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Economic Affairs

Crowdfunding buzz as banks, listed firms join the action

For some people, it takes a lifetime to earn a million bucks.

But for Apple products reseller EpiCentre, a unit of EpiCentre Holdings which is listed on the stock market, it took them just 26 hours to raise a million dollars from investors over the Internet.

The catalyst? The rise of crowdfunding, or peer-to-peer lending - an increasingly popular way for companies to tap the cash assets of thousands of individual investors looking for ways to earn interest on their savings.

While it has taken off overseas in countries like the United States, the wave is just starting to build here, with big institutional players finally acknowledging that this could be another way for companies to seek funding outside traditional bank lending.

Just last month, DBS Bank inked cross-referral agreements with two home-grown peer-to-peer (P2P) lending platforms to expand funding available to small businesses. The move was a landmark one, making DBS the first local bank to collaborate with such platforms in Singapore.

All of this, it seems, indicates a vote of confidence from big-name corporates in crowdfunding platforms - that they are much more than just a fleeting trend.

But are investors clearly aware of the risks involved?


ST ILLUSTRATION: MANNY FRANCISCO

The key here is that crowdfunding investors must know how to protect themselves. Most platforms advertise only the high rates of return for such lending activities. No one talks about the risks.

The authorities should insist that crowdfunding firms clearly warn of the risks of such investments, stating clearly that there is no guarantee that the money loaned will be returned to the lender.

BEAUTY IN SIMPLICITY

Most companies have a few options when it comes to funding their projects.

The traditional and still the most popular route is for firms to take loans from banks to finance their business. Another approach is for companies, especially those listed on stock markets, to borrow directly from the public. They typically issue bonds and pay a fixed interest rate, with a view to repaying the principal after a fixed period.

Crowdfunding takes the form of the latter, but with a small twist.

When companies issue bonds, they tend to borrow a huge sum of money, easily in the millions of dollars. Each bond in Singapore usually comes in tranches of $250,000 if it is targeted at institutional borrowers, and in much smaller tranches of $1,000 if it is targeted at individual investors.

But crowdfunding allows firms to take very small loans, as little as tens of thousands of dollars. Likewise, investors can also lend very small amounts, as little as $100 a pop.

Typically, a company puts out a sum that it needs to borrow and the platform, after carrying out its own screening process to accept the project, lists the request as a campaign. The company also states how much it is willing to pay in interest.

When the campaign kicks off, investors start to sign up and state how much they are willing to loan and what they expect to be paid for their money. The campaign ends when enough investors have pledged their cash, which gets transferred to the company. The firm then repays the investors through fixed monthly payouts.

For investors, this is a great way of generating yield on small amounts. Interest rates typically hit the double-digit range, anywhere between 10 per cent and 15 per cent, and the tenure of the loan also tends to be short, as little as six months.

For firms, they do not necessarily pay cheaper interest rates but it may mean easier access to funding which could take a long time to get approval from banks, especially in a slowing economy like today.

Another form of crowdfunding involves equity or securities, where accredited or institutional investors buy into or offer loans to a business and obtain shares in return. This process is regulated by the Monetary Authority of Singapore (MAS).

TAKING INVESTORS BY STORM

Over the past year or so, crowdfunding platforms of various sorts have mushroomed in Singapore.

There are at least 13 companies with a presence here - from more recognised names such as MoolahSense, CapitalMatch and CoAssets, to newcomers like EziFund, a real estate crowdfunding platform which made its debut on April 18.

Investors, for their part, have been lapping it up, taking the opportunity to look for yields on these crowdfunding platforms - and at breakneck speed.

A $150,000 campaign for a lift installation and maintenance company on MoolahSense last month was fully funded in the span of just two minutes. Firms on Funding Societies have also managed to raise smaller sums in the likes of $20,000 within just 30 seconds.

This is not surprising, given how some crowdfunding campaigns here come with interest rates as high as 25 per cent.

But the amount of money being poured into such campaigns and the speed at which this is happening may be cause for worry.

As Funding Societies co-founder and director Kelvin Teo himself puts it: "It's an unhealthy herd mentality."

