Crowdfunding Environment

4.1 Types of Crowdfunding 4.2 Crowdfunding Capital Flow Models

6. Recommendations 7. Conclusions
References

5.1 Economy and Financial Ecosystem 5.2 Technology Infrastructure and Business Capacity 5.3 Political Environment 5.4 Mexican Regulatory Environment 5.5 Cultural Context 5.6 The Current Mexican Crowdfunding Landscape 5.7 Points of Comparison: International Experience with Equity-based Crowdfunding Regulations

Appendix 1. Research Methodology Appendix 2. Use Cases

Acknowledgements

This report was commissioned by the Multilateral Investment Fund (MIF), a member of the Inter-American Development Bank (IDB), as part of an effort to promote the sustainable evolution of a financial ecosystem surrounding Mexican MSME. The study was carried out under the supervision of Csar Buenadicha and Frank Hoder of the MIFs Access to Markets and Capabilities unit and prepared by Massolution, a research and advisory firm specializing in crowdbased solutions. The main text of this report was written by Carl Esposti and Joseph Barisonzi of Massolution. First-hand survey research was conducted by Massolution in Mexico City, Mexico with local crowdfunding platforms, businesses, and public and private institutions. Special thanks go to Pepe Villatoro of Crowdfunder.mx for his invaluable support in coordinating interviews and providing substantive feedback on the report itself. Sincere thanks are also due to others who have provided insightful comments and practical guidance: Xon Fernandez Garca (MIF); Georg Neumann (MIF); and Guillermo Aguilar (IDB Mexico). Design coordination: Claudia M. Senz (MIF).

About MIF
The Multilateral Investment Fund is a member of the Inter-American Development Bank Group. Funded by 39 donor countries, the MIF is the largest technical assistance provider to the private sector in Latin America and the Caribbean, providing over US$100 million per year to projects reaching more than 4 million small producers, entrepreneurs, and poor and low-income households. The MIF serves as a knowledge broker and as the hub of a network of 1,000 local and international partners that share MIF development goals. It is a provider of grants, loans and equity investments with an average grant size of US$ 1.5 million, and serves as a gateway for knowledge and expertise on private sector solutions for economic development in the region. Through this project, MIF aims to fulfill its mission to act as a development laboratory for experimenting, pioneering, and taking risks to empower dynamic entrepreneurs and poor and vulnerable populations.

About Massolution
Massolution is a unique research and advisory firm that is pioneering the design and implementation of crowd-based solutions for government institutions and private sector enterprises that drive organizational efficiency, improved business performance, product and service innovation, and enhanced levels of customer engagement. Massolution provides consulting services to businesses on the adoption of crowdsourcing and crowdfunding and supports the design and delivery of new work processes through crowdsourced labor solutions. It also advises the public sector on the design and implementation of national crowdsourcing and crowdfunding strategies that aim to drive social and economic impact. Massolution also operates a leading industry website, www.crowdsourcing.org.

Abbreviations and Acronyms

AMIPCI Asociacin Mexicana de Internet APR Annual Percentage Rate CF Crowdfunding CFI Crowdfund investor CFP Crowdfunding platform/portal CNBV La Comisin Nacional Bancaria y de Valores (Mexico's banking and securities regulator) CONSOB Commissione Nazionale per le Societ e la Borsa (The Italian Stock Exchange Commission) CSP Crowdsourcing Platform CSR Corporate Social Responsibility C-STEP Crowdsourcing and Crowdfunding for Social Transformation and Economic Performance - Massolution's Crowdsourcing and Crowdfunding strategy development methodology. FINRA Financial Industry Regulatory Authority FSA Financial Services Authority (UK) IDB Inter-American Development Bank IMF International Monetary Fund INADEM Instituto Nacional del Emprendedor (National Entrepreneurship Institute) INEGI Instituto Nacional de Estadstica y Geografa (National Institute of Statistics & Geography)

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(Abbreviations and Acronyms continued)

IPADE Universidad Panamericana A Top 200 Global Business School ITAM Instituto Tecnolgico Autnomo de Mxico A Top 200 Global Business School IPO Initial Public Offering LAC Latin America and the Caribbean MCA Mexican Crowdfunding Association MIF Multilateral Investment Fund MSME Micro, small, and medium enterprise(s) MUSEIC Mexico US Entrepreneurship and Innovation Council NAFTA North American Free Trade Agreement OECD Organization for Economic Co-operation and Development PISA Program for International Student Assessment S.A. Sociedad Annima S.A.P.I. Sociedad Annima Promotora de Inversin SEC Securities and Exchange Commission (U.S) SME Small and medium enterprise(s) UN United Nations UNESCO United Nations Educational, Scientific and Cultural Organization UNODC United Nations Office on Drugs and Crime VC Venture Capital

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Glossary of Terms

Accredited or Qualified Investor. A term defined by various countries' securities laws that delineates investors permitted to invest in certain types of higher risk investments including seed money, limited partnerships, hedge funds, private placements, and angel investor networks. Differing by jurisdiction, individuals typically qualify through income, assets or qualitative characteristics. Campaign Owner/Issuer. The person or entity in charge of a crowdfunding campaign. For securitiesbased crowdfunding, a campaign owner is often referred to as the issuer. Crowdfunder. A donor or investor providing capital to a crowdfunding campaign via a CFP. Crowdfunding. A model for capital formation and market engagement where funding-needs and funding-purposes are communicated broadly via an open call, typically through the internet, and supported by the collective contributions of multiple independent donors or investors. Crowdfunding Campaign. The proposal (funding-needs and funding-purposes), process and activities associated with a campaign owner raising capital via a CFP. With a securities-based crowdfunding campaign this may be referred to as the offering. Crowdfunding Goal. The amount of capital a campaign owner/issuer aims to raise for a given campaign. Funds are often held in escrow until the goal is reached. Crowdfunding Models. The terms established to define the relationships and responsibilities of parties to a crowdfunding campaign, including CFPs, crowdfunders, and campaign owners or issuers. Terms are generally based on the nature of expected compensation for campaign contributions, if any. There are four primary types of crowdfunding models: donation-, reward-, lending- and equity-based. Crowdfunding Platform/Portal. A website that markets specific offerings/campaigns, receives individual funding contributions from donors/investors, holds funds in escrow (if applicable to the crowdfunding model), distributes funds to campaign owners, collects reimbursement from issuers, and channels reimbursement to crowdfunders (if applicable). Crowdfunding platforms vary in form and function, but most provide these basic services. Crowdfunding Raise. The amount of capital raised resulting from a crowdfunding campaign. Crowdsourcing. An online model used to source labor and expertise from the crowd for tasks related to production and problem solving. Large jobs can often be broken up into numerous small tasks taken on by individuals in the crowd and subsequently reassembled to produce a final product. Crowdsourcing Platform. A website to match and fulfill the demand for work with supply from a digital online labor marketplace. Debt-based Crowdfunding. Investors receive a debt instrument that pays a fixed rate of interest (in some cases interest is not paid) and the future repayment of principal. Interchangeable with lendingbased crowdfunding. Domestic Crowdfunding. A domestic issuer raising capital from domestic crowdfunders. Donation-based Crowdfunding. With a donation-based campaign, crowdfunders donate money to campaign owners and do not expect to receive a tangible benefit from the transaction.

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Equity-based Crowdfunding. Investors purchase a security in the form of an equity instrument for a company through an online CFP. Specific terms of equity instruments, including available exit strategies, may vary depending on the business or the CFP. Exit Strategy. A means of exiting an equity contract entered into through an online crowdfunding offering. This may be done by selling the equity stake at market value, through an IPO, or other contract-specific terms. Financial Crowdfunding. A term used to refer to lending- and equity-based crowdfunding, collectively. Interchangeable with the term securities-based crowdfunding. Foreign Capital Inflow. Foreign crowdfunders supporting domestic crowdfunding campaigns. Outward Capital Flow. A foreign company raising capital from domestic investors through a CFP. Funding Continuum. The variation in funding needs at different stages of the business growth cycle, from seed capital through various rounds of growth capital. Hybrid Platform. A CFP offering more than one crowdfunding option (i.e. where crowdfunders can support donation-based and reward-based campaigns) Investment Hub. A capital flow model where foreign companies raise capital from foreign investors through a third-party CFP (e.g. a Colombian company raises funds from investors in Panama through a Mexican CFP). Lending-based Crowdfunding. Investors receive a debt instrument that pays a fixed rate of interest (in some cases interest is not paid) and the future repayment of principal. Live and Event-based Crowdfunding. The incorporation of a live event in conjunction with an online crowdfunding campaign (e.g. a product launch party, a live investment pitch event, television promotion, etc.). Non-financial Crowdfunding. Crowdfunding models where contributors or donors expect no financial return from their participation, though they may receive a specific reward corresponding to a given contribution amount. Includes donation- and reward-based crowdfunding. Peer-to-peer (P2P) Lending. Peer-to-peer lending (also known as person-to-person lending) is the practice of lending money to individuals, or peers, through online platforms without the use of a traditional financial intermediary, such as a bank. This falls within the category of lending-based crowdfunding. Reward-based Crowdfunding. Crowdfunders pledge money to support campaign owners in return for a specific reward, such as an advanced copy of an album for contribution to a campaign supporting a bands recording of the album. Security. A security is a fungible, negotiable financial instrument that represents some type of financial value. A financial instrument that represents: an ownership position in a publicly-traded corporation (stock), a creditor relationship with governmental body or a corporation (bond), or rights to ownership as represented by an option. Unlike holders of debt securities who generally receive only interest and the repayment of the principal, holders of equity securities are able to profit from capital gains1. Securities-based Crowdfunding. A term used to refer to lending- and equity-based crowdfunding, collectively. Interchangeable with the term financial crowdfunding. Stakeholder. An individual or entity which can affect or be affected by the crowdfunding industry. Use Case. Known or potential application of crowdsourcing or crowdfunding that defines an interaction between an actor and the crowdsourcing or crowdfunding system, to achieve a goal.
1. Security. Investopedia.

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execuTiVe SummArY

New technologies have given rise to a multitude of innovative

ventures and business opportunities in Mexico. Funding the establishment and growth of these ventures must be equally innovative and new. One promising development is the creation of internet-based tools that drive value by harnessing the power of the crowdthe virtual community of people and resources that are connected through the internet and other technological tools of the digital age. While each individual resource may seem relatively insignificant by itself, the aggregation of these resources from hundreds, thousands, potentially even millions, of people has the power to make a substantial impact on local economies. Online platforms are now capable of channeling capital to a wide variety of philanthropic projects, artistic endeavors, social innovations, businesses, and entrepreneurial ventures at the click of a button. This process, known as crowdfunding, is emerging as an effective financing tool that leverages the collective force of the crowd and the power of digital technologies to fill gaps in funding needs.

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Crowdfunding has the capacity to galvanize innovation, create jobs, diversify economic activity, and contribute to the reduction of income inequality by improving access to affordable capital and bridging the gap between funding demand and capital supply for entrepreneurs and micro, small, and medium enterprises (MSMEs) in Mexico. This report, Crowdfunding in Mexico - The Power of Digital Technologies to Transform Innovation, Entrepreneurship & Economic Inclusion, was commissioned by the Multilateral Investment Fund, a member of the Inter-American Development Bank, and research and analysis was conducted by Massolution, a research and advisory firm specializing in the design and implementation of crowd-based solutions. The report provides an in-depth evaluation of the potential opportunities and challenges of the emerging crowdfunding market in Mexico. Furthermore, it assesses crowdfundings capacity to be used as a viable alternative financing mechanism for local businesses and entrepreneurs. Based on this evaluation, it presents a proposed road map guided by specific actions aimed at accelerating the sustainable development of the crowdfunding ecosystem in Mexico.

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Crowdfunding in Mexico

The report assesses the potential for online crowdfunding in Mexico by focusing on dimensions that are considered to be critically important for the success of crowdfunding: Economy and Financial Ecosystem, Technology Infrastructure and Business Capacity, Political & Regulatory Environments, and Cultural Context. GDP growth over 4% per annum combined with low unemployment and modest inflation have contributed to the current strength and stability of the Mexican economy. These conditions, in addition to high levels of consumer confidence and progressive economic reforms, are generating increasing confidence in the market. Although this should lend itself to opportunities for investment in new business ventures, institutional investors report difficulty in finding attractive opportunities. Currently, there is an adequate foundation on which a robust crowdfunding industry may be built. Rapidly expanding access to the internet and related technologies, combined with strong economic conditions, will enable more Mexicans to engage in crowdfunding. Progressive reforms enacted under the current administration, in addition to emerging leadership from INADEM (Instituto Nacional del Emprendedor, or National Entrepreneurship Institute) and a growing culture of local entrepreneurship, demonstrate the practicality of driving additional reforms addressing digital commerce and finance. For crowdfunding to become a successful financing mechanism for businesses and entrepreneurs, the public sector will need to play a pivotal role in molding the ecosystem that enables platforms, businesses, donors and investors to participate in online crowdfunding. One of the major challenges facing the development of this ecosystem to date in developed and developing countries alike has been the creation of rules and regulations needed to govern online financial transactions, including crowdfunding. The governments ability to draft and implement relevant legislation, ensure regulatory coherence, and establish effective enforcement mechanisms for online crowdfunding will depend on overall political stability, the capacity of domestic political institutions and leadership, and other factors. Although confidence in the reliability of new technologies has been slow to emerge, Mexico has many traditions of collective action. Thus, the concept of crowdfunding itself should not be difficult to comprehend. Efforts to boost confidence in online crowdfunding will build on increasing familiarity with related technologies by improving the security of online data and preventing negative externalities. Indeed, crowdfunding has already made substantial inroads in Mexico. A number of crowdfunding platforms are already operating in Mexico today. They include both home-grown enterprises as well as subsidiary operations of platforms based in other countries. The industry now appears to be
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arriving at a critical inflection point, which raises the need for concerted efforts to establish clear legal and regulatory frameworks that specifically address crowdfunding activities. To be sure, there are also challenges that must be addressed. Improving cybersecurity and fraud prevention mechanisms are primary among these. Furthermore, efforts must be made to educate public and private sector leaders, businesses, and investors in the mechanics and potential impact of crowdfunding. There is also room for improvement in the education of entrepreneurs in effective campaign promotion and use of digital technologies. Crowdfunding is not likely to take off without support from key stakeholders to develop the supporting ecosystem. However, if initial commitments from these stakeholders are manifested in actions that drive a clear regulatory framework, ensure consistent enforcement, and boost confidence in the use of digital technologies for financial transactions, an enormous potential for improved socioeconomic wellbeing may be unlocked.

Recommendations

Based on the findings of our research and analysis, we have formulated a set of recommendations that we hope will be useful in guiding the efforts of key stakeholders to actively address salient issues related to the sustainable development of crowdfunding in Mexico. While crowdfunding serves many purposes, these recommendations are largely focused on improving the capacity of entrepreneurs and small businesses to access capital needed to fuel innovation and economic growth. This is not intended to be a comprehensive list, but rather a starting point for stimulating productive dialogue and galvanizing collaborative actions in the public and private sector, as well as civil society.
`` There remains a substantial need for accessible funding amongst entrepreneurs and MSMEs in

Mexico. Improving the domestic capital supply will require making existing sources of capital more accessible and creating additional opportunities for domestic and international actors to provide funding through online crowdfunding platforms. While Mexican businesses can use existing platforms to raise funds, concerted efforts are needed to engage the public and private sector.
`` Businesses will need to improve their technological literacy and understanding of how to use

crowdfunding effectively to support their continued growth and development, as well as to assess the risks associated with it.
`` To generate confidence in the market, it is important to generate broad-based support by

engaging diverse actors and promoting better understanding of the potential uses and impact of crowdfunding mechanisms for entrepreneurs, businesses, donors and investors.

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`` In order to accelerate the development of the crowdfunding ecosystem in Mexico, key actors must

be well-organized and coordinate effectively. It is important that various stakeholders understand the roles and responsibilities that they need to assume to drive the industry forward, and that they understand those of others. A collaborative, multilateral approach to designing the rules and regulations needed to effectively govern a successful crowdfunding market will enable all stakeholders to engage in the debate.
`` At the national level, the public sector appears well-positioned to facilitate the design and

implementation of legislation needed to bolster the crowdfunding ecosystem. Developing specific parameters for lending- and equity-based crowdfunding, in particular, will expand opportunities for businesses and generate confidence amongst investors.
`` Further recommendations and specific action items, as well as key actors associated with each, are

included in the main text of this report.

Seizing the Opportunity

Mexico currently finds itself in a unique position to accelerate the development of the crowdfunding ecosystem, both domestically and internationally. Although crowdfunding as an industry is still in its infancy, the basic conditions are in place to enable entrepreneurs and small businesses to access financing that meets their needs. If advances can be made in the regulatory space in the short term, myriad investment possibilities are likely to emerge as well. Some of the main challenges that will need to be addressed are highlighted in this report. But the independent creation of the Mexican Crowdfunding Association, active engagement of public agencies such as INADEM, and progressive economic reforms being pushed through the current administration are all signs of optimism for the long term success of crowdfunding as a tool for innovation, entrepreneurship, economic growth and social cohesion. Moreover, the countrys, entrepreneurial culture, adequate (though short of ideal) technological infrastructure, and proximity to U.S. capital markets have created fertile ground for the cultivation of crowdfunding. Today, the opportunity is ripe for Mexico to step forward as a regional leader by paving the way for crowdfunding to develop throughout Latin America and other developing countries. It will be up to local stakeholders, however, to seize the opportunity before them.

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2.

INTroducTion

Entrepreneurs, start-ups and small and medium enterprises


in Mexico are struggling to raise the capital needed to establish and grow their businesses via traditional banking systems. Capital from commercial lending institutions typically requires the need for substantial securities in exchange and often carries extraordinarily high interest rates. However, small business owners and entrepreneurs rarely, if ever, have this collateral to satisfy these loan requirements. Moreover, high interest rates tend to be commercially unviable for most small producers starting a business. As a result, there is a substantial need to fill this financing gap with low-cost capital to support the growth and development of businesses.

