Crowdfunding craze: Little recourse if things go wrong

Crowdfunding craze: Little recourse if things go wrong

It was a simple concept that first drew financial analyst James Yeo to crowdfunding - the chance to earn bumper returns when decent yields from other investments were pretty hard to come by.

Mr Yeo (not his real name) made his first investment on a peer-to-peer (P2P) lending platform late last year, putting up a $1,000 loan to a seafood wholesaler that was raising funds to buy and farm hairy crabs.

The lure? A handsome annual return of 23 per cent.

Mr Yeo, who has received repayments for nine of the 12-month loan tenure, tells The Sunday Times: "It's good that in crowdfunding, I have control over my risk through my choice of loans. It's as though I'm playing the role of a bank in choosing which companies I want to lend to.

"Naturally, the higher-risk loans give higher returns. The effective interest rates, at around 12 to 20 per cent generally, are quite attractive."

Mr Yeo, 36, says he has invested $20,000 in such loans since he learnt about debt-based crowdfunding at a seminar last August, and earns an average of 1.5 per cent in cash returns every month.

Like him, many investors are moving into the crowdfunding space - and at breakneck pace.

In April, a $150,000 campaign for a lift installation and maintenance company on MoolahSense was fully funded in just two minutes, while firms on Funding Societies have managed to raise smaller sums like $20,000 within a mere 30 seconds.

That more mainstream, big- name corporates want in on the crowdfunding scene - DBS Bank, for instance, recently signed cross-referral agreements with two P2P lending platforms to expand funding sources to small businesses - has been seen as an endorsement of the budding industry.

The Sunday Times takes a closer look at why the crowdfunding scene is heating up so quickly and what this means for investors.

A WAY TO RAISE FUNDS

Crowdfunding, put simply, is the practice of funding a project or a venture by raising money from a large number of people on the Internet, typically in exchange for various types of "rewards".

The most prevalent form of crowdfunding is donations-based, where individuals can contribute to a campaign and receive a product or an experience.

Crowdfunding is also being used for charity.

For instance, a campaign to raise money for the families of two SMRT trainees who died after being struck by a train in March amassed about $47,000.

Where investors are concerned, it is lending-based crowdfunding, which offers interest on loans, that is most popular.

Typically, a company puts out a sum that it needs to borrow and the platform, after holding its own screening process, 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 lend.

The campaign ends when enough investors have pledged their cash, which gets transferred to the company.

The firm then repays the investors, usually through fixed monthly payouts.

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.

There are at least 14 companies with a presence here, including newcomers like EziFund, a real estate crowdfunding platform that made its debut on April 18.

Mr Leo Shimada, co-founder and chief executive of crowdfunding company Crowdo, notes that crowdfunding is increasingly gaining traction as an alternative source of financing and investment.

"While small and medium-sized enterprises (SMEs) form the backbone of the economy... the reality is that many businesses remain underserved by conventional channels of financing," he says.

"Meanwhile, investors are facing volatile and often underperforming public markets, while traditional means of investments, such as real estate, are in a challenging environment."

"Crowdfunding uses technology to efficiently connect these two parties - for businesses, it offers an efficient way to access capital, and for investors, it offers an additional way to diversify their investment portfolio to create more wealth."

Crowdo, one of the largest crowdfunding firms in South-east Asia, has about 22,000 members from around the world and has helped fund 500 campaigns.

And the industry is poised for further growth, notes Mr Pawel Kuznicki, director of P2P lending platform Capital Match, which has raised $9.5 million in loans.

"Banks will continue to be the main financial institutions providing companies and individuals with a variety of financial solutions, but there will be more and more alternative providers - crowdfunding being a major part of that - offering differentiated products and addressing the needs of unbanked customers."

AN ALTERNATIVE FOR INVESTORS

Investors are clearly on the hunt for alternative yields as traditional assets such as equities continue to perform poorly.

One key benefit for those who invest through crowdfunding is that they can have access to potential good returns with smaller sums of money, says Mr Getty Goh, chief executive and co-founder of real estate crowdfunding platform CoAssets, which is also the first listed crowdfunding company in Asia.

In P2P lending, investors can usually start with amounts as little as $100, coupled with interest rates that are usually within the double-digit range and loan tenures as short as six months.

"By investing small sums over a number of projects across a spectrum of industries, this also helps to diversify their risks," says Mr Goh.

MoolahSense chief executive Lawrence Yong adds that on top of lending to support the growth of local SMEs, the returns investors enjoy are "fixed and contracted upfront, so there is no need to time the market or be subjected to the volatility like in the stock market".