He told The Straits Times that this trend means investors are taking less time to evaluate each loan before committing to it, which is why Funding Societies sends out a detailed borrower report to investors hours in advance for them to deliberate over, before opening up the loan for investment.

If anything, the slowing economy has not killed appetite for investments but whetted it, as investors rush into alternative asset classes that are accompanied by the promise of beefier financial returns.

This could explain why crowdfunding is such an easy idea to sell today, given the lacklustre performances of traditional investment assets such as bonds and equities.

HIGHER RETURNS, HIGHER RISKS

But when the rush for yield turns into a stampede, as it seems to be doing now, perhaps it is time to take a step back.

For one thing, there is no guarantee that firms which borrow through crowdfunding sites will repay the loans they took out from the public, as history has shown.

In May 2013, local start-up Pirate3D raised US$1.43 million (about S$1.9 million) through US crowdfunding platform Kickstarter when it promised its financial supporters low-cost Buccaneer 3D printers in return. The campaign was wildly successful, hitting the initial US$100,000 target in just 10 minutes.

The firm planned to ship the first 500 units of Buccaneer by December that year, but only managed to ship just 200 units as of last August, due to delays in the project, before ceasing operations.

Many of the firms which use crowdfunding sites tend to be small, which may be why it is hard for them to secure funding from the banks in the first place.

Even some of the bigger names, which are using peer-to-peer lending, are not in the best of financial health.

EpiCentre, for instance, rolled out three campaigns on MoolahSense for a combined $1.5 million, offering investors repayments at an annual interest rate of 13.5 per cent. All three campaigns have been fully funded.

But take a closer look at EpiCentre's parent company, EpiCentre.

The group fell into the red for the six months to Dec 31 last year with a net loss of $753,000, down sharply from the net profit of $232,000 in the same period a year ago, dragged down by smaller profit margins and higher borrowing costs.

Its net cashflow from operating activities stood at $1.4 million, a far cry from the $6.6 million previously.

The high yield it is offering is attractive but with high rewards come higher risks.

There are other smaller companies offering much higher yields for loans. The question is whether investors are truly and fully aware of the risks accompanying such endeavours.

To be fair, crowdfunding platforms have come up with their own systems of internal checks and proprietary measures to assess each deal thoroughly.

But they are not party to the transaction that takes place between firm and lender, which means they are ultimately not liable for the failure of a company or a project.

There are other risks as well.

The notes or securities in crowdfunding are illiquid, which means there is no secondary market for investors to sell their "assets" if they decide, at some point, that they want to opt out.

Such investment schemes are also not regulated by the authorities, which means that the investor will have few avenues for recourse should something go wrong.

BUYER BEWARE

Nobody can deny that the excitement surrounding crowdfunding today is compelling.

Corporate lawyer Robson Lee, a partner at Gibson Dunn, noted such platforms will create a good ecosystem that engenders new entrepreneurs while educating new investors on the dynamics, risks and rewards of investing in promising start-up enterprises.

"This will no doubt enhance the vibrancy of the Singapore securities market when the new enterprises eventually seek a listing on the Singapore Exchange," he said.

But Mr Lee also likened the crowdfunding process to an initial public offering, where a company raises capital by going public, except there would not be any prospectus regulation to protect public investors.

This puts many retail or mom-and-pop investors, who may not have the financial literacy and experience to make investments in illiquid assets, in a vulnerable position.

For now, the MAS regulates only securities-based crowdfunding platforms, which have to obtain a Capital Markets Services licence in order to operate here and service mostly accredited investors.

Crowdfunding platforms such as MoolahSense and Funding Societies do not come under regulation, and are open to the wider public.

The key here is that crowd- funding investors must know how to protect themselves.Most platforms advertise only the high rates of return for such lending activities. No one talks about the risks.

The authorities should insist that crowdfunding firms clearly warn of the risks of such investments, stating clearly that there is no guarantee that the money loaned will be returned to the lender.

After all, when things go wrong, it would be too late. It could take just one default for a lot of public money and trust to be lost and leave everybody poorer despite the higher interest.

A version of this article appeared in the print edition of The Straits Times on May 04, 2016, with the headline 'Crowdfunding buzz as banks, listed firms join the action'. Print Edition | Subscribe