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Today, online technologies have facilitated the development of innovative new tools that drive value by harnessing the power of the crowd. The crowd is the virtual community of people and resources that are connected through the internet and other technological tools of the digital age. While small amounts of individual resources may seem relatively insignificant by themselves, the aggregation of these resources from hundreds, thousands, potentially even millions of people has the power to make a substantial impact on local economies. Online platforms are now capable of channeling capital to a wide variety of philanthropic projects, artistic endeavors, social innovations and businesses at the click of a button. This process, known as crowdfunding, is emerging as an effective financing tool that leverages the collective force of the crowd and the power of technology to fill gaps in funding needs. In addition to its utility as a source of capital, Crowdfunding can also serve as an alternative investment vehicle under the right conditions. The quantity of funders in the crowd means that the risk is dispersed broadly so that each investor assumes less risk, which addresses a significant aspect of commercial lenders hesitancy to offer capital to early-stage entrepreneurs with innovative business models and ideas. The success of crowdfunding globally and the opportunities being created in the United States, Europe, Australia, and other countries, prompted the commissioning of this report. In the U.S., new legislation under the JOBS Act is clearing the way for crowdfunding to enable investors and entrepreneurs to collaborate in the modern economy. Mexicos proximity to the U.S. market, in addition to the size and maturity of its economy, appears to present a unique opportunity to implement a crowdfunding initiative that would be the first of its kind in Latin America. To be sure, the Mexican market is distinct from the U.S. and other countries that have had success with crowdfunding to date in many ways. Thus, this study endeavors to identify these differences and analyze the advantages and disadvantages they present for Crowdfunding in the Mexican context.

This report assesses the potential for crowdfunding to serve as a viable funding and investment mechanism for Mexican businesses and philanthropic projects that are capable of contributing to robust socioeconomic development. It reviews the primary types of crowdfunding donation-, reward-, lending-, and equity-based and the relevant information on the global crowdfunding market today. It analyzes the key characteristics of the Mexican marketplace that are most relevant to crowdfunding, including the current level of technological diffusion and business infrastructure, cultural context, political environment, and the nature of the economic and financial ecosystem. Based on this analysis, we present specific recommendations intended to facilitate the development of the crowdfunding ecosystem and examine some of the roles and responsibilities that key stakeholders will need to assume to do so effectively. We have also included several illustrative use cases that could facilitate collaboration among key stakeholders in order to accelerate the development of the crowdfunding industry (see Appendix II). While we do examine the role that securities law and enforcement play in undergirding a vibrant crowdfunding ecosystem, the study does not pretend to be a comprehensive assessment of the Mexican legal and regulatory environment. Rather, it aims to provide an empirically grounded baseline from which stakeholders may take pragmatic steps to develop and scale an innovative financing and investment mechanism.

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Today, online technologies have facilitated the development of innovative new tools that drive value by harnessing the power of the crowd.

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3.

reSearcH meTHodoLogY

Massolution

conducted extensive primary and secondary

research in order to present a thorough analysis based on a robust empirical foundation. A number of sources were drawn on to collect relevant information and insight, including: Data on the global crowdfunding industry collected in connection with Massolutions annual crowdfunding survey and the publication of the 2013 CF Industry Report2. In-person interviews and data collection with key stakeholders from the public and private sectors in Mexico in July 2013. Surveys of Mexican Crowdfunding Platforms. Relevant literature and desk review.

2. 2013CF - The Crowdfunding Industry Report.

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The research helped to provide a macro-level understanding of the Mexican environment...

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The research helped to provide a macro-level understanding of the Mexican environment, which was focused on cultural, political, and economic aspects of the local ecosystem, as well as the quality of existing technological and business infrastructure. Massolutions C-STEP (Crowdsourcing and Crowdfunding for Social Transformation and Economic Performance) methodology provided the framework for the recommendations that resulted from this research and analysis. The five pillars of this framework are Capital Supply, Funding Demand, Market Strategy, Management and Enablers. The organization of our research and analysis under this framework helps us to identify challenges and better inform the interventions required to develop the crowdfunding ecosystem in Mexico.

First, we sought to gauge the levels of capital supply and funding demand (the first two pillars) in order to assess the magnitude of the gap between them. These pillars also focused on existing and potential sources of financing for local MSME, entrepreneurs, and philanthropic initiatives. The third pillar, Market Strategy, guided our research towards social, economic and political elements that might affect the development of the crowdfunding ecosystem or the implementation of a targeted crowdfunding initiative. Within the Management pillar, the focus shifted onto the institutional structures, supporting (or conflicting) organizations and other human elements needed to govern crowdfunding systems effectively. Defining the roles of major stakeholders, including the Mexican government, multilateral organizations such as the MIF or IDB, crowdfunding platforms, and the broader business community, is imperative for the creation of a viable roadmap that organizes efforts to develop the crowdfunding industry over time. As part of this pillar, we also honed in on the possible mechanisms for data collection and use regarding crowdfunding in Mexico. Finally, the Enablers pillar looked at the possible areas for reform in the regulatory and legal environment in Mexico that would better enable financial and nonfinancial crowdfunding to meet the needs of entrepreneurs and other issuers. We also noted how structural capacity, such as technological and cybersecurity infrastructure, may be improved to bolster the capacity of the crowdfunding ecosystem. Additional details regarding research methodology are included in Appendix I.

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4.

crowdfunding oVerView

Although it is only recently starting to capture global interest as


an alternative investment vehicle, crowdfunding has been around in less conspicuous forms for hundreds of years. Whenever we put a few dollars in the offering plate at church, chip in to fund to hold a Christmas party for neighborhood children, or give to a charitable organization, we are effectively participating in crowdfunding.

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Crowdfunding refers to any kind of capital formation where funding needs are communicated via an open call to a large group of individuals. As such, the merits of these needs and the purposes for which funds will be used can be evaluated by the crowd. This aggregation of individuals may decide whether to contribute to a campaign (the funding needs of an organization or individual communicated via the open call), resulting in the pooling of capital from a multitude of independent sources directed to these efforts. The person or organization promoting and/or managing the campaign is known as the campaign owner3. However, in the past crowdfunding was largely limited to personal, face-to-face campaigning; people donated when at church on Sunday, when they pass a campaign table at the market, or when a campaign owner knocked on their door to solicit contributions. Today, new technologies have revolutionized the nature of the open call. The advent of the internet now allows a campaign owner to present a single pitch that can instantly be disseminated to and accessed by users around the world. The flow of information across the internet means that an exponentially larger number of potential donors and investors can be reached via crowdfunding platforms.

Many small contributions support a single initiative.

3. Campaign owners in the case of equity-based crowdfunding are also known as issuers.

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Crowdfunding platforms are online portals that provide access to campaign information and draw attention to social and economic impact investment opportunities. Innovations in online and mobile banking technologies allow these platforms to channel individuals funds from the crowd to the campaigns they wish to support or invest in. They provide a digital forum where crowdfunders can comment on campaigns, request information, and track the progress of the crowdfunding raise, allowing the crowd to independently monitor and vet campaigns. In addition to its philanthropic utility, online crowdfunding is now gaining attention around the world as a model to form entrepreneurial capital that provides opportunities for small investors who are excluded from traditional investment mechanisms.

4.1 TYPES OF CROWDFUNDING


There are two overarching types of crowdfunding, which are defined by the relationship between the individual providing the financial resource (members of the crowd) and the recipient (the campaign owner). Non-financial crowdfunding and financial crowdfunding differ primarily in the association of individuals contributions to expectations of a financial return at some point in the future. Each type of crowdfunding has distinct implications for campaign promotion, engagement with investors or donors, and the institutions, infrastructure and regulations needed to support them.
The Four Primary Crowdfunding Models

DONATION

Philanthropic donation or gift, no return expected NON-fINANcIAL CrOWdfUNdING

Contribution in exchange for a perk or a pre-order of a product

REWARD

FINANcIAL CrOWdfUNdING

%
LENDING
Capital repayment most often with interest Investment for an ownership stake in the business

EQUITY

Graphic based on elaboration by Massolution.

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NON-FINANCIAL CROWDFUNDING: DONATION AND REWARDS-BASED CROWDFUNDING


Crowdfunding has its roots in open calls for charitable causes where donations are given without the expectation of a financial return. Owners of nonfinancial crowdfunding campaigns typically solicit funds for independent projects or initiatives that appeal to others with similar interests. For example, an NGO may launch a campaign to build a school for children in rural Mexico. As long as there is no expectation or legal obligation of a return for the money provided, the transfer is considered a donation or a gift and thus is referred to as donationbased crowdfunding. Another model of non-financial crowdfunding is known as rewards-based crowdfunding. On a reward-based campaign, crowdfunders provide capital to support a campaign in return for some kind of benefit or reward. For example, a group of artists who want to record an album may solicit funding for studio time by offering an advanced or signed copy of the album to individuals who contribute to the campaign. A strategy that is often employed under rewards-based crowdfunding is to offer better rewards for bigger contributions; a $25 contribution might be rewarded with an advanced copy of the recording, but a $250 contribution might result in a pair of concert tickets to see the band play at a local venue. Businesses may also use rewards-based crowdfunding as a tool to gauge demand for new products and services in the market before rolling out production en masse. By launching a funding campaign for a new product, entrepreneurs can make a limited set of said products and reward investors with the initial model. At the same time, this allows businesses to garner feedback on product design, functionality, and overall quality. They may also gain a better sense of optimal pricing and avoid serious problems before starting production on a larger scale. Improved understanding of market demand can serve to increase customer satisfaction and

profitability while hedging exposure to reputational damages resulting from a defective product launch. Donation- and reward-based crowdfunding present fewer risks than financial crowdfunding. As with all types of crowdfunding, they are exposed to the risk of fraudulent campaigns and as any ecommerce systems include risks of cyber security. For rewardbased campaigns, crowdfunders are also exposed to fulfilment risk (i.e. that the campaign owner will fulfil their promise to deliver a reward in return for financial support).

FINANCIAL CROWDFUNDING: DEBT AND EQUITY-BASED CROWDFUNDING


Logically, financial crowdfunding mirrors non-financial crowdfunding. Whereas non-financial crowdfunding refers to funding without the expectation of a financial return, financial crowdfunding is intended to provide opportunities to investors seeking financial remuneration in return for their support. Financial crowdfunding models are typically based on an investors capital contribution to an individual, business or entrepreneur who offers investors a defined financial return at a specific point in the future. Under financial crowdfunding, there are two primary models that have gained (and in some cases, are starting to gain) recognition as funding and investment mechanisms that provide viable alternatives to traditional (commercial) sources of financing: equity- and debt-based crowdfunding. The inclusion of expectations to provide financial returns to investors in these models effectively constitutes the sale of a security. With debt-based crowdfunding, investors receive a debt instrument that specifies the terms of future repayment. This is essentially an obligation of the campaign owner to repay the funds provided by the investor, which usually consists of the principal plus a fixed rate of interest. Interest is not always included in lending-based crowdfunding con-

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tracts, leaving room for impact investors to support budding entrepreneurs and businesses that require patient, low-cost capital to get started. Equity-based crowdfunding provides investors with equity instrument that confers a share of ownership or a share of future earnings. Under this model, crowdfunders returns are tied to the future success of the business they invest in. Equity-based crowdfunding therefore presents the potential for greater rewards as the value of their equity increases in accordance with the businesss success. However, it also presents greater risk to equity holders; in the event that the venture fails, investors tend to be subordinate to creditors in line for repayment. This places increased significance on the domestic legal environment, regulatory structures and institutional capacities for the viability of these crowdfunding mechanisms. Legislation is currently emerging in the United States (specifically, under the JOBS Act) and other developed markets that is designed to provide this type of support to the equity-based crowdfunding market. Equity contracts require specific terms defining possible exit strategies for investors. As a business grows, it moves along the funding continuum and will likely seek financing from other investors, such as venture capital funds, angel investors, or commercial banks. In order to facilitate this transition without diluting the value of crowdfunders initial

equity shares, crowdfund investors need to have well-defined options for exiting the contract. These terms will vary for different businesses, and provide ample room for innovative models that attract investment in Mexican crowdfunding offerings. As the market matures, additional securities structures are also being explored for sale through online crowdfunding platforms. Royalty-based crowdfunding, for example, is one such investment vehicle that provides a crowdfunder with a share in a unit trust, which pays the investor a percentage of a specific revenue stream. This is generally associated with a royalty interest in a companys intellectual property and the revenues it generates. The gains here are potentially unlimited at the established interest rate, but companies may stop operating with the intellectual property that was originally funded or sell it to a competing or acquiring firm. This makes the royalty-based model somewhat more complex and less commonly used, but provides an interesting example of emerging innovations in the crowdfunding market nonetheless.

Equity contracts require specific terms defining possible exit strategies for investors.

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GLOBAL CROWDFUNDING LANDSCAPE


USD $2.7 billion aggregate funding was raised through online crowdfunding platforms and distributed to projects, businesses and entrepreneurs around the globe in 2012. This is an 85% increase on worldwide funding volume from the previous year, which stood at USD $1.47 billion. The image below shows the geographic distribution of funding centered in the United States and Europe. Massolution forecasts worldwide crowdfunding volume will reach US$5.1bn in 2013, with the majority of funds still originating in the U.S. and Europe4.

WOrLdWIdE EUrOpE NOrth AmErIcA

$2.67 m
ASIA

$945 m

$1,606 m

$33 m

SOUth AmErIcA

$0.8 m

OcEANIA

$76 m
Total funds raised during 2012 in millions of USD.
Graphic based on elaboration by Massolution.

Global crowdfunding volumes

4. 2013CF - The Crowdfunding Industry Report.

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While the popularity of crowdfunding stems from its use for philanthropic and social ventures, recent years have marked a transition toward entrepreneurial uses. MSME and entrepreneurs are now the second most active category across all types of crowdfunding models at 16.9% of total funding volume, behind only social causes at 27.4%5. Small enterprises and entrepreneurs are using crowdfunding as a tool to support operational expansion as well as testing consumer demand for new products and services. Approximately 27% of financial crowdfunding volume is generated for these ventures, the most of any category6. Crowdfunding is developing as a global model, driven by internet access and pervasive social media networks that are not limited by geographic boarders. While country-specific regulatory frameworks are needed to govern crowdfunding, donors and investors may, in theory, be based anywhere in the world where there is access to internet. Today, 34.3% of the worlds population are internet users. 42.9% of the LAC population were internet users in

2012, equivalent to a more than 1,300% increase since 20007. The globalization of crowdfunding today requires regulations that cater to both domestic and international demographics in order to leverage the participation of investors, MSME and entrepreneurs. Targeted actions to attract international investment for domestic entrepreneurs and MSMEs, as well as measures that protect against domestic capital flight, are being taken to maximize the utility of online crowdfunding as an alternative financing vehicle. Currently, extra-national programs are targeting foreign investors and attracting capital from some Mexican investors who lack investment opportunities at home. For instance, the U.S. and Canada have developed cross-national Immigrant Investor Programs that attract foreign capital by providing foreign investors with special visas in return for substantial investments. In the U.S. an EB-5 Visa is awarded to foreigners who invest at least US$1m (or $500,000 in a Targeted Employment Area) and create at least 10 jobs for U.S. citizens8.

Financial versus Non-financial Crowdfunding Activities


Social Causes Business and Entrepreneurship Films and Performing Arts Music and Recording Arts Energy and Environment Fashion Art (general) Information and Communication Technology Journalism, Books, Photo, and Publishing Arts Non-Financial Financial Science and Technology 0% 5% 10% 15% 20% 25% 30%

Graphic based on elaboration by Massolution.

5. Ibid. 6. Ibid. 7. World Internet Users Statistics Usage. 8. EB-5 Immigrant Investor.

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4.2 CROWDFUNDING CAPITAL FLOW MODELS


The development of the crowdfunding ecosystem can be framed according to the relationships between domestic and foreign crowdfunders, campaign owners, and crowdfunding platforms. There are four primary scenarios that illustrate these relationships and help shape strategies supporting the implementation of crowdfunding initiatives in a particular national market.

Crowdfunding Scenarios

C-STEP Crowdfunding Capital Flow Model

Graphic based on elaboration by Massolution.

The respective origins of issuers (campaign owners) and investors (crowdfunders) present four alternative scenarios. Mexican issuers could raise money from local crowdfunders or from crowdfunders based in other countries. Alternatively, Mexican investors/crowdfunders could contribute to foreign campaigns, drawing capital away from the local economy. Lastly, foreign crowdfunders could contribute to foreign campaigns through Mexican CFPs, creating an investment hub scenario. There are two different groups of investors: domestic investors, those from Mexico, and investors who are domiciled in other countries. For the purpose of simplicity in this analysis, we refer to U.S.-based investors, but, in reality, investors could reside in any foreign country.

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Domestic Crowdfunding
DOmEStIc CrOWdfUNdErS CONtrIbUtE tO DOmEStIc CAmpAIGNS

Domestic crowdfunding, from the perspective of the Mexican market, is when a Mexican issuer raises money from local investors. The underlying assumption of this scenario is that there is sufficient capital available domestically or that there is significant capital leaving Mexico for external markets to warrant efforts to incentivize domestic crowdfunding. Indeed, UNCTAD statistics report that outward foreign direct investment (FDI) from Mexico to other countries was approximately US$25.6 billion in 2012, more than double outward FDI flows in 20119. One advantage of promoting domestic crowdfunding is that it is simpler than international models as it is only subject to local securities and capital regulations. Moreover, it allows for the alignment of incentives that deter capital flight by creating opportunities for investment in domestic businesses and entrepreneurs. Additional complexity arises in international transactions where issuers or investors are in different countries. Equity-based Crowdfunding is relatively new and most other countries are still in the early stages of forming approaches for the treatment of crowdfunded securities, whether in the form of no action statements, exemptions or regulations.

Foreign Capital Inflows


FOrEIGN CrOWdfUNdErS CONtrIbUtE tO DOmEStIc CAmpAIGNS

In the Foreign Capital Inflows model, foreign capital is directed to a Mexican issuer (entrepreneur). The advantage of this model is that, while operating within Mexican securities regulations, the domestic firm is not limited to receiving capital from Mexican investors. Allowing foreign investors to provide domestic issuers with capital via crowdfunding could potentially increase the capital supply substantially. In addition to general investors seeking
9. Measured in US dollars at current prices and exchange rates.