The firm has raised around $12 million in short-term notes for more than 70 SMEs to date.

Mr Michael Tee, chief executive of FundedHere, which services only accredited investors, notes that equity crowdfunding can potentially offer bigger returns than the stock market.

"Many crowdfunding investors are looking for the next (big thing). If a company supported by crowdfunding succeeds in what it sets out to do, the returns can be huge."

SIM University senior lecturer Walter Theseira notes that the crowdfunding scene here now appears to be in a "gold rush" period - characterised by excess money chasing a small number of loans, going by the speed at which campaigns are getting funded.

BUYER BEWARE: DANGER AHEAD

But the "hyper speeds" at which crowdfunding usually takes place can be dangerous for investors, says Mr Bryan Tan, technology venture capital partner at Pinsent Masons Singapore, as this "narrows the time frame for them to ask questions or seek clarification".

Mr Kelvin Teo, co-founder and director of P2P lending platform Funding Societies, agrees that this can be a problem for investors, as more platforms come on board.

"Rise in competition is triggering a race to the bottom when loans are approved recklessly and interest rates are set artificially low compared to their risks," he says.

"As investor supply outweighs loan demand, investors are hurried to invest."

Mr Teo believes this is "unsustainable" and he expects an industry shake-out soon, as loan defaults for some platforms will likely increase substantially.

Another big issue, particularly for unregulated crowdfunding platforms, is fraud, says Morgan Lewis Stamford partner Yap Wai Ming.

Likening them to online gaming platforms, he says the unlicensed ones "mushroom all over the place and some may create malicious codes to phish for credit card information".

Adding to that, retail investors may not fully understand the products that are being sold or crowdfunded for, Mr Yap notes.

"When companies sell their shares to the investing public, there are prospectus requirements and a whole set of risk disclosure documents that are set out before investors put their money in.

"Unfortunately, it is generally not feasible for crowdfunding platforms to provide such thorough disclosure, so the level of disclosure and steps for making such investments are generally simplified for the investors."

In the same vein, SIM's Dr Theseira says: "Many investors of crowdfunding products don't understand the risks... (which) are often very high because many crowdfunded investments are not rated by any independent credit ratings agency, and also because many crowdfunding loans are issued without collateral. There are very few realistic options for recourse in the event the funded entity fails to repay as agreed."

Where equity crowdfunding is concerned, the fact that private company shares are illiquid may put investors in an unfavourable position later on, says Pinsent Masons' Mr Tan.

"Having a very small stake in the firm would make it difficult to effect any real business change," he notes.

"Should the company go for subsequent funding rounds where it attracts professional venture capital, these new investors could receive superior rights because of their better bargaining position and the higher price they paid for their investment."

MANAGING THE RISKS

Mr Yeo, who chronicles his crowdfunding investment journey on a blog (letscrowdsmarter.com), acknowledges there is not much investors can do if a borrowing company defaults on the repayments.

"The crowdfunding platform has an obligation to pursue the loan and work out a loan restructuring solution. But if all fails, we have to accept it."

His strategy is to lend out small amounts - less than $1,000 - to as many borrowers as possible, "for diversification".

"The idea is to use the law of big numbers to my advantage. If I can lend out $5,000 to 50 borrowers from different industries - at $100 each - and each loan yields an average interest rate of 15 per cent, then I can still make a profit even if five out of my 50 loans turn bad."

Mr Yap of Morgan Lewis Stamford says it is key for investors to know that crowdfunding platforms merely act as intermediaries.

"They do not represent the companies that are trying to raise funds on their platforms. They are like exchanges. They earn their commission for successful trades done via their platforms."

So if a company defaults on a loan or even goes bankrupt, investors are then left to their own devices.

"For small sums invested, it may not be feasible for investors to seek protection or file claims against such companies which do not live up to their promises," says Mr Yap.

He adds: "Investors should do their homework carefully, check the background of the crowdfunding operator and carry out their own due diligence on the companies that are listed on their platforms. Ultimately, it is still very much a caveat emptor (buyer beware) situation here."

Mr Marc Lansonneur, head of investment products (Singapore) at DBS Bank, says investors should not be blinded by high yields, which can often mean higher default and payment risks.

"Do your homework in analysing factors, such as the funding demand and the business conditions, and try to get information on the company and its directors," he adds.

Investors should also invest only via a reputable crowdfunding platform, with reputable shareholders and robust track records.

"This is a high-risk investment so we recommend to invest only a small part of your available savings - not more than 5 per cent," he says.

tsjwoo@sph.com.sg


This article was first published on June 5, 2016.
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