High risk, high reward in new funding option

Equity crowdfunding helps companies raise funds and gives more options to investors. But risks remain.

In 2012, nearly 10,000 people on US-based crowdfunding website Kickstarter gave money to a firm which had developed a virtual reality gaming headset called Oculus Rift.

The campaign raised US$2.4 million in 30 days.

When the company was acquired by Facebook last year for an eye-popping US$2 billion (S$2.7 billion), none of these contributors - or "backers" as they are known in crowdfunding parlance - received a single cent.

Backers took to social media to accuse the company of "betraying" them as they were not able to enjoy any of that Facebook windfall.

Unfortunately, they were not entitled to it.

When backers contributed to Oculus Rift's crowdfunding campaign, they were not buying stock in the company but merely giving cash in exchange for small tokens or "rewards" like Oculus Rift T-shirts.

This incident stirred up a debate about equity crowdfunding.

Traditionally, crowdfunding involves small businesses and individuals making a pitch online in the hope that others will like their ideas enough to pledge cash.

Many crowdfunding platforms require project creators to reward supporters in some way for their funding support.

Equity crowdfunding is a variant of this, in that those pledging support receive equity in exchange.

It offers an alternative source of finance to businesses, particularly small and medium-sized enterprises (SMEs).

The issue has come to the fore in Singapore in recent months.

A definite ripple of excitement went through the start-up community in February when the Monetary Authority of Singapore (MAS) called for comments on proposals to allow equity crowdfunding here.

But there was a fly in the ointment.

The MAS' proposals open the door to equity crowdfunding but only to accredited and institutional investors - defined as those with an annual income of at least $300,000 or having $2 million in net assets.

The MAS said that crowdfunding carries "significant risks" and that there is "a high probability of capital loss".

In addition, securities issued in this form of funding "are more illiquid compared to traditional securities investment instruments".

But many market players are keen for the opportunity to be open to a wider group of investors - in other words, to live up to its name of getting funding from the "crowd".

In submissions for the MAS consultation paper, which closed earlier this month, as well as in comments to this newspaper, crowdfunding platform operators said restricting access to equity crowdfunding would defeat the purpose of obtaining funding from the "crowd".

So should equity crowdfunding be made available to a wider pool of investors?

If so, how can retail investors be protected?

Already, platform operators are springing up, especially in recent months.

Several equity crowdfunding platforms have joined the scene, including FundedHere.

Crowdonomic, one of the first crowdfunding platforms set up in Singapore, is looking at a "gated community" approach to equity crowdfunding, open to white-collar professionals from industries such as accounting, banking and financial services, and law.

Even the Singapore Exchange will be teaming up with Clearbridge Accelerator, a high-tech venture capital firm, to set up a crowdfunding platform for SMEs by the midddle of the year.

Demand from SMEs

MEANWHILE, there is growing demand for such funding, especially from the start-ups and the SMEs, which now mostly have to rely on the traditional methods of bank loans or the founder's capital for financing.

The interest is not restricted to tech firms, said Mr Adrian Koh, Asia-Pacific general manager of another crowdfunding platform, FundedByMe.

The high-tech scene is "well- served by venture capitalists and angel investors", he noted.

"In fact, traditional businesses which are not the typical high- tech companies are also taking more of an interest in crowdfunding."

A key draw of crowdfunding is the scope it offers for raising awareness about a company's product or service, and building a loyal pool of potential customers or brand advocates.

"Companies can get feedback from an engagement with potential customers...

"Equity crowdfunding augments current forms of seeking financing," said Mr Linus Goh, the chairman of the Singapore Business Federation's SME sub-committee on financing.

Equity crowdfunding is also becoming an alternative investing option for those keen on growing their money.

Much of the appeal lies in having a direct and personal connection to the investment.

While the amount put in might be small relative to a typical stock market transaction, there is a sense of having personally contributed to the development of a good product or growth of an inspiring company.

Equity crowdfunding is unlikely to replace other forms of investing even for younger, more tech- savvy retail investors, but it offers an interesting - and fun - option for portfolio diversification.

High-risk venture

PLATFORM operators have pointed out that limiting participation in equity crowdfunding would prevent it from realising its full potential.

Yet despite the hype surrounding the crowdfunding scene, it is clearly one of the riskier investment options.

At least half of fresh start-ups are not expected to last even five years, according to industry experts.

"We should remember that even venture capitalists and private equity funds tend to make more losses than returns, and there is a high risk of start-ups failing," said Ms Farhana Siddiqui, a director at law firm Drew and Napier.

At the same time, however, there is a growing number of tech-savvy investors who may not have as much funds as an accredited individual, but are in a position to assess the pros and cons of investing because of their experience or interest.

Therefore, the key issue is to make equity crowdfunding safer for the larger crowd that wants to get involved.

Protecting retail investors

REGULATORS, companies seeking funding, platform operators and investors themselves all have a role to play.

Besides drawing from the experiences of other jurisdictions, Singapore's regulators could consider drawing a distinction between crowdfunding for debt and equity, said SBF's Mr Goh, who is also OCBC Bank's head of global commercial banking.

Debt and equity have very different characteristics and investors take on different kinds of risks when investing in each, he added.

Debt can be structured shorter term and usually provides investors with defined, regular returns.

Meanwhile, "many companies that go in for equity crowdfunding are young companies" and are likely to declare dividends only much later.

"Equity crowdfunding is about jumping in along with the owners and founders for the longer term."

Limiting equity crowdfunding only to accredited investors "makes sense" as retail investors might not be equipped to take on the risks associated with equity crowdfunding, Mr Goh said.

When it comes to crowdlending - or peer-to-peer lending - there is scope to loosen the rules and open participation to a wider pool of investors.

"The opening up of debt (crowdfunding) will also bring more alternatives for companies to seek funding and for investors to place their spare money," he added.

SMEs could make use of such a debt platform to get financing support for specific projects, equipment, working capital or other short-term needs.

Peer-to-peer lending platforms grew in popularity in Europe and the United States after the global financial crisis, when credit from traditional sources dried up, said Mr Goh.

There, peer-to-peer lending is facilitated by platforms which help potential lenders conduct basic risk assessments of borrowers, monitor borrowers' repayment profiles, and educate both borrowers and lenders.

FundedByMe's Mr Koh said that platform operators "need to take on significant responsibility" and screen crowdfunding campaigns carefully.

Companies, for their part, which are keen to raise funds this way "have to be absolutely transparent" about their business model, financials and market opportunities, he added.

It seems unlikely that equity crowdfunding will become available to the man in the street in the short term, but regulators should consider gradually making the playing field more inclusive.

As crowdfunding gains traction globally and the pool of young, tech-savvy retail investors here continues to grow, equity crowdfunding can potentially become a viable alternative for firms and contribute to the diversity in Singapore's financing ecosystem.