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opportunities in the global landscape, there are many successful members of the Mexican diaspora who may be enticed to contribute to the growth of small businesses in their homeland. This could include crowdfunding models that tap into the significant amount of remittances flowing into Mexico (Mexico is the largest market for remittances across Latin American countries, currently at US$22 billion annually10). This scenario provides the opportunity for attracting new and diverse sources of capital. However, one would need to consider any potential challenges and costs associated with the migration of capital across international borders considering any resulting issues that restricted foreign investors repatriating capital. In order for this model to flourish, investor protections and clear yet robust legal remedies for resolving problems such as fraud would be required. International investors will require an investment environment that is both appealing from the perspective of potential returns as well as having the necessary safeguards that are on par with leading international capital markets. In order to successfully attract foreign capital through crowdfunding, it is important to ensure that the rules governing the use of foreign capital and foreign ownership of the businesses are clearly delineated and compatible with securities regulations of a crowdfunders country of origin. Alicia Garcia Herrero, Chief Economist at BBVA Research responsible for emerging economies, argues that Mexico, despite some critical challenges (e.g. more fully exploiting the positive current economic cycle), is still an open market for foreign investors interested in a range of investment opportunities11.

Outward Capital Flows


DOmEStIc CrOWdfUNdErS CONtrIbUtE tO FOrEIGN CAmpAIGNS

Capital flows from Mexican crowdfunders to foreign companies are considered outward capital flows. Mexico has an interest in ensuring that this is done in a way that supports its social and economic development objectives. There is also an interest in ensuring that the rules and regulations associated with investing and crowdfunding take into consideration the appeal for middle class investors of accessing the overseas capital markets. For instance, Mexican investments in the U.S. during 2012 increased by 11% and currently stand at US$27.9 billion12.
10. Maldonado R., Hayem, M. Remittances to Latin America and the Caribbean in 2012: Differing behavior across subregions. 11. Garcia- Herrero, Alicia. Investing in Mexico: Challenges and Opportunities. 12.Estevez, Dolia. Wealthy Mexicans' Investment In The United States Sharply Up in 2012.

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Under this scenario, a U.S. subsidiary of a Mexican company is not limited to only U.S. investors13. Mexican companies could leverage solicitation rules and guidelines permitted by U.S. securities regulations and with the cooperation and support of the licensed intermediary raise capital from Mexican investors. A strategy to develop crowdfunding to support the investment by Mexicans in overseas subsidiaries of Mexican companies could be favorable to Mexican investors wishing to invest in alternative regulatory environments.

Investment Hub

FOrEIGN CrOWdfUNdErS CONtrIbUtE tO FOrEIGN CAmpAIGNS thrOUGh DOmEStIc CFPS

MEXICAN PORTAL
Channeling international capital through Mexican crowdfunding platforms to foreign companies would position Mexico as a crowdfunding Investment Hub. Currently, Mexican companies are eligible to raise money in the United States with a foreign entity exemption14. Raising capital through the U.S. Securities process provides a high level of protection to the investor. The World Bank ranking on the protection of investors shows U.S. is the 6th safest country of the world for investors Mexico is 49th15. Mexican companies could take advantage of these exemptions by raising funds through CFPs operating in these markets. Alternatively, Mexico could itself become an investment hub for foreign companies wishing to raise money from other countries by offering a similar type of exemption and strengthening the crowdfunding regulatory framework (e.g. A Salvadorian business could raise money on a Mexican CFP from Canadian investors).

Implications of Capital Flows


Both the Outward Capital Flow and Investment Hub models present risks to Mexicos capital market and the development of crowdfunding in Mexico. The development of strong crowdfunding markets internationally could draw capital away from Mexican crowdfunding campaigns, which could also negatively affect Mexicos traditional capital markets. In the absence of a strong domestic regulatory environment, capital markets may risk losing domestic capital to overseas offerings. Thus, it is important to consider how specific regulations, or lack thereof, will affect the flow of capital to and from Mexican issuers and crowdfunders.

13.Accessing the U.S. Capital Markets A Brief Overview for Foreign Private Issuers. 14.Ibid. 15.Protecting Investors.

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35

5.
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ANALYSIS OF THE MEXICAN CROWDFUNDING ENVIRONMENT

the world, existing models are adapted to local market conditions and cultural influences. Similarly, crowdfunding in Mexico will need to adapt to its unique history and local environment. The research and analysis of this report is focused on central dimensions of the Mexican context that are considered to be critically important for the success of crowdfunding: Economy and Financial Ecosystem, Technology and Business Infrastructure, Political Environment, and Cultural Context. In addition, we provide an overview of the current crowdfunding platforms operating in Mexico and the state of the industrys development to date. The section aims to provide a review of factors within each dimension that have an impact on the current state of crowdfunding in Mexico, which are important considerations for the formulation of the recommendations that follow. The analysis of these factors contributes to the overall assessment of the potential for crowdfunding to serve as a viable financing mechanism for businesses and entrepreneurs in Mexico.

As the adoption of crowdfunding continues to expand throughout

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5.1 ECONOMY AND FINANCIAL ECOSYSTEM


Summary:
`` The current strength and stability of the Mexican economy are generating confidence in the market. `` Progressive market-oriented economic reforms are improving competitiveness and generating

new economic opportunities across various sectors.


`` Cumbersome and costly requirements for business registration inhibit formalization of many micro

and small enterprises, which proliferates informal sector activity.


`` Commercial credit, as well as informal sources of credit, is prohibitively costly for many small

businesses and entrepreneurs, particularly those in early stages of development.


`` Institutional investors have difficulty finding appealing investment opportunities, resulting in excess

capital supply. However, small businesses and start-up entrepreneurs may be able to leverage crowdfunding to raise smaller amounts of capital at lower rates of return.

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CrOWdfUNdING IN MEXIcO

In this section we examine the general economic conditions in Mexico, with particular focus on those that might affect the development of crowdfunding and, in particular, its ability to serve as a viable alternative financing mechanism for entrepreneurs and MSME. These economic conditions provide the backdrop for investors willingness to engage in the market and the amount and availability of other sources of financing that enable entrepreneurial ventures and expansion of existing businesses. We then examine existing sources of financing available to businesses and the characteristics of current funding demand. By defining the dynamics of the existing capital supply and funding demand, recommendations can be more effectively tailored to meet the needs of the entrepreneurial economy in Mexico. Economic Conditions
The Mexican economy, the second largest in Latin America, showed resilience amidst the recent financial crisis and continued challenges of the global economic environment. It posted an average annual GDP growth of 4.3% between 2010 and 2012. Unemployment also fell to 4.47% in November 2013, down from 5.12% the previous year16. Although weak external demand has lowered the growth projection to 1.8% for 201317, there is growing optimism for 2014. A flexible exchange rate, low inflation (under 1%), a modest current account deficit (less than 36% of GDP), and robust international reserves will provide a strong foundation for economic stability in the coming year18. Mexicos Consumer Confidence Index was 94.1 against a base of 100 as of October 201319, indicating strong public optimism regarding the overall state of the economy and personal finances. High confidence in the economy is in part a reflection of the 19 % increase in GNI per capita, to $16,450 (PPP, current international $), from 2009 to 201220. Although Mexicos relatively high income inequality (amongst OECD countries, as measured by the Gini coefficient)21 will require more equitable growth strategies, the growing wealth in metropolitan areas of the country will enable a strong base of initial support for crowdfunding success. Moreover, by channeling financing to entrepreneurs and funding for community development projects, crowdfunding itself may serve to reduce this inequality. Economic policy reforms have increased economic freedom and opened markets to competition, leading to increased investment in the private sector and spawning new levels of entrepreneurship. According to the Heritage Foundations Index of Economic Freedom, Mexico is considered to be a highly attractive emerging market; in 2013, its score rose 1.7 points to 67, well above the world average of 59.622. At No. 50 out of 185 countries, Mexico is doing significantly better than four top emerging markets; Brazil (100), Russia (139), India (119) and China (136). However, it is still considered

16.Indicadores Oportunos de Ocupacin y Empleo 17.Mexico Overview 18.Ibid. 19.Mexico Consumer Confidence 20."GNI per Capita, PPP (current International $)." 21.Mexico: Key Issues and Policies 22."Index of Economic Freedom 2014."

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39

only a moderately free economy, demonstrating that there is still substantial room for improvement. Weak protection of property rights, corruption and strong labor unions are some areas that need to be strengthened to improve economic freedom. Competitiveness: Recent reforms to privatize the energy sector will increase competitiveness and provide additional opportunities for investment. These reforms have already contributed to a hike in Mexicos credit rating by Standard & Poors to BBB+, the level it had achieved before the 2009 financial crisis23. Macroeconomic reforms, including revision of fiscal and monetary policies, have improved the conditions that allow the free market to function well. However, there is still room for microeconomic reforms to facilitate free market activities. New reforms are making strong headway in these areas, but more work is needed to fully capitalize on the existing potential for economic growth. Tax Regime: Structural reforms to the tax regime are promising. Most taxes in Mexico are collected at the federal level, resulting in limited opportunities for states to offer tax incentives. However, certain Mexican states have begun competing aggressively with each other for investments and most have developed programs for attracting investment. These include reduced price (or even free) real estate, employee training programs, and reductions of the 2% state payroll tax. In addition, lower taxes on real estate, land transfers, and deed registration, as well as new infrastructure, such as roads, are being used to garner new investments24. Business Regulations: The regulatory framework has been reformed to facilitate entrepreneurial activity, including the removal of minimum capital requirements. Launching and registering a business has been simplified, now requiring six well-defined procedures. However, completing licensing re23. Webber, Jude. Christmas Cheer for Mexico. 24. 2011 Investment Climate Statement - Mexico.

quirements can cost over three times the level of average income. Traditional sources of financing are structured to support businesses registered in the formal sector, yet these have often been prohibitive requirements; for example, a business must operate for two years before it is eligible to open a corporate bank account and apply for credit25. Markets require basic levels of oversight and regulation, including mechanisms to ensure accountability and transparency, in order for markets to work efficiently and to build capital supply. While overregulation is not conducive to entrepreneurship and business growth, drastically unregulated markets pose significant risk of fraud. In an unproven market, a few high profile cases of fraud in online crowdfunding would create serious setbacks to the industrys development. Prevalence of the Informal Sector: Despite improvements in the requirements for starting a business, many entrepreneurs still operate in the informal economy, electing not to register businesses and avoiding commercial bank accounts and corporate taxes. The majority of Mexican businesses operate without formal banking relationships. 95% of businesses are family owned and nearly 50% of business owners report that their firm is not registered with the authorities26. Additionally, 30 million Mexican workers participate in the informal economy27. This lack of participation in the formal economy limits growth potential and increases the risk to prospective investors. Interviews revealed that many Mexicans choose not to register their businesses in order to avoid the complexity of registration, filing and paying taxes, and the potential loss of privacy. Financial Services: Both U.S. and Latin American companies are increasing offerings of dealer/broker services in Mexico28. However, there is significant scope for further enhancing the availability of pro-

25. Doing Business 2014: Understanding Regulations for Small and Medium-Size Enterprises. 26. Bruhn, Miriam. Who Are Informal Business Owners? 27. Hughes, Krista. Mexico Aims to Bring Shadow Economy Into the Light. 28. Moore, Michael J. Goldman Sachs to Open Broker-Dealer in Mexico Next Year.

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fessional services provided by regulated intermediaries, such as lawyers, accountants, management consultants, financial advisors, and marketing strategists. Providing fertile ground for the development of secondary financial institutions, such as insurance companies and credit unions, will also improve MSME and entrepreneurs abilities to increase productivity and employment and develop successful businesses. Emerging Technology Sector: There is an emerging tech-culture amongst start-ups and entrepre-

neurs in Mexico, many of which have been cultivated by U.S. business incubators and accelerators in areas such as Silicon Valley Austin, Texas, Boulder, Colorado, and Boston, Massachusetts. Initiatives like 500 Mexico City, a leading accelerator and early stage investor in the region, provides seed funding of up to US$250k in addition to business mentoring programs. The growing presence of an endogenous technology sector will provide a foundation on which other tech businesses can be developed through crowdfunding.

Capital Supply
In the United States, the critical issue for crowdfunding is addressing is the lack of capital supply to meet funding demand. However, in Mexico many institutional investors noted that there is more available capital than qualified demand. It seems that the funding gap issue is less related to a dearth of capital and more to the disconnect between investors interests and available investment opportunities. This may, however, be more a matter of transparency and effective communications than a shortage of businesses to invest in. Crowdfunding facilitates the connection of available capital to qualified businesses that need it and have a valid plan to use it productively. Crowdfundings online platforms are designed to share information regarding existing investment opportunities, which allow investors to find and connect with businesses easily. Commercial Bank Resources: First-hand interviews indicated that banks had untapped capital supply but lacked attractive investment opportunities in local businesses. Although capital availability is a positive aspect for the emergence of crowdfunding, improving accessibility for businesses and entrepreneurs remains a challenge. Availability and accessibility could be improved as part of hybrid traditional/crowdfunding solutions (e.g. crowdfunding raise matched with a pre-qualified bank loan). However, many individuals lack access to basic financial instruments. Only 27% of Mexicans over the age of 15 have a bank account (compared with 56% in Brazil and 88% in the U.S.) and only 13% of Mexicans over the age of 15 have a credit card29. This is likely due in part to the high costs of owning a credit card. At Banamex, for example, users of a basic credit card are required to pay a MNX$600 (about US$45) up front annual fee, which is reimbursed if debts are adequately serviced by the end of the year. Interest rates for the card run at over 46% APR, late payment fees of MNX$330 (about US$25), and a host of other charges, including fees for the use of online payment systems and printing of account statements, illustrate the extraordinary impediments for most people to access commercial credit cards in Mexico30. Multilateral Funding: Mexico has a history of publically and privately supported micro-finance, including initiatives supported by the UN, World Bank, IMF and IDB. So there is a well-established infrastructure and vehicle for distribution for the micro lending to individuals. This forms a solid foundation for specialist non-financial crowdfunding to take root and to lift those individuals up into businesses and then, over time, allowing those businesses to become targets for financial Crowdfunding.

28. Moore, Michael J. Goldman Sachs to Open Broker-Dealer in Mexico Next Year. 29. Guthrie, Amy. Mexico Financial Reform Seen Improving Credit Data, Collections. 30. Tarjeta De Crdito Clsica.

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41

The success in the Mexican context of the micro loan program and the way it addressed the challenge it faced as it developed provides valuable case history that should inform and inspire the development of the crowdfunding industry. Independent (Private) Investors: There is a lack of capital supply from independent investors in the private sector. A lack of traditional investor protections, concerns about ineffective regulation and lackluster enforcement of the intermediary market, and strong competition from the U.S. private capital markets have reduced the number of individual investors participating in Mexicos private capital market. The emerging middle class has the potential to augment the supply of private capital, but has yet to find attractive investment opportunities. Emerging Venture Capital Market: The emerging venture capital market in Mexico is creating exciting new funds and bringing new investment products to targeted industries and in targeted communities. Further supported by investments like the Multilateral Investment Fund (MIF) equity investment like last year of US$5m in the MDF-I fund31 that supports companies that provide education, financial and retail services, or produce eco-friendly products targeted at a growing and young local middle class. This new market is creating opportunities for entrepreneurs to invest in businesses that uniquely address Mexican-market-based demands. A vibrant venture capital market provides a liquidity opportunity and exit strategy for primary investors who participate in early-stage companies via Crowdfunding. This is important to both investors and businesses, and presents an important component of the landscape of funding options. Foreign Capital: The stabilization of the Mexican economy combined with financial reforms has prompted the highest amount of foreign investment in Mexico in years. International investors pumped US$5.6 billion in fixed-income and equity flows through May 8, 2013, three times the amount
32. Thompson, Adam. Aztec Tiger Begins to Sharpen Its Claws.

that went to Brazil. This capital inflow helped push Mexican sovereign borrowing costs to record lows, and the stock market to record highs32. Foreign capital is flowing in not only from the United States but also from around the world. Remittances: Mexico remains the largest beneficiary of remittances across Latin America with US$22 billion in 2012, over US$100M greater than the rest of Central and South America combined33. In total, remittances accounted for over 2% of Mexicos GDP, the majority of which came from the U.S. Although most remittances arrive in small amounts to support family members expenditures on basic necessities and household consumption, some crowdfunding models are being designed to support the flow of remittances (e.g. Zafen.org in Haiti). The volume of remittances to Mexico may present similar opportunities to leverage these funds through crowdfunding platforms in order to increase investment in MSME and entrepreneurs in Mexico. Aligning incentives through lower transfer costs, for example, could push a greater portion of these capital flows into productive investment rather than simple consumption. Proximity to U.S. Capital Markets: The geographic proximity of Mexico to the well-established capital market in the United States presents both challenges and opportunities to increasing capital supply through crowdfunding. On one hand, the vibrancy of the U.S. capital market draws capital away from Mexico, especially given the market boom in the second half of 2013. However, the resurgence of the U.S. economy also means that investors will remain bullish and looking to diversify their portfolios. Moreover, as wages continue to increase in China and other Asian economies, Mexico should become more a more attractive destination for U.S. investment. Still, lackluster investor protections and regulations should be improved to support the development of a more robust financial ecosystem in Mexico, which is needed to take advantage of its proximity to U.S. capital supply.

31. MIF Invests in Mexican Venture Capital Fund to Support Education, Financial and Retail Services. 33. Maldonado R., Hayem, M. Remittances to Latin America and the Caribbean in 2012: Differing behavior across subregions.

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Funding Demand
Funding Continuum Gaps: The funding continuum refers to the funding needs of a business at different stages of the growth lifecycle (from initial seed-capital through various rounds of growthcapital needed for expansion and increased productivity). In Mexico, financing options are limited. Entrepreneurs find it most difficult to acquire initial startup capital or early-stage growth capital after market value has been proven. Capital for these businesses has typically come from venture capital funds or, more recently, angel investors. More commonly, however, businesses rely on personal savings or family loans to get operations up and running. The image below shows vendors and personal savings and family loans account for nearly 80% of financing for Small and Medium businesses in Mexico, while commercial banks provide only 18%34. In addition, funding the expansion of operations to employ more workers is a significant challenge for small business owners. Taking a business from a micro-enterprise to a small business and from small to medium-sized business is a difficult transition to make34. This is attributed primarily to inadequate access to capital and relatively low levels of education and basic business training in areas such as financial planning, accounting, or operations management.

Financial Sources for Mexican SMEs

naTionaL deVeLoPmenT BanKS

18

commerciaL BanKS

famiLY LoanS

33

VendorS and PerSonaL SaVingS

%
Source: Forbes.com

46

34. Barnett, Chance. Is Equity Crowdfunding Coming To Mexico? 35. Massolution interview in Mexico City with Banamex. June 2013.

