Will crowdfunding help startup Asia’s economy?

Conventional stock markets raise funds for large corporations, but it takes a long track record in earnings and reputation before SMEs can find the sponsors and the funding to list in the stock markets. 

Crowdfunding is now a buzzword for raising money for start-ups, but until recently it was illegal to raise equity (in the form of tradable securities) from the public unless approved by securities regulators. That process is not only costly but also complicated for SMEs to manage.

Crowdfunding became popular in the US when website platforms started to raise small amounts of money for charities (and for political donations) from the public. 

The US Securities and Exchange Commission (SEC) this week gave the green light for companies to use crowdfunding to offer and sell securities to the investing public from May 16 onwards. 

This revolutionises the access of SMEs to funding, and also investors’ ability to take equity in start-ups. 

Traditionally, start-ups get their equity from family and friends. With the arrival of the Internet, some enterprising start-ups began accessing capital from strangers among “the crowd”, while platforms looked to become “start-up exchanges” to help SMEs crowdfund their activities. The risks of investing in such unregulated platforms are twofold: the possibility of investing in fraudulent companies, and thr threat of being cheated by the platform. Unregulated P2P platforms in China are now shutting down and losing investor trust after several scams. 

To protect the public, the SEC generally bans companies and private funds from offering or selling securities unless the transaction has been registered with the SEC or an exemption from registration is made. Exemptions are only made for certain securities, such as hedge and venture funds with higher risks and for “accredited investors”. If the investor is rich and experienced enough, he or she will be allowed to buy these exempt funds or securities, because the principle of “caveat emptor” (“buyer beware”) applies. 

“Rich enough” means an annual income of $200,000 and net worth (excluding primary residence) of more than $1 million. In Hong Kong, the broad definition of a professional investor is one with net assets of over HK$8 million (Bt36.8 million).

With crowdfunding, however, the door is now wide open to anyone to invest in these start-ups. So how can the SEC protect investors? The protection is again twofold. The first is informing investors how to judge how much they can risk investing in these assets. The second is to ensure that the crowdfunding platforms are actually run by broker-dealers or funding portals regulated by the SEC or the Financial Industry Regulatory Authority (FINRA). 

Like the definition of accredited investors (www.sec.gov) www.sec.gov), each crowdfunding investor should learn how much they can afford to invest during any 12-month period. The investor is subject to both an income and wealth test. If the income or net worth is less than $100,000 (excluding primary residence), then they can invest within one year up to $2,000 in the crowdfunding security or 5 per cent of the lesser of annual income or net worth. If the annual income or net worth is more than $100,000, then the investor can invest up to 10 per cent of annual income or net worth, whichever is lesser, but not to exceed $100,000. 

Since the crowd-funding portal or broker dealers are regulated, the chances of fraud are reduced but are not zero. Companies or start-ups cannot access crowdfunding directly from the public but must use the regulated portals or broker-dealers.

Furthermore, to safeguard themselves, crowdfunding investors are advised to understand the high risks involved and to do their homework in researching and understanding what they are buying or investing in. 

The investors need to understand fully their speculative risks, illiquidity, cancellation restrictions, difficulties of valuation, limited disclosure and information, fraud, lack of professional advice, and most of all, that they are betting not on assets, but on individuals or teams. Young start-ups often make many mistakes – technical, legal and basic management of people and talent. Thus, risks in these assets can be very high and the chances of success are not great. But some start-ups do make it big.

The good news is that once the SEC takes the lead in clarifying the rules for crowdfunding, other regulatory agencies in Asia will be able to adapt these rules to help create the local ecosystem for crowdfunding. Last year, the Malaysian Securities Commission published guidelines to facilitate equity crowdfunding. The Hong Kong Securities Commission consulted on the subject in 2014, but has yet to introduce specific laws or regulations for crowdfunding. 

The real issue about start-ups is actually finding the right expertise to coach them on how to make their ideas and ventures more commercial, professional and fundable. This is highly intensive work, which is currently not taught in universities, but mostly learned on the job. 

Policymakers throughout Asia pay a lot of lip service to the need to help nurture SMEs, but the record is so far uneven. Throwing money at the problem is not the right answer. The reason is that there is a terrible shortage of understanding – not just in the market place but also at the official and bureaucratic levels – of the real difficulties that start-ups face. Cutting back the barriers to SME success needs a concerted effort from different agencies, departments and regulators, but also mobilising skills from academia, business associations and civil society. 

If we don’t get the energies of our youth into start-ups, can we surprised if they channel their energies into calling for nchange on the street? 

Crowdfunding is not the be all and end all of helping SMEs, but the SEC guidelines are a good start. 

 

Andrew Sheng writes about Asian and global issues.