RobsonLee5.16bRobson Lee, a partner at Gibson, Dunn & Crutcher LLP which has 1,200 lawyers in 18 offices in the US, Europe, South America, the Middle East and  Asia. NextInsight photo.NextInsight: The MAS has introduced new measures for securities-based crowdfunding. Can you explain the types of crowdfunding that these measures address?

Robson Lee: Crowdfunding generally refers to a capital raising approach that seeks to raise funds from a large number of investors or “backers”, the term popularized by Kickstarter. Typical approaches to crowdfunding currently include donation-based crowdfunding, rewards-based crowdfunding, lending-based crowdfunding and equity-based crowdfunding.

The new measures introduced by the MAS seek to regulate securities-based crowdfunding (lending-and equity-based) (“SCF”) in Singapore.

In the case of lending-based crowdfunding, investors pool funds together to provide cash loans to or purchase debt securities from a borrower. With equity-based crowdfunding, investors invest in shares or equity securities of a company.

 

What are the key measures that are relevant to (a) companies (b) investors?

Robson Lee: (a) Companies

The new measures relax certain requirements to licencing for platform operators, as well as clarify the Government’s approach to the industry in general. The lower bars to entry may result in more platform operators coming to the market, which gives companies more choice in terms of the platforms and products available to them.

The easing of retail investor pre-qualification requirements under the “Small Offers” prospectus exemption will increase the available investor pool for companies looking to undertake a securities-based crowdfunding campaign.

(b) Investors

The easing of the retail investor pre-qualification requirements may allow more investors to participate in SCF. The risk disclosure requirements and acknowledgement forms should help to make investors aware of the risks associated with SCF.

Investors will also be more secure in knowing that the platform operators are regulated by the MAS, and meet certain the standards expected of a holder of a Capital Markets Services licence.

Numerous crowd funding campaigns have successfully raised money in recent years. Generally, to your knowledge, how have the outcomes been for investors?   

Robson Lee: Outcomes appear to be mixed with anecdotal evidence indicating that more often than not, these campaigns do not yield rewards for investors. High profile failures like the Pirate 3D printer project that raised over a million dollars from thousands of investors highlight just how risky investing in such campaigns is.

What issues do you reckon might yet surface?

Robson Lee: It is likely that equity-based crowdsourcing will give rise to the biggest complications in future.

Besides the high risk nature of early stage investing, investors in an equity-based crowdsourcing campaign will find that realizing their investments will take time. These companies are unlikely to declare dividends or become profitable in the short to medium term. Even super start-ups like Uber and Airbnb, with their valuations soaring into the tens of billions of dollars, are still burning cash to expand.

Investing in private companies offers little in the way of investor rights. Later stage investors in a successful startup will likely include powerful funds or companies, whose investments will dilute early stage investors, and may impose terms that are less than favourable to minority shareholders. Investors may also find that an exit could be difficult to achieve. 


Q: In particular, with interest rates at pretty high levels (12% a year is not unheard of) are companies just waiting to default?

RobsonLee 2011Robson Lee:  Not necessarily. The promissory notes commonly used in SCF are essentially unsecured loans to young companies. The interest rates reflect the risky nature of the debt. To put matters into perspective, credit card debt and personal lines of credit bear interest at around the 20% p.a. mark. 

"It really comes down to whether the management of these companies have made the right choice in choosing debt based SCF to meet their financing needs. If management have clear budgets and properly execute business plans, there is no reason to believe that such companies are just waiting to default. A well-managed company may eventually find that paying 12% in interest over a year or two is far cheaper than the dilution from an equity-based crowdfunding exercise.”

 
(NextInsight file photo)

With the benefit of several years of market experience, what are some of the things companies should do to reap benefits from crowdfunding?

Robson Lee: There are a number of established crowdfunding platforms operating now. Companies now have the benefit of selecting the most suitable platform for their campaign. They should consider the various factors such as cost, user/backer base size and demographics, campaign success track record before selecting a platform.

History indicates that a well-designed and comprehensive campaign is much more likely to result in a successful fundraising exercise. There is now data that shows that campaigns with professional videos and infographics enjoy a far higher success rate. A slick and professional campaign with consistent and timely responses from the founder is more likely to persuade investors to part with their money.

How about investors? What should they do in order to benefit, instead of ending up on the losing end?

Robson Lee: Issuers seeking to raise funds through crowdfunding platforms are almost invariably in the early stages of product development that are raising funds to complete product development, establish manufacturing capability and commercialise their products. Early stage investing is an inherently high risk endeavour. Even if an issuer is able to develop its first product and enjoy some early sales, there is no guarantee that the venture will be profitable in the long term and yield rewards for investors.

Investors need to do their homework on investee companies before investing. Some basic tips would be to prefer all-or-nothing crowdfunding campaigns, where the investee only receives the funds where a minimum amount is raised. This at least gives some comfort that the investee should have sufficient reserves to meet its immediate goals. Consider the qualifications and background of the founders, an ineffective management is unlikely to make a success of even the most innovative product.

It is also important to recognize that the different types of crowdfunding carry different risks and considerations.

For example, a backer in a rewards-based campaign is really only looking forward to the campaign and project being successful and receiving his or her reward, which is usually a discount on the retail price or early delivery of the product. This kind of commitment is fairly short term.

Backers who invest in an equity-based campaign will have far more complex considerations. Such backers will invariably be minority shareholders in a company. In the case of an unsuccessful venture, backers can realistically expect to receive no returns. They should also be aware that a successful venture is likely to result in further rounds of fundraising from sophisticated investors, which will dilute their interests. Backers should have a clear understanding on the modes of exit available to them. Unlike investing in a listed company, minority investors will have limited means of realizing their investments and will receive little in the way of minority rights and protection.

This is Part 1. Look out for Part 2 next Sunday.


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