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The middle class in other markets utilizes friends and family and traditional credit instruments for raising launch capital. In Mexico, however, credit is restricted by high credit qualification requirements imposed by banks (collateral, formal credit history, liquid assets, etc.) and high fixed fees. APR interest rates on credit card debt can reach over to 40%, resulting in less than 25% of the population (29.6m) having credit cards. Financial instruments such as micro lending have focused on smaller micro-entrepreneurs resulting in a lack of traditional consumer and business financial instruments (equivalent to a U.S. Small Business Association-backed-loan provided through private banks). These independent entrepreneurs are often

part of the informal economy. Without the means to raise additional capital to grow their businesses, they are not able become part of the formal business infrastructure. MSME generate 52% of GDP but 75% of MSME fail within two years36, highlighting the need to address this funding gap (while failure is not necessarily caused by a lack of capital, it can be a contributing factor). The figure below shows where the best fit for various sources of financing fall on the continuum; Non-financial crowdfunding is typically most appropriate for entrepreneurial idea development or for testing market demand for product prototypes where needs are less than US$50k, while financial crowdfunding is most appropriate for small businesses between startup and early-growth stages, with funding needs of US$50k US$1m.

Where Crowdfunding Fits on the Funding Lifecycle37

Crowdfunding Investing < US$1M Once ideas have met minimum viable tests by the crowd or community an equity or debt-based crowdfunding campaign is appropriate. It will provide increased capital for growth and vested interest of supporters. Angels can also play an important role here. Mainstream Financing > US$1M At this stage, once ideas are proven, models tested and customer interest engaged, the risk for follow on, larger, more traditional capital from Angel Investors, Venture Capital. or Private Equity may be engaged.

Crowdfunding Investing < US$50K Amount of Capital Needs $ Donation or perks based crowdfunding is a good fit for idea/inception and proof of concept/prototyping. It allows the community to decide which ideas are worth funding early on. Funding Gap

Institutional Capital Companies that have proved sufficient market growth and traction that are increasingly capital intensive may be able to seek funding from investment banks at this stage.

Idea/Inception PoC/Prototype Startup Early Growth Expansion

36. Rostro, Francisco. General Diagnosis of Mexican SMEs from the Perspective of the Marketing Practices Efficiency. 37. Crowdfundings Potential for the Developing World.

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Markets with Significant Growth Potential: From agriculture to energy to telecommunications, businesses in established markets are generating significant funding demand and present significant growth potential. The recent opening of investment opportunities in the (formerly statecontrolled) energy market, for example, will require capital to take advantage of growth opportunities. The continued development of the agricultural sector also presents ongoing demand for capital. Reforms that have been presented to Congress to open up the monopolized telecommunications industry will create further opportunities for investment when passed (which is expected to happen in 2014). Other emerging industries present broadbased investor appeal and high-growth potential, from green-tech to archeology and ecotourism, which generate diverse opportunities for increased funding demand. Broad-based Demand in Non-financial Crowdfunding Markets: The emergence of non-financial return CFPs and resources has demonstrated significant demand for funding. This provides a strong basis on which to promote financial crowdfunding, which can offer additional funding options to entrepreneurs and MSME, especially with recognized organizations such as Kiva.org establishing operations in Mexico. Secondary Market: Another area of the funding continuum in Mexico that requires attention is the need to create liquidity for private companies that do not pursue an IPO. A viable secondary market of funds and investors would complement the primary

investment market (i.e. a market for the purchase of stakes in businesses that were initially crowdfunded, but continue expanding further). There are a growing number of these firms in Mexico but they have not yet reached sufficient scale to reduce liquidity risks. Crowdfunding could be used to support the creation of secondary funds to provide exit strategies for initial investors (e.g. purchasing private securities to be held until a liquidity event occurs). At the same time, the underlying technology of crowdfunding platforms and their experience with private company markets could support the development of regulated CFPs hosting such a market. Systemic Underinvestment and Undercapitalization: There is systemic underinvestment and undercapitalization of MSMEs throughout Mexico. The cycle of underinvestment stretch businesses and undermines the development of entrepreneurs. The pressure of operating in an underfunded environment has put incredible stresses on these businesses and their leadership. Incomplete Data to Demonstrate True Funding Demand: Funding demand is typically measured by the application for capital products. However, the economic conditions reviewed here demonstrate multiple factors that deter many people from even attempting to apply for credit to start or expand a business. Thus, the data available does not include who do not apply for funding because they know they do not meet commercial bank requirements who would not be able to repay at such high interest rates, which may contribute to lower calculations of funding demand than actually exist.

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5.2 TECHNOLOGY INFRASTRUCTURE AND BUSINESS CAPACITY


Summary:
`` Access to internet is improving throughout the country. While the percentage of the total

population with internet access is low relative to developed countries, the absolute number of Mexicans using the internet is sufficient to facilitate the growth of crowdfunding.
`` Most internet users actively engage in social media platforms, which will help campaign

issuers to successfully meet fundraising goals.


`` While increasing rapidly, the use of online payment mechanisms is less common than in

other markets due to concerns regarding cybersecurity and the protection of personal and financial information online. Inadequate enforcement of cybercrimes and low penetration of credit and debit cards are contributing factors.
`` The capacity to use crowdfunding technologies effectively is currently limited. Entrepreneurs

lacking formal business training will find difficulty in understanding and disseminating information investors will look for regarding financial crowdfunding opportunities.

In order to better understand the impact of the Mexican technology infrastructure and business capacity on the potential development of crowdfunding, we looked at levels of internet access, use of technological devices, social media engagement, utilization of e-commerce, technological literacy and business training. These elements are directly related to peoples willingness and ability to actively engage in an entrepreneurial economy as both crowdfunders and business owners.

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Internet Access: The internet and related technologies have revolutionized communication, commerce, and daily life in the 21st century. The internet facilitates global communication through email, blogs, instant messages, message boards, social media and websites. Businesses have taken advantage of the internet by promoting and selling products and services online, offering customer services, and broadening their reach in new markets. Technological innovations have made the internet easier to access for people around the world, though the infrastructure needed to support it remains underdeveloped in many countries. Availability of the internet and the technologies that enable people to access it are among the most critical determinants of crowdfundings potential to serve businesses and entrepreneurs as an alternative means of raising capital. Ciscos VNI Global IP Traffic Forecast recognizes Mexico as the largest internet hub in Latin America. By the middle of 2013 there were approximately 51 million Mexicans connected to the web38. While this represents only 43% of the population, this proportion has been increasing quickly; in 2000, less than 5% of the population had access to internet. Increasing internet usage is supported by improvements in technological infrastructure. The number of secure internet servers in Mexico increased 83% from 2009 to 2012 to 3,392. With respect to its population, this represents 28 servers per 1 million people, which is higher than the average for other upper middle income countries (20 servers per million) but well below the world average (181 servers per million). The number of fixed broadband subscribers per 100 people39 in Mexico is above both the world and upper middle income country averages40. Although there is obvious room for improvement to increase access to the internet in Mexico, the existing capacity resulting in over 50 million
38. Bosco, Ben. 10 Fastest Growing Nations in Internet Use.

active internet users represents the critical mass needed for crowdfunding to be a viable funding mechanism for issuers. There is a solid foundation of internet users and continued efforts to increase access will bolster crowdfunding in the future. Access to internet-capable technologies used for online crowdfunding, such as computers and mobile devices, is relatively high among a young, urban, middle-income demographic that will be important for driving the adoption of crowdfunding in Mexico. Internet use is highly concentrated in major cities and business centers near the U.S.Mexican border where the upper and emerging middle classes have access to these technologies and investment capital. Internet usage is high among the youth population as well; 40% of all internet users are 18-34 years old41. Decreasing costs of mobile technologies are allowing for broader access to the internet and social media applications. There are 176 million internet-capable devices in Mexico, which is almost 1.5 times more than the population42. However, adoption is still limited in rural areas of the country, where approximately 37 million people reside43. This is partly due to high costs of ownership and difficult terrain in parts of Mexico that pose challenges to the installation of the physical infrastructure needed to support internet connectivity (namely electricity and secure internet servers). Social media is considered to be an integral tool for the solicitation of funding, dissemination of information, channeling feedback and promoting products and services. The ability of issuers to access the crowd through social media thus serves as an important proxy for campaign success. 93% of Mexican internet-users access social media and 82% identify social media as one of the primary reasons for internet usage, just below sending/re-

39. Fixed broadband Internet subscribers are the number of broadband subscribers with a digital subscriber line, cable modem, or other highspeed technology. 40. The World Bank: World Development Indicators. 41. AMIPCI, 2011. Research Report Hbitos de los usuarios de internet en Mxico. 42.Bosco, Ben. 10 Fastest Growing Nations in Internet Use. 43.OECD Rural Policy Reviews: Mexico 2007.

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ceiving email (87%) and searching for information (84%)44. This means that over 47 million Mexicans are accessing Facebook, Twitter and/or other social media platforms, which are critical to successful crowdfunding campaigns45. The internet has also surpassed other forms of media (print, radio and TV) from 2006 to 2012 as the primary source of information among adults (see image below). Access to Electricity: In 2013, Mexicos electricity utility, Comisin Federal de Electricidad, streamlined the process for obtaining electricity by offering training to contractors and implementing a geographic information system (GIS) that maps the countrys electricity network, resulting in reduced time to obtain a new electricity connection in Mexico City from 291 days in 2009 to 8547. While this represents a significant reduction of procedural hassle

needed to start a business or expand internet access, waiting three months to be able to plug in a computer is still far from ideal. Ecommerce and Online Payment Systems: Ecommerce in Mexico expanded faster than anticipated in 2012, spurred by widespread increases in internet and mobile device usage. According to AMIPCI, Mexicos e-commerce sales totaled US$6.0 billion in 2012. 21.6 million internet users (about 46% of all internet users in Mexico) made purchases online, spending an average of approximately US$378 per year. This represented a 46% increase over the previous year. eMarketer projects ecommerce sales in Mexico will reach $7.98 billion in 2013 and will continue to grow at healthy double-digit rates through 2016, when annual sales will near an estimated $13 billion.

2006

2007

2008

2009

2010

2011

2012

Online

2.30

2.96

3.12

2.96

3.45

3.62

Radio

2.48

2.56

3.10

3.06

2.57

2.62

TV

1.83

1.83

1.87

1.87

1.85

1.88

1.88

Print

0.50

1.00

1.00

1.00

1.00

1.00

1.00

TOTALS

7.62

8.39

9.09

8.87

8.91

9.12

Daily Time Spent with Select Media Among Adults in Mexico, 20062012 (hours)
Note: numbers may not add up to total due to rounding Sources: GroupM, Interaction 2012, April 9, 2012; table reproduced from www.emarketer.com

46

44. Hbitos de los usuarios de internet en Mxico. 45. Crowdfundings Potential for the Developing World. 46. Internet Users in Mexico Embrace Online Entertainment. 47. Doing Business 2014: Understanding Regulations for Small and Medium-Size Enterprises.

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While a quarter of the population own credit cards, ecommerce sites typically do not accept payment by credit cards for online purchases, though most accept debit cards. Only 14% of internet users (approximately 6m people) make online purchases on a regular basis of 20% of them (1.2m) use PayPal and another 20% (1.2m) use an alternative method of payment. However, ecommerce is forecasted to increase quite rapidly over the next few years (see image on page 50). In 2012, 47% of online shoppers made a purchase using a mobile device, 21% more than in 2011. AMIPCI estimates that the volume of mobile sales will surpass fixed Internet sales by 2014. In 2012 35% of Mexicans only bought on Mexican sites, 46% both on Mexican and foreign sites and 4% on foreign sites only. Travel (36%), financial services (12%), and media & entertainment (12%) were the leading categories for online purchase. Other large categories included electronic equipment, apparel, computer software, and mobile phones48. 51% of the population provides personal information online and 44% are highly wary of giving credit card information out at all, regardless of the medium. The amount of confidence in the security of personal and financial information online can have a significant impact on the use of electronic payment systems. Many people in Mexico believe that there is a high probability that hackers will be able to access sensitive personal information entered online. However, entrepreneurs have demonstrated tremendous creativity, flexibility and responsiveness in bringing culturally appropriate and effective ecommerce solutions to the Mexican market. A diverse array of alternative payment mechanisms, including mobile phone payments, kiosks, pre-paid cards, and remittance solutions, have been utilized to spread the availability of online purchasing.

Business Education: Business education relates largely to the knowledge and skills needed to run a business. It is important in the context of crowdfunding insofar as it enables campaign owners to develop a persuasive, cogent pitch to potential funders and, especially, investors. A sound understanding of market forces and the ability to present the central tenets of a business plan, including financial projections, will also enhance the quality of issuers campaigns. However, business education is important not only to entrepreneurs, but to crowdfunders and investors as well. Investors need to understand the implications of financial projections, market conditions, and fiduciary risk associated with crowdfunding in order to thoroughly evaluate a campaign. Ensuring crowdfunders engaging in P2P lending or equity-based crowdfunding, in particular, are well aware of the risks associated with their investments is essential to avoiding negative publicity that could detract from the industrys momentum if the supported ventures do not generate the expected returns. In general, the sparse availability of business training and education programs contributes to low levels of business literacy among Mexican enterprises. The existence of only three ranked business schools in Mexico EGADE, ITAM and IPADE49- illustrates this deficiency. As a result, the capacity to teach business management skills to entrepreneurs is severely limited. Additionally, studies by the Program for International Student Assessment (PISA), of the OECD, and UNESCO, indicate that the Mexican education system lags behind the educations systems of many developed countries. According to the PISA study (2012), Mexico scored below the OECD average in writing, math and science skills among 15-year-olds. Only half of 15-19 year olds are enrolled in school, compared to an OECD average of 82%, constraining students ability to acquire the skills needed to raise their productivity, improve earnings and contribute to economic growth50. However, Mexico does

48. Internet Users in Mexico Embrace Online Entertainment. 49. Quacquarelli, Nunzio; Byrne, Danny. QS Global 200 Business Schools Report. 50. Jeffrey Puryear, Lucrecia Santibaez, and Alexandra Solano. A New Vision for Mexico 2042: Achieving Prosperity for All.

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boast the second best educated 15 year olds in Latin America, behind only Chile. This indicates strong potential for youth to acquire business skills, but few opportunities for formal business education or prohibitively high costs, may contribute to lower enrollment rates in post-secondary education. Correspondingly, interviews revealed business education to be a significant concern affecting many entrepreneurs and businesses ability to utilize crowdfunding effectively. Technological Literacy: While access to internet and relevant crowdfunding technologies are critical enabling factors for crowdfunding, peoples capacity to use these tools will determine the degree to which they are able to engage in crowdfunding as a donation, investment, or financing mechanism. For businesses, technological literacy is important for conducting online marketing, ecommerce, and creating successful crowdfunding campaigns. Moreover, the use of quality videos in crowdfund-

ing campaigns has been shown to significantly increase the rate of success in reaching established funding goals. Similarly, the general public must be able to navigate the internet effectively in order to find projects they are interested in supporting as crowdfunders. They need to be able to understand how to use a credit card, debit card, or other digital payment mechanism to make online transactions. More engaged internet users will generate more thorough dialogue surrounding campaigns on CFPs, resulting in lower levels of fraud and greater confidence in online funding mechanisms over time. Although the lack of technological literacy among MSME in Mexico limits their ability to fully leverage digital tools, it does not prevent crowdfunding. Rather, it will provide opportunities for digital marketing and consulting services to emerge in support of entrepreneurs striving to take advantage of todays digital marketplace.

$12.92 $11.40 $9.88 46.7% 44.2% $4.18 $2.85 15.4% 47.3% $6.16 23.8% 29.6% 13.3% $7.98

B2C Ecommerce Sales in Mexico, 20102016 (billions and % change)


Note: includes travel, digital downloads and events tickets purchased via any digital channel (including online, mobile and tablet); excludes gambling; converted at the exchange rate of US$1 = MXN13.16 Sources: eMarketer, Jan 2013; graph reproduced from www.emarketer.com

2010

2011

2012

2013 % Change

2014

2015

2016

B2C Ecommerce Sales

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5.3 POLITICAL ENVIRONMENT

Summary:
`` Overall political stability contributes to an attractive investment climate in Mexico. `` Progressive reforms enacted during the first year of President Pea Nietos term generate

confidence in the public sectors ability to design and implement policies that support the development of the crowdfunding ecosystem.
`` Active engagement of public agencies, led by INADEM, in dialogue with CFPs and private

sector actors on crowdfunding regulation puts Mexico in a strong position to build broadbased consensus and effectively implement reforms.
`` Although efforts to improve transparency and reduce corruption are underway, lack of trust

in public institutions remains a significant concern.

For crowdfunding to be successful in becoming a viable financing mechanism for businesses and entrepreneurs, the public sector will play a pivotal role in molding the ecosystem that enables CFPs, businesses, donors and investors to participate in online crowdfunding. One of the major challenges facing the development of this ecosystem to date in developed and developing countries alike has been the creation of rules and regulations needed to govern online financial transactions, including crowdfunding. The governments ability to draft and implement relevant legislation, ensure regulatory coherence, and establish viable enforcement mechanisms for online crowdfunding will depend on a variety of elements in the domestic political environment. In addition, these efforts will likely be affected to some extent by existing commercial policies and regulations. Here we examine Mexicos overall political stability, capacity of domestic political institutions and leadership, the shape of governance structures, relevant laws and regulations for crowdfunding and online commerce.

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Political Stability: The relatively stable political climate in Mexico provides an environment that should be conducive to developing crowdfunding, as it reduces investor uncertainty and thus increases the prospects for capital supply. Mexico has a participatory democracy where the military is not directly involved in government affairs and elections are considered free and fair. The political landscape has been transformed from the 71-year single-party reign of the Institutional Revolutionary Party (PRI) to a diverse democracy. Since the 1990s, Mexico has operated with three primary political parties: the PRI, PAN, and PRD51. In the June 2012 elections, Enrique Pea Nieto received more than 38% of the votes, finishing over 6% ahead of his main competitor Andrs Manuel Lpez Obrador (31.64%). By comparison, former President Felipe Caldern won by only 0.58% votes in 2006. The wider of margin of victory indicates broader initial public support for the present government, which will be in office through to July 201852. To be sure, media coverage has focused overwhelmingly on the drug war and related crimes over the past decade. This remains an important concern; under Calderns presidency, over 60,000 people were killed in drug-related violence53. Although it continues to struggle with security concerns, President Pea Nieto has pursued a vigorous reform agenda to liberalize the economy and improve transparency and accountability. Emerging Leadership: The National Entrepreneurship Institute (INADEM) is leading efforts to support the entrepreneurial ecosystem in Mexico. INADEM is an agency of Mexicos Ministry of Economy that aims to coordinate national policy to support the inclusion of entrepreneurs and MSME by promoting innovation, competition, y access to domestic

and international markets. In conjunction with local CFPs, INADEM has established a working group to promote dialogue and support the development of crowdfunding legislation and regulation needed for the ecosystem to flourish. The direct involvement of the public sector in this proactive initiative is demonstrative of Mexicos advantageous positioning for successful design and implementation of relevant crowdfunding reforms. Reform Initiatives: The swift implementation of progressive economic reforms during the current administrations first year in office augurs well for the timely introduction of crowdfunding legislation. The Foreign Investment Law, the General Law of Mercantile Societies, and the Public Administration Law were all introduced in 2012 to reduce bureaucratic red tape for businesses. The administration also introduced an initiative to increase transparency of teacher hiring and evaluation in February 2013, resulting in immediate charges against education officials involved in illicit spending or other forms of corruption54. These and other reforms, including a shift to online business registration, indicate political acknowledgement of the need for greater transparency and reduced burdens on local businesses55. The government is also considering raising foreign ownership limits in energy, transportation, and telecommunications in order to promote economy dynamism and competitiveness. The strong political support for major reform bills like these indicates the feasibility of passing reasonable reforms, particularly those designed to encourage innovation and economic growth. Public Transparency and Trust: From the perspective of crowdfunding, trust is considered an essential component underpinning the performance of

51. Barone, Michael. Mexico Becomes a Stable, Politically Diverse Neighbor. 52. Romero, Henry. Tax Hikes, Security Dent Mexican President's Approval Rating: Poll. 53. O'neil, Shannon K. Mexico Makes It. 54. Barone, Michael. Mexico Becomes a Stable, Politically Diverse Neighbor. 55. Tucker, Duncan. Mexican Reform Aim to Streamline Start-Up Formation.

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Trust in public institutions is a significant issue that the government is actively working to address

and the increasing attention afforded to issues of trust, transparency and accountability in the halls of government. It seems public officials are coming to recognize that economic development will be stifled if these issues are not tackled, which has resulted in positive signs of progress. The emerging middle class57, which now makes up 39.2% of Mexicos population, has increased levels of confidence in Mexican institutions, as indicated by increased voter turnout as a measure of public trust in government (from 48% in 2009 to 63% in 201259). While a large number of older citizens remain skeptical, the emerging middle-class population is much more optimistic about the future. While lower levels of trust in public and private institutions have been historically widespread, this perception is waning among many. Excessive complexity in public institutions can be detrimental to the success of crowdfunding. When public bureaucracies are overly opaque, the private sector and the general public may lose trust in these institutions. Regardless of its validity, it is important to address such perceptions in order to bolster confidence in the governments ability to effectively and objectively enforce crowdfunding rules. Bureaucratic complexity can also create opportunities for corruption, which remains a significant concern in Mexico. In 2013, Mexico scored a 34 on Transparency Internationals Corruption Perceptions Index on a scale of 0 (highest) to 100 (lowest). That score put it in a tie with several other countries, including Bolivia, Gabon, and Niger, at #106 out of 177 countries included in the rankings60. To widen this perspective, Mexico ranks just above Ethiopia and Tanzania, but lower than countries like China, Malaysia, Philippines and Zambia, to name a few.

capital markets. Historically, levels of trust in Mexico in key public or private institutions have not been high. Only Turkey and Chile ranked lower than Mexico levels of trust among OECD countries in 2011; according to the OECD report, only 26% of Mexicans expressed high level of trust in others, compared to over 80% in Nordic countries and still well below the OECD average of 59%56. According to a 2012 study 71% of Mexicans do not trust their local police, 66% do not trust lawmakers, and 65% do not trust the judiciary system. These figures all increased from the previous year57. Trust in public institutions is a significant issue that the government is actively working to address (specifically by rooting out corruption). The establishment of the Federal Institute for Access to Public Information in Mexico under the 2005 transparency law, for instance, demonstrates this commitment

56. Society at a Glance 2011. 57. Poll: 71% of Mexicans Don't Trust Their Local Cops. 58. Clases Medias en Mxico. 59. Voter Turnout Data for Mexico. 60. Corruption Perceptions Index 2013.

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5.4 MEXICAN REGULATORY ENVIRONMENT


The legal and regulatory environment will command a central role in the efficient operation and integration of capital flows. This will be paramount to the development of a safe, reliable and sustainable equitybased crowdfunding market. The legal and regulatory frameworks sanction the regulator, set the participation rules for market actors, and set compliance standards.

Existing regulatory frameworks are designed for traditional investment instruments and models that move more slowly than technology-enabled innovations such as crowdfunding. This is one reason equity-based crowdfunding models have been particularly slow to emerge. Regulatory agencies focus most of their attention on traditional banking and financial services, since these activities have been most prevalent in the economy. However, grassroots movements have been successful more recently in bringing new crowdfunding models to their attention and promoting productive dialogue surrounding necessary regulation of the industry. While this report does not venture to provide a comprehensive analysis of relevant financial regulations in Mexico, here we review some of the most relevant aspects that will require more detailed examination and analysis. The actions of crowdfunding innovators around the globe have championed change while promoting crowdfunding as a way of addressing the funding challenges of start-up, small, and medium size businesses.

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CrOWdfUNdING IN MEXIcO

Business Laws and Regulations: Despite reforms, there is still opportunity to make further advances in improving the domestic business climate for private enterprise. There is a notable lack of commercial laws and regulations that are essential for the use of internet-based technologies, including, for example, those pertaining to intellectual property rights (IPR), electronic signatures, and proprietary data protection. Although this is partly the result of bureaucratic delays that prevent regulations from keeping up with the development of new technologies, establishing mechanisms to ensure the protection of online data, secure payment services, and privacy are crucial to the success of crowdfunding. While commercial contracts are typically upheld, courts are often unable to prosecute contractual violations as efficiently or effectively as could be desired. Similarly, although the legal framework addresses intellectual property rights, prosecution of IPR infringement remains ineffective. Additional regulations needed to foster a vibrant crowdfunding marketplace would address the activities enabled through new technologies, such as requiring CFPs to take steps to prevent fraud and money laundering and ensure the accountability of issuers. Legal Classifications: Currently legal classifications available for most private enterprises, such as Sociedad Annima (S.A.) and Sociedad Annima Promotora de Inversin (S.A.P.I.), do not adequately address the needs of Mexican companies to secure foreign investment. As a result, many Mexican companies and VC funds have established legal entities other countries, particularly in Canada, for the purpose of raising foreign capital. This is inefficient, expensive, and reduces capital supply in the Mexican market. However, organizations like the Mexico-U.S. Entrepreneurship and Innovation Council (MUSEIC)61 are, at present, actively involved in advocating for the

creation of an appropriate new legal classification for domestic enterprises that facilitates access to capital. Institutional and Qualified Investors: The Mexican Securities Market Law and associated regulations define institutional investors as Mexican and foreign banks, broker dealers, insurance and bond companies, bonded warehouses, financial leasing companies, factoring companies and investment funds, private pension and annuities funds and foreign pension and investment funds (Institutional Investors). Such regulations define qualified investors as individuals and corporations that maintain, during the previous year, investments in securities for an amount equal or similar to 1.5 million Unidades de Inversin (approximately US$450,000) or that have obtained during the previous two years a gross income of at least 500,000 Unidades de Inversin (approximately US$160,000). Institutional Investors are heavily regulated and subject to the supervision of different supervisory bodies including the CNBV and Banco de Mxico. Generally, institutional investors may only invest in those assets that the regulations explicitly permit62. Investor Protections: Entrepreneurs and MSME need to attract investment to expand production, develop new products and services, and boost productivity. But investors are naturally hesitant to provide funding if there is uncertainty surrounding the use of funds or high risk of fraud. Without specific legislation allowing minority shareholders to hold companies accountable, investors will remain reluctant to invest, stunting the economys capacity to finance private sector growth. Recent studies show that regulatory effectiveness can be improved by increasing scrutiny by market supervisors, establishing specialized courts, and waiving legal fees for shareholder suits63.

61. MUSEIC is comprised of representatives from the U.S. State Department, Mexicos Ministry of the Economy and the U.S. Embassy in Mexico. 62. Perez, Pablo, and Rich Mueller. Mexico. 63. Doing Business 2014: Understanding Regulations for Small and Medium-Size Enterprises.

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To date, the Mexican regulatory environment has followed a model of investor beware, putting the responsibilities for due diligence largely in the hands of the investor. Few officially licensed and regulated intermediaries have emerged to assume substantial degrees of liability and reducing risks to investors. Additionally, there is no public organization whose primary responsibility is to protect investors from fraud or misleading claims. Conversely, heavily regulated markets, such as that of the U.S., increase investor protections by making it harder to commit fraud, but it comes at a cost. Government oversight of the regulatory environment, as well as the requirements for professional service providers, such as tax advisors, financial advisors, or brokers, can increase the cost of capital (requiring audited financial statements, for example, may require CFPs to hire accountants and public notaries). Less regulation has benefited Mexico in early stages of the markets development where the challenge has been to gain investment. However, as investment increases, there is a corresponding need to increase investor protections through disclosure and transparency requirements and adequate legal recourse. The less developed regulatory environment in Mexico actually provides greater flexibility to address CFI concerns while allowing MSMEs and entrepreneurs access to affordable capital through crowdfunding.

Crowdfunding Regulations: The sale of securities via online crowdfunding models is a new phenomenon and remains to be fully understood by most governments. As is the case with other governments, a grassroots movement is forming that is embracing this new model, which is now starting to draw the attention of larger audiences. Current securities laws around the world are being reviewed and, in some cases, reformed to support the sale and advertising of securities via the internet to different classes of investors (e.g. U.S. Securities Reg. D exemption now permits solicitation of accredited investors) . As in other markets at early stages of crowdfunding development, interviews revealed a general lack of clarity regarding the scope of what is currently permitted today or what should be permitted under new regulations addressing crowdfunding. Many believe that changes are needed to provide the legal foundation necessary to support crowdfunding. Investors with experience in U.S. capital markets have high expectations regarding investor protections and accountability of issuers, which currently do not exist in the Mexican securities framework. The private sector seeks government support to ensure that contracts are honored and that the consequences of breaking the law are stiff enough to deter criminal activity and duly enforced in practice.

As in other markets at early stages of crowdfunding development, interviews revealed a general lack of clarity regarding the scope of what is currently permitted today or what should be permitted under new regulations addressing crowdfunding.

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5. CULTURAL CONTEXT

5.5

Summary:
`` Despite persistent stigmas tied to failure, a dynamic entrepreneurial culture is developing in

Mexico, which generates opportunities for innovation and investment.


`` Strong family ties, customs of collection action and collaboration through religious institutions

contribute to rich social fabric and sense of community, bolstering peoples underlying willingness to support one another.
`` High levels of drug-related crime and perceptions of lacklustre cyber security infrastructure

contribute to general apprehension towards online mediums of transaction and providing personal or financial information. Overcoming low levels of trust in internet-based technologies will be a key challenge in facilitating the comprehensive development of the crowdfunding ecosystem.

The dimensions of the Mexican crowdfunding ecosystem discussed to this point pertain largely to the state of technical criteria that can enable or inhibit the use of crowdfunding as a practical financing mechanism for entrepreneurs and MSME. But, at its core, crowdfunding is driven by social forces that determine the degree to which funds can be successfully channeled to these businesses through online portals without engagement of the crowd, crowdfunding is impossible. As such, it is important to consider various aspects local culture that may influence the crowds willingness to engage in online crowdfunding. Here we look at key aspects of Mexican culture with the potential to influence the development of crowdfunding.

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57

Entrepreneurial Culture: In the past, pervasive poverty and fickle economic foundations diminished confidence in the potential of business to provide economic stability or upward social mobility. Today, however, despite the persistence of negative stigmas associated with failure, the emerging middle class appears to have a much more dynamic entrepreneurial spirit than prior generations. While social stigmas may diminish peoples willingness to take risks, crowdfunding can allay this apprehension by tying the success of the issuer to the campaign funders. Entrepreneurs will be likely to take more risks and pursue innovations if they have access to patient, low-cost capital than commercial offerings. However, the impact of entrepreneurs garnering the support of social circles is less clear cut. On one hand, the support of friends and family may motivate entrepreneurs to work harder to succeed. On the other hand, the negative influence of social stigmas could be magnified in the case of a failed entrepreneurial venture that was funded by people within the entrepreneurs social circle. Strong Family Ties: Mexican culture is marked by a strong family fabric. Family ties constitute a significant aspect of Mexican society64, which presents an incredible opportunity for crowdfunding, especially as the number of internet users and the prevalence of social media rise. Family connections are not limited to the direct family, and the closeness of extended family creates broader networks throughout communities and the diaspora. Extended families in Mexico also influence individual and household financial decisions65. In particular, in smaller communities and rural areas, family ties constitute the foundation of trust and commitment within the community. In Mexico, the commitment of the family network to higher levels of involvement in family matters such as running a business is more likely to influence career decisions and affects positively the likelihood of an individual of becoming an entrepreneur66.

Customs of Collective Action: The proliferation of collective action to achieve common goals is also an indicator of cultural readiness for the adoption of crowdfunding. For example, the custom of quinceaera parties, in which extended family contributes to fund the party and presents for a girls passage into womanhood. The tanda custom, a form of rotating savings and credit association, is another example of collective action prevalent in Mexican culture, which indicates a strong linkage to crowdfunding (and may even be considered a mode of crowdfunding itself ). Religious Collaboration: There is a deep sense of mutual support and collaboration in communities that share religious affinities. More than 83% of Mexicans are Roman Catholic (93M). Churches which are also funded through a tradition of donationbased crowdfunding are active and involved in many aspects of society and constitute a significant source of collective action. The Catholic Church is an influential institution that could promote further development of the crowdfunding ecosystem. It could even potentially utilize crowdfunding itself as an alternative means of garnering financial support from its members or as a mechanism for channeling funds to the community initiatives it sponsors, such as a soup kitchen or homeless shelter. Trust: As a cultural aspect, trust can impact peoples propensity to use the internet as well as how they use it. The extent of social media usage and the prevalence of online purchases are important factors for the potential success of crowdfunding. Confidence in the security of digital systems will have a strong influence on their willingness to engage in online crowdfunding. Lower levels of trust in general have important implications regarding individuals level of trust using online payment mechanisms, engaging in social media, and sharing information online. A relative lack of familiarity of the internet and associated technologies may also compound

64. Carrasco, Fernando P., Dr, and Maite Lot. Family Culture in Mexico and the Well-Being of the Population. 65. Farfn, Gabriel. Extended Families across Mexico and the United States. 66. Camp R.A. Entrepreneurs and Politics in Twentieth-Century Mexico.

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the influence of the general lack of trust in society, which could potentially increase aversion to use the internet. Indeed, research by McKnight and Chervany (2002) shows that a lack of confidence in digital technologies and the internet, including web-based vendors, can hamper the adoption of ecommerce67. Interviews also revealed general concern that online transactions could be undermined without adequate options for redress in the case of fraud or the misrepresentation of products or services purchased online. A recent study by the National Institute of Statistics and Geography (INEGI) shows that distrust has increased in Mexico due to corruption and increasing incidence of crime and violence. Such insecurity and uncertainty has resulted in a desire by many people to remain anonymous. Trust and personal safety are critical for fostering entrepreneurship and doing business. Levels of crime and a lack of confidence in the judicial system, in particular, are significant barriers for entrepreneurs and businesses across Latin America68. Crime and Cybersecurity: Criminal activities in Mexico have also generated concerns surrounding the use of the internet. Interviews indicated that Mexicans are hesitant to provide personal information online because they fear they might be exposed to risks of identity theft, data loss, becoming

embroiled in a money laundering scheme or, in the extreme, physical danger. Currently, online security is perceived to be inadequate to prevent these risks from occurring. The costs of online frauds and cybercrimes have rapidly increased over the last few years. While the government struggles to keep up with the pace of constantly evolving technologies, the costs of investigating cases and pursuing perpetrators of cybercrime in Mexico are nearly double what they were in 2011, highlighting the countrys unwelcome status as a regional hub for online crime69. One of the traditional assumptions of crowdfunding is that the crowd provides an opportunity for greater transparency and accountability by and between businesses and investors (and indirectly through the broader community). One of the recurring themes that surfaced through our interviews, however, was that the Mexican business and investment culture does not necessarily pursue high standards of transparency. Businesses do not disclose more information to the public or their investors than they have to. Moreover, few people have high expectations that such disclosures are consistently reliable. Given this reality, many Mexican investors have traditionally invested in physical assets such as land and real estate, which tend to be more predictable than other investments but which are seldom considered drivers of economic dynamism.

mEXIcO

67. McKnight, D., & Chervany, L. What trust means in e-commerce customer relationships. 68. Brunetti, Kisunko and Weder. International Obstacles to Doing Business. 69. Southwick, Natalie. Norton Says Cyber Crime Costs Mexico $3B Per Year.

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5.6 THE CURRENT MEXICAN CROWDFUNDING LANDSCAPE


Crowdfunding platforms are emerging in other markets as powerful players with the capacity to bridge the gap between capital supply and funding demand. Mexican CFPs also hold this potential. In fact, despite its nascence, a number of CFPs are already operating in Mexico today, using both non-financial and financial crowdfunding models. They include both home-grown enterprises as well as subsidiary operations of CFPs based in other countries. Here, we provide a brief overview of these platforms and highlight several noteworthy trends that are beginning to surface in the market.

Crowdfunding Platforms in Mexico70


The largest and most established non-financial return CFPs in Mexico are Fondeadora (Fondeadora.mx), and Idea.me. Fondeadora offers both donation-based and reward-based models and launched in June 2011 and is approaching US$800k in total funding volume across 121 successful projects. Fondeadora has seen rapid growth in the Mexican Crowdfunding market, raising as many funds in the first half of 2013 as it did in its first three years of operation, indicating a substantial increase in participation. Idea.me, which offers reward-based crowdfunding, launched in Chile and Argentina in August 2011 and in Mexico in March 2012 Idea.me also operates in the U.S., Colombia, Brazil and Uruguay. Idea.me has raised US$1.8m across all countries and US$300k on its Mexican portal.

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Platform Name

Type of CF Donation, Reward Equity

Total Funding Volume in Mexico (USD) $800,000 $4,100,000

# of Campaigns Funded 121 N/A

Client Base Artists, Entrepreneurs Entrepreneurs Entrepreneurs, Artists, NGOs, Community Projects Entrepreneurs, P2P P2P, Entrepreneurs P2P, Entrepreneurs Investors, Entrepreneurs

Country of Origin

Date Launched (in Mexico) June 2011 November 2012

Fondeadora.mx Crowdfunder.mx

Mexico Mexico/USA

Idea.me

Reward

$300,000

57

Argentina

February 2012

Kiva.org

Lending

$10,500,000

22,000

USA

October 2006

Prestadero.com

Lending

$840,000

204

Mexico

June 2012

Kubo Financiero

Lending

$1,100,000

640

Mexico

November 2012

Vakita Capital

Equity

N/A

N/A

Mexico

April 2013

Vakita Capital (vakitacapital.com), which is in the process of launching, and Crowdfunder Mexico (Crowdfunder.mx) are currently the only two CFPs offering (or preparing to offer) equity-based crowdfunding. Crowdfunder Mexico launched in November 2012, operating in unison with its U.S. parent (Crowdfunder.com). It currently supports Mexican entrepreneurs raising capital under U.S. Securities Regulation S offerings. Regulation S is available for offerings of both equity and debt securities where the offer or sale must be made through an offshore transaction and where no directed selling efforts may be made by the issuer, a distributor, any of their respective affiliates, or any person acting on their behalf. Vakita Capital, which was incorporated April 2013, will be the first CFP offering domestic equity-based crowdfunding. Vakita Capital will support Mexican issuers raising capital from qualified investors in Mexico. This year, Vakita Capital was awarded US$400k investment capital from INADEM when it

applied for funds as part of INADEMs Convocatorias program71 and has established the Vakita Fund to provide investment support for entrepreneurial businesses through its online platform. There are also several lending-based CFPs operating in Mexico. Kiva.org, for example, entered the market in October 2006 and has since made loans to over 22,000 entrepreneurs and MSME totaling approximately US$10.5 million. Other traditional lending-based CFPs include Kubo Financiero (kubofinanciero.com) and Prestadero.com. Three other CFP platforms, Lenddo.com, Confianza Digital (Credilike.me) and Kueski.com, operate slightly differently; they fund small loans from other sources of capital rather than from community-based networks. Additionally, Kubo Financiero is registered as a SOFIPO (Sociedad Financiera Popular), which allows crowdfunders to select their desired rate of interest, but prohibits them from deciding whom to loan their money to . This results in the pooling of

70. The platforms shown in this table are meant to provide a basic snapshot of the industry in Mexico today; it does not aim to provide an exhaustive list of all platforms. 71. Convocatorias # 3.2: Program to Develop Entrepreneurial Capital.

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capital through Kubos platform and the selection of loan recipients is left to Kubos management. Lastly, a number of smaller non-financial crowdfunding sites have launched in Mexico, including Karmashop.org, Geteo.org, MiCochinito.com.mx, and Bandtastic.me (in the process of re-launching). Recently, Karmashop won first place in the 2013 Intel Global Challenge at UC Berkeley, receiving a $10,000 award from the Intel Foundation. Karmashop created a crowdfunding platform that allows users to customize how they receive donations and gives donors Karma Points in return. For example, a Karmashop campaign raising money for community members affected by recent floods in Mexico gave donors the option to contribute specific relief items including drinking water, first aid and shelter72. The development of the crowdfunding ecosystem is moving quickly and, as seen above, there are a number of players that are already contributing and more looking to enter the market in the near future. Pioneering entrepreneurs are launching both nonfinancial and financial CFPs. They are building unique
NON FINANCIAL CROWDFUNDING
REWARD-BASED

business models tailored to the local market while promoting their brands and forming strategic relationships with service providers. Moreover, donors and investors are using CFPs to channel their funds. Key stakeholders have started to formally collaborate by proposing the creation of the Mexican Crowdfunding Association (MCA) in order to design viable strategies and promote actions in support of the nascent crowdfunding ecosystem. The proposed MCA would include leaders from various Mexican CFPs, commercial banks, and the public sector (namely INADEM). This group could provide a recognizable forum through which policies may be reviewed and reforms proposed to foster new types of crowdfunding, improve investor protections, educate entrepreneurs and investors, and strengthen cybersecurity. It could also facilitate discussion of other relevant issues for crowdfunding and help to establish relationships among key actors. Large enterprises are also gaining interest in crowdfunding in Mexico. Commercial service providers (e.g. Banamex, PayPal) are evaluating the market, gauging
FINANCIAL CROWDFUNDING
EQUITY-BASED

REWARD/DONATION HYBRID

DONATION-BASED

LENDING BASED

Mexican CFPLandscape (Dec 2013)


Graphic based on elaboration by Massolution. 72. Chilean Students Win Intel Award in Silicon Valley Entrepreneurship Experience.

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demand, and considering their preferred points of entry and timing. Crowdfunding is increasingly being recognized as a model capable of supporting corporate social responsibility (CSR) agendas as well as an incubator for content, talent and intellectual property that larger companies are increasingly aware of. Fondeadoras partnership with Televisa, a major media outlet, provides one example of this. Recognizing the value of brand association with independent content producers via crowdfunding, Televisa will match funds raised through Fondeadoras platform against a selection of high-interest crowdfunding projects. Fondeadora is also collaborating with Masisa, one of Latin Americas largest producers of wood particle and fiberboards. These partnerships build on Fondeadoras experience supporting the development of Coca Colas Mexican CFP, Transformadora . Coca Colas platform was launched to support the introduction of its water brand, Cielo, in Mexico. Again, there is a matching component whereby Coca Cola will match funds for specific projects; the Agua Cotidiana campaign, for instance, is developing a filter that cleans and re-cycles shower cubical water73. Other initiatives are channeling support for marginalized businesses through crowdfunding. As part of the Womens Entrepreneurship in the Americas (WEAmericas), the FINPYME Mujer Empresaria Trust Fund at the Inter-American Investment Corporation, a member of the IDB group, is leveraging publicprivate partnerships by enlisting the support of international financial institutions to increase womens economic participation and addressing three barriers female entrepreneurs often confront in starting and growing MSME: access to training and networks, access to markets, and access to finance74. While this is a slightly different way of crowdfunding, it is compatible with existing models and could be supported through integration with CFPs. Further, the support of key local stakeholders in the public and private sector, as well as international
73. Agua Cotidiana. 74. Women's Entrepreneurship in the Americas (WEAmericas).

institutions, reflects confidence in crowdfunding as a viable mechanism to galvanize entrepreneurial activity and improve access to funding through proven technologies. Investments in the development of the market are increasing awareness of crowdfunding and providing the knowledge to enable the model and its potential to be understood. Crowdfunding in Mexico has generally followed a pattern similar to the experience of other countries. The market initially found traction through nonfinancial crowdfunding models, which helped to lend credibility to debt- and equity-based models. Subsequently, pressure from political and financial interests, both domestically and abroad, create opportunities for the revision and reform of securities laws to facilitate the transition to financial crowdfunding. This enables stakeholders to incorporate lessons learned through the rollout of non-financial crowdfunding in the design and implementation of financial crowdfunding initiatives. Reputational Risk: As a new market mechanism based on digital financial transfers, crowdfunding is naturally viewed with some uncertainty. As such, it is critical to disseminate early success stories and avoid highly visible failures and negative press that could impede the long term development of crowdfunding. Without basic systems in place to ensure transparency and accountability, the risk of fraud will continue to increase as more actors engage in various crowdfunding models. Both financial and nonfinancial models are exposed to the risk of fraud, which is a significant concern considering the severe harm that could be caused if donors or investors funds were channeled to phony businesses or projects. In the U.S., exposure to fraud is limited by requirements for businesses and charities to be formally registered with a recognized bank account, file taxes, and be subject to oversight by specific regulatory committees and industry watchdogs. Looser regulations in Mexico generate increased exposure to this risk, which could undermine the potential for both financial and non-financial crowdfunding.

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5.7 POINTS OF COMPARISON: INTERNATIONAL EXPERIENCE WITH EQUITY-BASED CROWDFUNDING REGULATIONS


Distinct conditions across markets have led to different forms of implementations of equity- and lending-based crowdfunding. It is important to consider the experience of crowdfunding in other markets in order to consider best practices and lessons learned when pursuing the development of the crowdfunding ecosystem in Mexico. The following examples illustrate some alternative approaches75.

75. Further information on international legal crowdfunding frameworks in other countries can be found in the Massolution 2013CF Crowdfunding Industry report.

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5.7.1 Rapid Implementation on a Controlled Basis Italian Equity Crowdfunding


The Italian financial securities commission, CONSOB, became the first European country to pass legislation, which went into effect on 27 July 2012, permitting equity-based Crowdfunding76. Regulation No. 18592, permits any investor, regardless of nationality or place of residence, to purchase equity-based securities through an Italian equity-based crowdfunding platform, provided the investor passes a test demonstrating understanding of the risks involved and can afford the possibility of losing their investment. In comparison to other markets, Italy moved quickly to establish a set of rules aimed at revitalizing its struggling early-stage capital market and providing a framework to protect investors. Key elements of the framework include restricting entities raising capital to a category defined as Innovative Startups (recognized as such by the Chamber of Commerce), an institution or professional investor must subscribe to a minimum of 5% of the securities sold, limiting the raise to 5 million, enabling investors to back out before the round is closed, and to sell their shares if the majority owner liquidates their investment. In addition, equity-based CFPs must be run qualified professionals with requisite certifications or experience in the financial sector. CONSOBs strategy was to move quickly with the introduction of equity-based crowdfunding in a more limited fashion to accelerate start-ups access to seed capital, with the mandate to periodically evaluate what worked and what didnt and to modify the law if necessary.

5.7.2 Responding to Market Developments While Considering Changes to National Policy Equity Crowdfunding in the United Kingdom
The UKs regulatory body, the Financial Services Authority (FSA), is adopting a dual pronged approach. It is evaluating the longer-term strategy of making changes to national regulatory policy in parallel to licensing individuals CFPs that apply for authorization and pass the required audit. FSA authorization increases investor confidence and provides additional levels of protection. Crowdcube.com was the first UK equitybased CFP to receive FSA authorization as a regulated CFP.

76. Lerro, Alessandro M. Protections Offered to Investors Under Italy's Equity Crowdfunding Law.

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5.7.3 Implementation in a Highly Regulated Market U.S. Equity Crowdfunding


The Entrepreneur Access to Capital Act was the first U.S. bill designed to create a regulatory exemption for crowdfunded securities. Subsequently, two Senate bills (S.1791 and S.1970) were introduced and similarly focused on a new crowdfunding exemption. Another bill was introduced into the House (H.R. 3606) in December of 2011 to relieve companies with annual revenue of less than $1 billion from certain SarbanesOxley Act compliance requirements. Faced with a plethora of overlapping bills, a new version of H.R.3606 was introduced to the House and renamed the Jumpstart Our Business Startups (the JOBS Act77). As part of the JOBS Act, the Crowdfunding bill was promoted based on its potential to jumpstart small businesses and create new jobs in the economy. While the timing of the bill proved advantageous in regards to its rapid progress through Congress, it did not follow typical legislative process. As a result, the bill passed without broad-based stakeholder involvement in the drafting or in the garnering of public support. The Securities and Exchange Commission (SEC), along with organizations like FINRA and the traditional private capital players, was taken by surprise, unable to provide counsel on important issues. Instead of champions emerging from within the regulatory environment to facilitate its implementation, the SEC and FINRA reticently faced a complex challenge to fit equity-based crowdfunding into a complex regulatory framework that was designed for a different capital market structure. While without the driving political circumstances the bill may not have passed, the price paid for the expedited legislative process was a protracted period of rule making. It will be approximately two years after the bill was passed before its full implementation is in effect which has had material ramifications on how the market has developed. Instead of the market developing with strong momentum out of the gate, we now see a dispersal of the market. Many of the pioneering CFPs and individuals that formed the early movement ran out of funds and have fallen away before the market was able to operate legally and take shape. Additionally, discontented with the implementation of equity-based Crowdfunding at a federal level, many States are now considering their own version of the JOBS Act and Crowdfunding bill. The lack of harmonization of securities laws will ultimately inhibit the industrys development in the U.S. Understandably, actors are initially taking a precautious approach and diligently evaluating important issues regarding the needs of investors, issuers and intermediaries, as well as the operating environment of crowdfunding going forward.

77. 112th Cong. HR 3606. Congressional Research Service.

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6.

recommendaTionS

The research and analysis presented in this report are intend-

ed to inform a set of specific recommendations that will support the development and acceleration of the crowdfunding ecosystem in Mexico. The strengths, weaknesses, and distinct idiosyncrasies identified in the current ecosystem will guide efforts to enhance the potential impact of crowdfunding on Mexican entrepreneurs, MSME and investors. While substantial consideration is given to the unique aspects of the local context, the recommendations offered here are also informed by international experience with crowdfunding reform in other markets. Concerted efforts will accelerate crowdfundings development, which has been organic thus far in Mexico, and enable entrepreneurs to drive economic growth and dynamism. In this section, recommendations are organized in accordance with the C-STEP Five Pillars of Intervention: Capital Supply, Funding Demand, Market Strategy, Management and Enablers. We propose a set of recommendations for each pillar, accompanied by a brief explanation and a list of concrete action items associated with each. Based on our analysis, we suggest which actor(s) appear to be in the best position to effectively pursue a given action. In most cases, action items will require coordination between multiple stakeholders and definition of responsibilities in order to achieve the desired results. Action items are ordered according to the perceived level of priority and urgency in order to focus the attention of key actors and decision makers on issues where timeliness is a relevant concern. At the end of the day, it will be up to local stakeholders to determine the appropriate path for the development of a robust crowdfunding ecosystem in Mexico. There are many ways to do this, but we hope that at a minimum these recommendations will stimulate a productive dialogue and engage leaders from the public and private sector and civil society.

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6.1 CApItAL SUppLy

The preceding analysis identifies several issues affecting the ability of entrepreneurs and businesses to access the capital needed to start or grow their operations. First, information asymmetries inhibit existing financial institutions from identifying lending or investment opportunities in the domestic market. Similarly, potential crowdfunders may be unaware of such opportunities as well. Second, existing sources of capital supply generally exclude a large segment of the market and are often prohibitively expensive for many budding entrepreneurs and small businesses. In addition, the proximity to the burgeoning U.S. market presents both opportunities and potential challenges. The attractiveness of the investment climate in Mexico will determine whether capital flows into or away from the domestic economy. Improving the domestic capital supply will require actions to make existing sources of capital supply more accessible and providing additional opportunities for domestic and international actors to provide funding through online crowdfunding platforms. The goal of the Capital Supply pillar is to increase access to funding for entrepreneurs, businesses, social projects, and independent ventures to meet their demand.

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RecommendatIons

1
Leverage the Existing Regulatory Environment to Increase Available Capital for Entrepreneurs

2
Build a Stable Non-financial Crowdfunding Market

3
Support the Development of the Equity-based Crowdfunding Market

4
Create Incentives for Capital Repatriation through Crowdfunding

5
Create Incentives for Foreign Investment

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6.1.1 Leverage the Existing Regulatory Environment to Increase Available Capital for Entrepreneurs
While regulatory reforms are needed to strengthen the prospects of equity-based crowdfunding in Mexico, opportunities remain to leverage the capacity of new technologies to better connect qualified investors with businesses within the existing regulatory environment. One way issuers and investors can take advantage of these opportunities is through better access to information and crowdfunding technologies. This will require targeted efforts to correct the informational asymmetries between existing sources of capital in the domestic market and entrepreneurs with investable business plans.

Action Item Document crowdfunding success stories in donation, rewards-, and debt-based models. Document the associated models (and use cases) in which current players have effectively engaged in the Mexican regulatory environment using CFP technologies.

Facilitators Universities, External consultants, MIF

Priority High

Disseminate case studies and success stories to relevant sectors, business councils, and the general public. Develop a strategy for leveraging existing models that can be adapted to crowdfunding.

INADEM

High

Universities, External consultants, CFPs, INADEM

Medium

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6.1.2 Build a Stable Non-financial Crowdfunding Market


Supporting the growth and stability of non-financial crowdfunding will increase capital supply and build awareness and confidence in the model throughout the market. In the short term, the relative simplicity of non-financial crowdfunding makes it easier to promote in the Mexican market where online mechanisms are less prevalent. Crafting straightforward policies that engender early successes in this sector will generate confidence in the basic functionality of online crowdfunding transactions. As a result, increased confidence in these less complex forms of crowdfunding will create momentum that will help financial (particularly equity-based) crowdfunding, which will require a longer timeframe to develop relevant standards and regulations, to gain traction. Moreover, donation and rewards-based crowdfunding have already made inroads in the market and provide opportunities to draw participation from foreign crowdfunders who are more comfortable with online payments and well-known non-financial platforms such as Kiva.org. The adoption of donation- and reward-based crowdfunding tends to generate momentum for the adoption of securities-based crowdfunding as confidence in the market grows. However, both require appropriate controls in order to be viable. Unfortunately, a completely unregulated non-financial crowdfunding market dramatically increases the risk of fraud in this category. If fraud occurs in the non-financial crowdfunding space, it may exacerbate skepticism surrounding securities-based crowdfunding amongst both domestic and international crowdfunders. Preventative safeguards are critical to avoid fraudulent activities that could be detrimental to the development of the market as a whole.

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Action Item

Facilitators

Priority

Provide targeted support to help campaign owners on non-financial platforms to gain crowdfunding-skills training and education resources that improve their ability to reach funding goals. Develop content to disseminate information back to crowdfunders to provide transparency (e.g. validation that funds make it to the campaign owner, how funds were used, etc.). This could be achieved in conjunction with a strategy to create a recognized and trusted brand to be associated with safe crowdfunding. Develop a simple financial instrument with regulatory standards for fundraising escrows and microloan accounts. Research alternatives and form recommendations for consumer protection and compliance standards, including transparency and reporting standards (could be modeled on the Charities Review Council in the U.S.78). Encourage non-financial CFPs to continue to participate in the Crowdfunding Association and other industry initiatives alongside financial and hybrid CFPs. Develop partnerships between non-financial and financial based CFPs to help form the continuation of the funding relationship (i.e. the funding continuum) so that business case raise money via non-financial and then have a path to financial crowdfunding.

INADEM, Non-financial CFPs, Universities

High

CFPs, INADEM

High

CNBV, INADEM

Medium

Universities, CNBV, Banks

Medium

INADEM, MCA

Medium

MCA

Low

78. About the Charities Review Council.

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6.1.3 Support the Development of the Equitybased Crowdfunding Market


Efforts to bolster non-financial crowdfunding should be pursued in parallel to the development of specific rules and regulations needed to promote a viable equity-based crowdfunding market. A parallel process for policy changes to support financial crowdfunding would allow time for the development of institutional capacity, leadership, and infrastructure needed for the sustainable development of all types of crowdfunding. Rather than prescribing a singular model, however, the focus should be on supporting the markets maturity in collaboration with current and emerging stakeholders. This will help to establish an industry identity and build consensus regarding the requirements for a stable and sustainable framework for equity-based crowdfunding. The historical excess of funding demand over capital supply (by a ratio of approximately 2:1 worldwide) emphasizes the need to build investor confidence by ensuring adequate investor protections through the clarity of legal rights, together with the certainty of expeditious enforcement. Action Item Organize a group of endorsed industry actors to form a set of recommendations for securities regulation in order to support the development of a legal framework for equity-based crowdfunding. Expand the definition of qualified investors for private offerings under Article 8 of the Securities Market Act, specifically those associated with the classification of a security offered through a crowdfunding platform. Secure the participation of big brands and large enterprises to fund and support community based crowdfunding events and forums. Recognition of crowdfunding platforms as a new type of financial intermediary operating within the existing regulatory environment through amendment to Article 232 of the Securities Market Act to establish crowdfunding platforms as authorized exchanges. Facilitators INADEM, CNBV Priority High

CNBV

High

MCA

Low

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6.1.4 Create Incentives for Capital Repatriation through Crowdfunding


The strength and relative stability of the U.S. capital markets has proven to be a tremendous draw for capital investments from around the world. Correspondingly, these investments bypass opportunities in Mexico. Crowdfunding platforms provide an opportunity to draw this capital back to the domestic market. A concerted effort to create incentives to bring capital back to Mexico will increase the flow of capital to Mexican businesses. Action Item Develop a set of recommendations for legislative and regulatory reform that will provide domestic and diaspora investors with reasonable incentives to invest in the Mexican market through crowdfunding. Develop investor protections that are enforceable in accordance with the capacity of public institutions. Research the feasibility of incentives that could be provided to the diaspora to invest a portion of remittances in productive activities via crowdfunding platforms. Design and implement a publicity campaign to educate the Mexican diaspora on how to engage in crowdfunding and the impact it can have on local socioeconomic wellbeing. Research the scope of capital flight and its potential impact if kept local. Review legal and tax restraints to understand why capital is leaving the country. Facilitators MCA, Instituto de los Mexicanos en el Exterior Priority High

CNBV, INADEM, External Consultants

High

MCA, CNBV, IDB

Medium

INADEM, CFPs

Medium

Universities, External Consultants

Low

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6.1.5 Create Incentives for Foreign Investment


The emergence of crowdfunding in other markets presents an important opportunity to support all forms of crowdfunding in Mexico. Progressive reforms have already been taken by the Pea Nieto administration to open competition in the energy sector. Subsequently, improving incentives for inward capital flows will bolster efforts to increase access to domestic sources of capital as they increase confidence in the functionality of online crowdfunding. Action Item Develop a set of regulations and strict penalties for fraudulent campaigns promoted through CFPs. Aim to strike a balance between the liabilities of campaign owners and crowdfunding platforms. Research factors that are restricting the flow of foreign capital into the market. Specifically, review the foreign investment law (Ley de Inversin Extranjera); Title 4 (Articles 17 & 17A), Title 7 (Articles 31 36) and other clauses related to the limits on total foreign investment (since crowdfunding enables numerous investors to channel funds to an issuer, expanding percentage limits on foreign investment in domestic enterprises can open many doors to entrepreneurs and small businesses in Mexico. Facilitators CNBV, External Consultants Priority Medium

CNBV, External Consultants

Medium

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6.2 fUNdING dEmANd

Businesses need capital at all stages of their development. However, they dont always have access to the capital they need or, in some cases, do not know how to access available sources of capital. Therefore, it is important to reconcile these gaps by helping businesses realize how Crowdfunding can support their continued growth and development.

RecommendatIons

1
Educate Entrepreneurs and MSME to Utilize Crowdfunding Effectively

2
Ensure the Inclusion of Businesses Excluded from Other Sources of Funding

3
Target Businesses that Match Investor Requirements for Non-Traditional Investments.

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6.2.1 Educate Entrepreneurs and MSME to Utilize Crowdfunding Effectively


There is a perceived lack of businesses that are qualified to receive funding from investors. Improving the skills of these SME to take advantage of crowdfunding opportunities it is key. The capacity of businesses to express funding needs must also be enhanced. Improving the quality of online campaigns requires education and training in business skills and campaign promotion. Action Item Develop training materials that help businesses and entrepreneurs to attract crowdfunders through existing CFPs, including business planning, marketing and audiovisual skills training. Invite MSMEs and entrepreneurs to workshops designed to educate entrepreneurs on generating a detailed business plan, producing a successful crowdfunding campaign, producing campaign videos, engaging potential funders through CFPs and social media, and other best practices. Launch publicity campaigns targeting small and medium enterprises to promote workshops and raise awareness of the potential uses and benefits of crowdfunding. Incorporate CF modules into existing training programs for SMEs provided by public institutions and promote inclusion amongst other service providers in the non-governmental and private sectors. Facilitators INADEM, CFPs, MCA Priority High

INADEM, MCA, Business Associations

High

INADEM, MCA

High

INADEM, MIF, Universities, MCA

High

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6.2.2 Ensure the Inclusion of Businesses Excluded from Other Sources of Funding
The traditional systems of venture funding work well for specific industries, corporate profiles and entrepreneurial demographics. However, many businesses fall outside the scope of VC funding priorities. Crowdfunding presents a viable mechanism that can channel funds to businesses that are not eligible for VC investment, microfinance, Angel investment or commercial lending products. Action Item Develop a regular tracking report on access to capital by targeted MSMEs to develop a base line of information so there is shared accountability for the results. Connect capital and CFPs to existing organizations that engage targeted communities via crowdfunding platforms. Provide technical support (e.g. skills, networking support) to CFPs focused on entrepreneurs and MSME that are excluded from traditional sources of financing. Provide financial support to CFPs that promote underserved market segments. Facilitators INADEM, MCA, Universities Priority Medium

INADEM, MIF, NGOs

Medium

INADEM, MFIs, MIF

Low

INADEM, MIF, Corporate Foundations

Low

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6.2.3 Target Support to Help Businesses Appeal to Investors


One way to generate funding demand that matches available supply may be by promoting the types of businesses that investors will support. Clearly defining the types of businesses that investors are attracted to could enable businesses to align themselves with potential investors more easily. This could be done by disseminating blueprints of preexisting business models (e.g. the franchise model which is inclusive of brand, structure, training, etc.) or by supporting innovative entrepreneurs with high-growth, high-impact potential. Targeting support to help local businesses appeal to investors may effectively channel resources by drawing investors attention toward businesses that match desirable profiles. Action Item Facilitate the transition for MSMEs and entrepreneurs that successfully raise and utilize capital through non-financial crowdfunding campaigns to migrate to financial crowdfunding. Create program of micro-funds/loans channeled through qualifying CFPs that are available to businesses in advanced stages of entrepreneurial development in order to provide targeted technical assistance and financial support. Support franchisors to expand opportunities for franchisees in association with crowdfunding and blending financial models that include crowdfunding. Facilitators INADEM, MCA, MIF Priority Low

MFIs, CFPs, INADEM

Low

Franchisors, CFPs, MIF

Low

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6.3 MARKET STRATEGY

As a new tool for promoting collaboration, entrepreneurship and investment, people are naturally hesitant to actively engage in crowdfunding on their own. The market needs to be carefully cultivated in its early stages of development to allay this inherent skepticism. Here we provide several recommendations and associated action items that can be undertaken to generate confidence in the market and effectively facilitate the match between capital supply and funding demand. Careful messaging and deliberate targeting of different groups of actors will be important to achieving these goals. It is important to generate broad-based support in the industry by engaging diverse actors and promoting better understanding of the potential uses and impact of crowdfunding mechanisms for entrepreneurs, businesses, donors and investors.

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RecommendatIons

1
Promote Broad-based Participation in Crowdfunding

2
Promote Early Success Stories

3
Engage Leading Firms to Develop Business and Technology Infrastructure

4
Empower Marginalized Communities and Develop Emerging Sectors

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6.3.1 Promote Broad-based Participation in Crowdfunding


Crowdfunding is part of the global democratization of personal finance spreading to the private capital markets. At its core it is about empowering the individuals to act. Crowdfunding enables individuals to invest in the brands, businesses and people they wish to support. Similarly, entrepreneurs gain the ability to reach investors by leveraging social media platforms and online payment mechanisms to reach a broader audience. Building a broad base of support and participation across an array of industry sectors will facilitate cross-sector mobilization and economic integration. The potential of crowdfunding as an emerging model that can provide broad benefits across all sectors helps ensure that it will be embraced by a larger element of the Mexican population. In order for this potential to be reached, the involvement and enthusiasm of as diverse a group of stakeholders as possible will be necessary. It will also support a comprehensive promotion strategy at the national and local level. Additionally, confidence in the emerging market may be built through the engagement of established and trusted business brands. The adoption of crowdfunding by major enterprises worldwide and in Mexico (e.g. Coca-Cola), sets the stage for Mexican models headlined by established brands that can contribute to raise awareness and confidence of crowdfunding. Participation of recognized businesses and associated brand names in crowdfunding will build confidence among stakeholders in the market. Action Item Develop a marketing and communications strategy to promote crowdfunding in Mexico. Create content for specific target audiences that can be marketed effectively, including engagement with the diaspora. Identify opportunities to publicize crowdfunding through various communications channels. Build cross-industry enthusiasm for crowdfunding. Increase awareness of crowdfunding through events. Identify potential crowdfunding ambassadors with recognized credibility and networks that can promote the industry through speaking engagements and other types of informational or promotional events. Encourage corporate sponsors to establish matching crowdfunding campaigns (matching up to 100% of crowdfunded contributions) for social or economic development projects. Support the development of crowdsourcing business models to familiarize people with engaging online communities and workers in a non-financial environment and to disseminate other successful experiences demonstrating the power of the crowd. Mexican Crowdsourcing platforms like YoPropongo, Torneo de Ideas, Citivox and Codeando Mexico are already producing results in this area. Facilitators MCA, External Consultants Priority High

CFPs, INADEM, MIF

High

INADEM, MIF, MCA

Medium

INADEM

Low

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6.3.2 Promote Early Success Stories


There is a need for early high-profile success stories in the emerging crowdfunding market. The institutional players interested in cultivating a vibrant crowdfunding market have a unique opportunity to play a role in maximizing the likelihood of initial high profile success. Business will gravitate to attract funding where other businesses have successfully raised money. Investors will gravitate to invest via CFPs that have hosted businesses that properly manage funds and deliver expected returns. Action Item Identify publicity channels to promote the success of entrepreneurs that acquire financing through crowdfunding campaigns. Hold workshops with businesses, local leaders, and other stakeholders to disseminate the early successes of crowdfunded campaigns. Develop case studies that analyze successful entrepreneurs and other initiatives funded by online campaigns. Facilitators MCA Priority High

INADEM

High

Universities, MCA

Medium

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6.3.3 Engage Leading Firms to Develop Business and Technology Infrastructure


Drawing recognized enterprises into the fold will support the development of business and technology infrastructure needed for crowdfunding to thrive in the market. Large firms have the capacity to improve telecommunications infrastructure, cybersecurity networks, and digital payment systems and escrow services. Moreover, it may help secure mainstream economic and political support throughout the country. Action Item Identify businesses, organizations and individuals that have already engaged in crowdsourcing or crowdfunding initiatives to build off the progress made by existing market actors. Develop and launch a critical CFP in a targeted industry with industry leaders. Match the interests of companies with a target sector and develop a critical CFP in the space. Support the formation of advisory boards for CFPs to include key business leaders (e.g. The CEO of PayPal Mexico is on the board of Bandtastik, a Mexican CFP). Facilitators CFPs, MCA Priority High

Corporate Foundations, MCA, INADEM

Low

External Consultants

Low

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6.3.4 Empower Marginalized Communities and Develop Emerging Sectors


One of crowdfundings central advantages is the potential for people everywhere (i.e. in the crowd) to support anyone, anywhere. In order to ensure that the development of crowdfunding does not exclude certain communities, such as those in rural areas or indigenous populations, there must be intentional efforts to ensure equitable access to crowdfunding. Empowering marginalized communities and emerging sectors in this way will potentially increase their participation in the mainstream economy. While this aspect is not as crucial to ensuring crowdfundings immediate success as other recommendations, it is unquestionably important for the long-term development of the crowdfunding ecosystem and provides an opportunity to address the high levels of economic inequality in Mexico. Action Item Train NGOs and organizations working with disadvantaged communities to educate entrepreneurs and small businesses to use crowdfunding effectively. Provide financial support for crowdfunding initiatives that promote womens entrepreneurship and participation in the economy. Provide financial support for crowdfunding initiatives that promote economic and social development in indigenous communities. Create benefits for social enterprises (for-profit businesses that have a measurable and verifiable social impact) raising capital through crowdfunding to expand social impact. Facilitators External Consultants, MIF Priority Low

INADEM, NGOs

Low

Comisin Nacional para el Desarrollo de Poblaciones Indgenas, NGOs INADEM, CNBV

Low

Low

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6.4 MANAGEmENt

In order to accelerate the development of the crowdfunding ecosystem in Mexico, key actors must be well-organized and coordinate effectively. It is important that various stakeholders understand the roles and responsibilities that they need to assume to drive the industry forward, as well as those of others. A collaborative, multilateral approach to designing the rules and regulations needed to effectively govern a successful crowdfunding market will enable all stakeholders to engage in the debate. However, specific activities should be pursued by the organizations best positioned to do so in order to avoid conflicting initiatives and promote the most efficient use of resources. Consistent with the experience of other markets, in Mexico we see informal and formal groups organizing themselves to develop operating standards, coordinate industry communications, and educating users and potential campaign owners. Recognizing the potential impact of the industry on economic growth, these grass-roots actors have taken the initiative to develop innovative solutions to local market challenges and engage with public officials on a variety of issues from tax policy and industry regulation to cybersecurity and financial inclusion. The thoughtful organization of an industry management structure will facilitate this process.

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RecommendatIons

1
Establish Reporting Standards for Online Crowdfunding Platforms

2
Consolidate the Industry Leadership Structure

3
Educate Leaders

4
Connect Experts and Tools with MSME to Help Raise and Deploy Capital

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6.4.1 Establish Reporting Standards for Online Crowdfunding Platforms


One of the main constraints to the development of crowdfunding identified in our analysis was a general lack of empirical data available regarding levels of funding demand and capital supply. Information corresponding to successful versus unsuccessful campaigns was also sparse. In order to effectively manage the industry going forward, robust information should be collected from crowdfunding platforms regarding the nature of different campaigns. The size and type of campaigns, size and types of complementary sources of financing, duration of the campaign, industry or focus area the funds will be used for, size of the business or organization (number of employees), location, and a host of other details are incredibly important for the development of rigorous impact assessments that will contribute greatly to the continuous improvement of the crowdfunding ecosystem. Action Item Create a comprehensive list of data points that are relevant to financial and non-financial crowdfunding campaigns and will facilitate better understanding of the evolution of the crowdfunding industry, as well as informing the design of future interventions intended to strengthen the local ecosystem. Research existing capacity of CFPs operating in Mexico to collect relevant information on campaigns. Define transparency levels and periodic reporting standards (i.e. who reports what information to whom) for the Mexican crowdfunding industry. Hold seminars with audit firms to define and disseminate new transparency and reporting standards. Facilitators Universities, External Consultants Priority High

MCA, Universities, External Consultants

High

CNBV, MCA, INADEM

High

CNBV

Low

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6.4.2 Consolidate the Industry Leadership Structure


As a nascent industry, crowdfunding activities have been undertaken almost entirely through independent initiatives with little coordination amongst first-movers in the industry. Today, however, crowdfunding is approaching an important point of maturity that will require more and better communication between key stakeholders. Establishing an industry leadership structure will clearly define the roles of these stakeholders in order to promote transparent management and facilitate the design of an industry development plan that generates additional confidence in the market. In the early stages of the development of industry leadership, there should be a focus on the achievement of specific goals such as the drafting and passing of relevant legislation, launching promotional events, or pursuing other such recommendations included in this report. Consolidating the industry leadership structure will foster a system of communication and ensure mutual accountability amongst multiple stakeholder groups. Action Item Establish an industry leadership group including representatives from a diverse cross-section of industries, public policy makers, commercial banks, and academia. Develop an industry management framework that details roles and responsibilities of influential stakeholders, defines industry development goals according to a specific timeline, and effectively aligns incentives in the market. Establish an advisory group to aid the development of crowdfunding in Mexico (stakeholders that are knowledgeable and influential in international markets and that are interested in the success of crowdfunding in Mexico). Facilitators INADEM Priority High

CF Industry Development / Leadership Group

High

External Consultants

Low

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6.4.3 Educate Leaders


Accelerating the development of the crowdfunding ecosystem will require vocal, well-informed leaders who are willing and able to influence tangible changes in policies and regulations affecting the industry. Again, the novelty of crowdfunding, particularly as a securities and investment mechanism, has curtailed thorough understanding of crowdfundings potential impact on entrepreneurship, business productivity, employment, economic growth and social enrichment. To cultivate local champions in the public and private sectors, as well as civil society, concerted efforts to engage key actors is crucial to the industrys development. Action Item Hold a series of workshops with public and private sector stakeholders and civil society organizations to inform key actors of the existing and potential uses of crowdfunding in Mexico, the current restraints to the development of the crowdfunding ecosystem, the major risks associated with crowdfunding, and discussion of possible roles of primary and secondary leaders in the industry. Incorporate presentation of the industry management framework when complete. Support the development of an industry website through endorsement, content and active participation in the development of the online community. Promote the website and related industry news, events and best practices through traditional communications channels (e.g. public news outlets, industry newsletters, etc.). Promote the inclusion of crowdfunding mechanisms in business- and development-oriented academic curricula. Facilitators INADEM, MIF Priority High

INADEM, MIF

Medium

Ministry of Education, Universities

Low

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6.4.4 Connect Experts and Tools with MSME to Help Raise and Deploy Capital
A wide range of professional services from technology skills training and social media marketing strategies to accounting services, insurance, and legal advisory may help businesses, investors and CFPs more effectively and profitably engage in the emerging crowdfunding market. Proactively engaging these support resources in the development of the market ensures a better product and expands the leadership base for the industry. Helping businesses raise and deploy capital by improving access to these resources will develop the services sector of the economy as it continues to grow and diversify. Action Item Hold a crowdfunding conference to promote the industry, develop strategies and share best practices. Develop and implement a research agenda including a quarterly report profiling industry developments and successes. Create a working group in collaboration with financial services firms to develop products and services that could be used by CFPs to reduce risk exposure and facilitate business development. Assign or underwrite the appointment of an organizer to intentionally identify, organize and connect business development service providers, which could be an appointee of the industry development group. Facilitators INADEM, MCA Priority High

Universities, MCA

Medium

Financial Services Firms, CFPs, External Consultants

Low

INADEM, Business Accelerators

Low

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6.5 ENAbLErS
In order to ensure crowdfunding technologies and applications can be used in the most effective way possible, certain external structures and conditions must be in place. Technological infrastructure, regulatory frameworks, tax policy, and human capital are all critical elements affecting the evolution of the crowdfunding industry. To date, there has been little emphasis placed on the adaptation of these elements to the 21st centurys technological landscape. Yet, as we come to realize the potential impact crowdfunding can have on local socioeconomic development in Mexico, it is important to review the state of these elements to determine how they may be modified to support the development of the crowdfunding ecosystem without creating adverse social or economic effects. Once again, we point out that initial failure to support crowdfunding through effective legislation could be detrimental to the industry and curtail its potential long-term impact. The development of a network of licensed intermediaries and business development professionals, as well as enhanced legislation pertaining to the use of new online technologies and the protection of intellectual property are important elements needed to build a viable marketplace. Up-to-date laws and regulations backed by strong institutions with effective monitoring and enforcement mechanisms will enhance the legal and regulatory framework needed to support the crowdfunding ecosystem in Mexico. An enabling system will also include favorable tax policy and appropriate measures to prevent fraudulent activity.

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RecommendatIons

1
Develop a Regulatory Environment that Generates Confidence in Online Crowdfunding

2
Take Measures to Enhance Cybersecurity Infrastructure and Prevent Fraud

3
Ensure the Tax Regime is Conducive to Crowdfunding

4
Increase the Capacity of the Financial Sector to Support Crowdfunding

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6.5.1 Develop a Regulatory Environment that Generates Confidence in Online Crowdfunding


Specific regulatory changes that support the general solicitation and sale of securities to broader demographics of investors need to be balanced with investor protections in a way that increases confidence in Mexican capital markets. While different approaches are being implemented in different countries, it is essential not to be too prescriptive and to look at this in the context of the existing Mexican securities regime. Ensuring collaboration between multiple stakeholder groups from the public and private sector, as well as civil society, will be more likely to lead to a politically viable solution. An expedited process designed without consensus and without proper legislative scrutiny will likely lead to delays in the legislative process, as was the case in the U.S. Action Item Establish a legal framework enabling securitiesbased crowdfunding, including issuer obligations to disclose information to investors and frequency of reporting. Develop a set of legislative recommendations to modernize Mexican securities, banking and corporate laws to facilitate the use of online technologies for commercial activities, including the solicitation, sale and settlement of securities: Define funding thresholds (i.e. how much accredited or unaccredited investors can loan or invest through crowdfunding), the types of entities (individuals and businesses) that are able to raise funds through different crowdfunding campaigns (donation, rewards, lending, and equity), the types of solicitation to be allowed through different communication platforms, and clarification of the legal implications and use of CFPs and social-media. Define terms of various exit strategies (i.e. sale of equity shares, loan principal and interest repayments, IPO, etc.) and penalties for non-compliance. Facilitators CNBV, INADEM, Secretaria de Hacienda Priority High

CNBV, INADEM

High

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Action Item Support the establishment of a new legal classification for equity-based crowdfunding investments that addresses the propensity of Mexican companies and VC funds to establish legal entities in other countries. Drive a legislative effort to increase intellectual property and online data protections (in the event that these issues are not adequately addressed through ongoing Trans-Pacific Partnership negotiations or other domestic legislation). Determine which changes need to be made to existing legal or regulatory frameworks to enable the use of products and services that support crowdfunding (e.g. escrows, digital signatures, insurance). Expand the variety of securities that are legally transacted in Mexico via online brokers. Clarify the regulatory stipulations that pertain to such securities and require dissemination of this information through online brokerage platforms.

Facilitators CNBV, INADEM

Priority High

CNBV, MCA, INADEM

High

MCA

Medium

CNBV, MCA

Low

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6.5.2 Take Measures to Enhance Cybersecurity Infrastructure and Prevent Fraud


In order to use crowdfunding effectively, people must be willing to divulge sensitive personal and financial information online. Low levels of trust and underdeveloped cybersecurity infrastructure in Mexico make this an especially challenging yet nonetheless imperative issue to address. The push towards privatization of the telecommunications industry presents fertile opportunity to address cybersecurity concerns through the private sector. Action Item Establish a working group to design effective mechanisms to prevent fraud and money laundering. Increasing the severity of penalties for improper use of information, hacking, and other cyber-crimes is a good place to start. Consider incentives that could be provided to private sector companies to improve internal cybersecurity systems. Increase the allocation of resources to public agencies charged with investigating and prosecuting cybercrimes, improving cybersecurity infrastructure, and maintaining the integrity of digital systems. Create awareness campaigns to inform internet users of the improvements in the state of cybersecurity in Mexico and the consequences of illegal activities. Define a best practice operating model for CFPs to meet existing and new regulatory standards, including the use of existing systems and processes for the prevention and detection of fraud and money laundering, while providing investor protection through transparency and disclosures. Facilitators CFPs, Law Enforcement Agencies, AMIPCI Priority High

Universities, MCA

High

AMIPCI

High

CNBV, INADEM

High

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6.5.3 Ensure the Tax Regime Is Conducive to Crowdfunding


Concerns about an unfavorable tax environment also raise the need for a review of the domestic tax implications on individuals participation in private equity markets and thus, securities-based crowdfunding. Research suggests that investment volume is highly sensitive to changes in taxes and interest rates81. A tax policy that is conducive to the crowdfunding market in Mexico will increase the amount of capital available to entrepreneurs and MSME engaged in productive economic activity. Action Item Research the economic impact of tax incentives offered to drive securities-based crowdfunding. Facilitators Secretaria de Hacienda (Sistema de Administracin Tributaria), INADEM Secretaria de Hacienda (Sistema de Administracin Tributaria), INADEM CNBV, MCA, INADEM Priority Medium

Implement tax incentive programs for investors who invest via crowdfunding initiatives associated with incubators and accelerators.

Medium

Establish tax exemptions for small businesses using crowdfunding to finance a new entrepreneurial venture or expansion of current operations. Define specific characteristics of qualifying businesses and set a cap on the crowdfunding capital raise eligible for such exemptions.

Medium

81. Ramirez-Verdugo, Arturo R. Tax Incentives and Business Investment: New Evidence from Mexico.

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6.5.4 Increase Capacity of the Financial Sector to Support Crowdfunding


Crowdfunding is a tool that can be used by existing financial services firms. However, few firms are actively engaged in efforts to expand product or service offerings to meet the growing needs of the crowdfunding industry. Directing the attention of these firms to the opportunities provided by crowdfunding will support the industry through the development of sources of revenue. Moreover, building the capacity of the financial sector will increase investors confidence in the market by increasing the availability of products that reduce or mitigate risks, such as escrow services or insurance products. It can also help entrepreneurs who launch successful crowdfunding campaigns to access financial products and services that are more suited to their needs as their businesses evolve over time. Action Item Identify existing financial products and services that can support the development of the crowdfunding ecosystem in Mexico. Relevant services include: Facilitators NADEM, MCA Priority High

i.

Mini-escrows, escrow, and trust services that ensure the safety of donor/investor funds during the fundraising process.

ii.

Digital payment systems providers that can develop relevant payment solutions for the local context.

iii.

Secondary (resale) market firms to create liquidity for investors and to enable businesses to access other traditional banking and investment banking services.

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Action Item Support the development of micro banking/financial accounts to facilitate the transfer of funds and improve the efficacy of escrows. Research the potential for development of a private secondary market to support the expansion of the primary crowdfunding market to increase market liquidity for investors and leverage initial investments with additional resources. Create a seed fund to increase capital liquidity in the crowdfunding market.

Facilitators Financial Services Firms, INADEM

Priority Medium

External Consultants, CNBV

Low

Private Investors

Low

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7.
expediently.

concLuSionS
New technologies have given rise to a multitude of innovative ventures and business opportunities in Mexico. Today, entrepreneurs and organizations with diverse missions are already utilizing online portals to channel funds to product testing and development, operational expansion, charitable projects, artistic endeavors, and a variety of other crowdfunded initiatives. Donation-, reward-, lending-, and equity-based platforms have emerged to meet growing demand for alternative financing. However, these platforms have created opportunities by leveraging the existing ecosystem, which has yet to fully address the evolving capacities of modern technology. In order to facilitate the industrys long term success, prudent rules and regulations must be designed and implemented

In the absence of regulation, the risk of fraud or other failures could undermine the capacity of crowdfunding to allocate capital to entrepreneurs and businesses. Negative experiences associated with crowdfunding at such an early stage could be extraordinarily detrimental to its future development. In addition, the general distrust for internet applications in Mexico make public education and promotion of early success stories integral to the broader adoption of crowdfunding. Public sector actors can help allay this skepticism by increasing institutional transparency, enhancing cybersecurity infrastructure, increasing the severity of penalties for violations on digital privacy, and improving the effectiveness of enforcement for such infringements. Still, there remains a substantial need for accessible funding amongst entrepreneurs and MSME in Mexico. Online crowdfunding holds enormous potential to serve these funding needs and promote the development of the entrepreneurial ecosystem. While Mexican businesses can use existing platforms to raise funds, concerted efforts are needed to engage the public and private sector. Businesses will need to improve technological literacy and understanding of how to use crowdfunding effectively, as well as the risks associated with it. At the national level, the public sector appears well-positioned to facilitate the design and implementation of legislation needed to bolster the crowdfunding ecosystem. Developing specific parameters for lending- and equity-based crowdfunding, in particular, will expand opportunities for businesses and generate confidence amongst investors. If these activities can be regulated as part of the free-market economy, crowdfunding could galvanize the entrepreneurial economy, invite domestic and foreign investment and increase socioeconomic wellbeing throughout the country. At present, it appears that small and medium sized enterprises will be best equipped to utilize equity-based crowdfunding. These are businesses that are registered in the formal sector, making them easier to monitor and regulate. As the crowdfunding ecosystem develops, viable opportunities for micro-enterprises will continue to emerge and incentives to join the formal economy will improve. Regardless, individuals and entrepreneurs will continue to be able to make use of donation-, reward-, and lending-based crowdfunding opportunities for various purposes. Supporting the quality of non-financial crowdfunding platforms and campaigns should ultimately generate added momentum for financial crowdfunding. In both cases, however, expanding internet access, the availability of credit cards and other online payment mechanisms, as well as promoting the use of social media, will help to increase the adoption of crowdfunding. Mexico currently finds itself in a unique position to accelerate the development of the crowdfunding ecosystem both domestically and internationally. Although crowdfunding as an industry is still in its infancy, the basic conditions are in place to enable entrepreneurs and small businesses to access financing that meets their needs. If advances can be made in the regulatory space in the short term, myriad investment possibilities are likely to emerge as well. To be sure, there are challenges that will need to be addressed as well. But the independent creation of the Mexican Crowdfunding Association, active engagement of public agencies such as INADEM, and progressive economic reforms being pushed through the current administration, are all signs of optimism for the long term success of crowdfunding as a tool for innovation, entrepreneurship, economic growth and social cohesion. Moreover, its proximity to U.S. capital markets, entrepreneurial culture, and adequate (though short of ideal) technological infrastructure, have created fertile ground for the cultivation of crowdfunding. Today, the opportunity is ripe for Mexico to step forward as a regional leader by paving the way for crowdfunding to develop throughout Latin America and other developing countries. It will be up to local stakeholders, however, to seize the opportunity before them.
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aPPendix I
RESEARCH METHODOLOGY
Massolution is a leading advisory and research firm with a focus on the design and implementation of crowdsourcing and crowdfunding business models and ecosystem development initiatives at a national, institutional or enterprise level. Massolutions research methodology, known as C-STEP (Crowdsourcing and Crowdfunding for Social Transformation and Economic Performance), crowdfunding industry taxonomy and metrics used throughout this report have been developed over the course of several years of research and multiple advisory engagements in the U.S. and internationally. C-STEP: CROWDSOURCING AND CROWDFUNDING FOR SOCIAL TRANSOFRMATION & ECONOMIC PERFORMANCE C-STEP provides a unifying framework for strategizing, designing, implementing, and executing initiatives promoting crowdsourcing or crowdfunding. C-STEP provides a set of guidelines for:
`` Analyzing the problem at hand; `` Defining and evaluating approaches for matching funding demand and capital supply; `` Analyzing and evaluating approaches and mechanisms for implementation in specific markets; `` Identifying potential challenges and formulating appropriate solutions.

To develop this report, extensive research was conducted over a four-month period, guided by Massolutions C-STEP framework, which drew on the following sources of information: 1. Data on the global crowdfunding industry collected in connection with Massolutions annual crowdfunding survey and the publication of the 2013CF Industry Report . 2. In-person interviews and data collection with key stakeholders from the public and private sectors in Mexico in July 2013. 3. Surveys of Mexican Crowdfunding platforms. 4. Relevant literature and desk review.

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1.

Data on the global Crowdfunding industry collected in connection with Massolutions annual Crowdfunding survey and the publication of the 2013CF Industry Report .
The 2013 CF Industry Report provides a unique and in-depth analysis of the global crowdfunding market trends and composition. 362 CFPs provided data (both active and pre-launch), via a survey on the industry website www.crowdsourcing.org. The response rate of 45% was an increase of 6% compared to Massolutions 2012 CF Survey, and the quality of the submissions resulted in an 85% acceptance rate. Massolution conducted significant follow-up research through other reliable channels to complete the profiling of the global crowdfunding industry. 85% of the total market estimate can be explained by primary and secondary research with the remaining 15% being extrapolated taking regional and model distributions into account.

2.

Interviews With Key Mexican Crowdfunding Industry Stakeholders


Primary data collection was performed through a series of face-to-face meetings and workshops with key stakeholders in Mexico City, Mexico on 10-12 July. Massolution met with the key stakeholders to gather information and local insights in order to understand the dynamic of the emerging crowdfunding industry, including perceptions of challenges and opportunities in the local market.

3.

Surveys of Mexican Crowdfunding Platforms


The current CFP market in Mexico is in its infancy and as such we are at the early stages of the development of the market, when viewed from the supply side. Currently, there are approximately fifteen CFPs operating with a relatively even representation across all types of crowdfunding models. Therefore, while a data set collected from the CFPs will not in comparison to more developed markets be large, it is important in terms of mapping the current market landscape and volumes. Each CFP was sent a survey to collect information on the CFPs activities related to:
`` Campaign owners `` Campaigns / Projects `` Contributions `` Crowdfunders / Contributors `` Crowdfunding market

Analysis
The research conducted led to a macro-level analysis of Mexico to learn more about the business environment, as the context for how crowdfunding might flourish or be hindered, as well as micro-level analysis of key areas where interventions might be required in order to develop crowdfunding. The research and analysis of this report focused on four dimensions of the local context considered to be critically important for the success of crowdfunding: Culture, Political Environment, Economy and Financial Ecosystem, and Technology and Business Infrastructure.

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aPPendix II
USE CASES
Here we review examples of potential categories of use cases that are intended to provide a baseline for discussion of initiatives that could be supported to develop the crowdfunding ecosystem in Mexico. A shared commitment amongst multiple stakeholders to the systematic implementation of use cases in a series of phases will most effectively focus available resources. Early success of multiple crowdfunding models, from a mix of partners, supporting a range of attractive businesses with inspiring stories will produce momentum for continued investments in the industry. Building the environment in collaboration with a diverse group of stakeholders is critical to sustaining growth. In order to promote crowdfunding, projects should consider strategies to maximize visibility of successful ventures. In addition, the risk of fraud should be assessed and actions taken to mitigate it. Use cases that would contribute to the building the environment, we considered contributions that would be made in the areas of: infrastructure, technology, products, tools, legal capability, leadership development, actor development, fostering entrepreneurship and sustainability.

1.

University Crowdfunding CFP


Academic institutions are a critical driver of economic success and one of the greatest sources of new business development and success. University participation could be valuable not only in educating and supporting entrepreneurs, but in the research on the critical assumptions and investments made in the emerging industry. A university Crowdfunding model could include Crowdfunding for research, commercialization of research, and support of businesses developed through the entrepreneurial and business management programs.

2.

Accelerator and Incubation Initiatives


Education and support networks provided via business accelerators and incubators help business owners and entrepreneurs build their capacity. This also builds market confidence that recipients of private capital investment will have the resources and support to maintain investor accountability. Crowdfunding has a unique opportunity to support and be supported by a network of accelerators and incubators by integrating an intentional connection between accelerator/incubators. These initiatives should focus on building the capacities of local issuers, while allowing them to raise capital in both domestic and U.S. markets. The profile of the incubator would provide the additional desired oversight and operational support for increased investor confidence.

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3.

Second Stage Initiatives


The success of the primary P2P microfinance market has not evolved along the capital continuum to create a second stage option. The second stage option would support migration from a Peer-to-Peer to a Peer-to-Organization scenario. A Mexican initiative to connect the capital source with a crowdfunding engine could be enormously powerful.

4.

Impact Investing Initiatives


Crowdfunding took a foothold first in the non-financial space in the United States and Europe. There is significant support for crowdfunding in the philanthropic sector, which would build a foundation for security-based crowdfunding work. For example, a partnership between a development institution and philanthropic foundation to support a hybrid donation/lendingbased type of crowdfunding site targeting the rural areas of Mexico.

5.

Target Industry Initiatives


The market reach and capacity of the premier large industries in Mexico provide an excellent opportunity to quickly establish and then institutionalize the way Crowdfunding works. Synergies between Mexicos large enterprises and Mexican MSME Crowdfunding can be developed to rapidly progress opportunities in Telecom, Entertainment, and Real Estate Sectors.

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referenceS
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