Crowdfunding at the speed of trust

Building trust in the crowdfunding space

Capital raising has always been a key challenge for startups and MSMEs in growing their business or keeping the business afloat. With the recent release of the Rules and Regulations Governing Crowdfunding (the Regulations) by the Philippine Securities and Exchange Commission (SEC) under SEC Memorandum Circular №14–2019, we are seeing a growing number of companies that have immediately leveraged this new regulation to raise the necessary debt financing through a popular crowdfunding platform in the Philippines — Seed[in].

Based on the Seed[in]’s own statistics as of this writing, the platform have helped startups and MSMEs in the Philippines raise Php161.5 million or US$3.2 million in capital (and Php7.6 billion across Asia Pacific!) since they started operations. From the investment listing, it appears that the platform has operated since 2017 but with majority of funding activities happening only during 2019, representing ~80% of total fundraise.

Lending through crowdfunding presents a fantastic investment opportunity for most individuals with no access to more sophisticated securities and capital market offerings. With an annual rate of return of around 10% to 20% in most legitimate crowdfunding platforms (not including the crazy returns available in underground crowdfunding markets exceeding 100% return p.a.), passive returns in these type of securities present an attractive money placement proposition compared to depository interest rates.

With the advent of crowdfunded lending activities and the ease of investing into these passive income opportunities, are there enough safeguards in place to protect the interest of investors?

We explore in this article the disclosure requirements of the SEC as required by the Regulations, the current state of compliance of issuers and how crowdfunding platforms can be more effective intermediaries between investors and issues.

What is required by the SEC?

With the Regulations released last July 2019, there are no published crowdfunding intermediaries accredited with SEC yet as of this writing. Issuers of securities through crowdfunding should provide sufficient information for investors to assess the investment risks in relation to issuer’s securities. These include:

• Name and other details of the intermediary
• Nature of its business, financial condition, historical reports of operation
• Business plan with respect to CF offering
• Risk factors of investing in its project
• Procedure on how to return funds if target offering is not met
• Procedure to complete or cancel investment commitment

In addition to these, issuers are further required to make their annual reports with all the required disclosures to be posted in the platform’s website which should include explanations on deviations between planned and actual execution of the business plan among others.

From the platform’s perspective, other than the required disclosures from the issuer as indicated above, the platform should further include the following information for the interested investors’ benefit:

• Issuer disclosures including offering statement, annual report and progress update
• Information on how the crowdfunding platform facilitates the investor’s investment

Considering that most crowdfunded securities at this stage are considerably small (i.e., less than Php10 million), these disclosures, when complied with, should provide the diligent investor with sufficient information to analyse and decide on the crowdfunded investment.

How is the current state of disclosure?

Most of the popular crowdfunding sites — such as Seed[in] and Cropital — in the Philippines are used by issuers to raise debt financing carrying a fixed rate of interest over a certain period of time. With no crowdfunding platform accredited yet, current disclosures provides very minimal information that will enable investors to make a careful evaluation of the potential investment risks.

An example of such disclosures in Cropital for a small lot (Php30,000 target funding) crowdfunding is shown below:

This disclosure presents limited insight as to how the raised funds will be used by the farmer, the risk factors involved, and the historical yields of the farmed lot, to enable investors to make a guided assessment of the farmer’s ability to repay the loaned amount.

On the other hand, when raising monies for private companies which is inherently more risky (because of the crowdfunded amount and business risks involved), we expect more detailed disclosures to provide investors with sound information to assess the business risks. Below is an extract of the business plan disclosures presented in the “Fact Sheet” of Seed[in]:

The extent of the information presented clearly does not provide sufficient context on the business operations of the issuer for a reasonable investor to assess the issuer’s business model, default risks and historical performance.

While we don’t expect platforms to perfect the disclosure requirements, improving the quality of such disclosures would prove helpful in the building of platform credibility and drive better trust in crowdfunding by institutional investors. With the current state of disclosures, diligent retail investors with moderate to conservative risk profiles are highly unlikely to be interested in such securities.

How it can be improved

The use of crowdfunding as an alternative capital raising platform can be a very effective tool to provide much needed financing to startups and MSMEs and a potentially sound investment instrument for investors. However, with the speed that investors are investing into crowdfunded securities, establishing trust in this nascent space plays a critical role in creating sustainable investor-issuer relationship.

Improving the current state of disclosures provided by crowdfunding platforms plays a vital role for the crowdfunding space to mature and become a more viable money placement alternative for investors. Some of the immediate steps that crowdfunding platforms can do to improve the current state of disclosure include:

Stricter scrutiny of issuer financials

From a quick look into some successful issuers in crowdfunding platforms, it clearly appears that several issuers lack the ability to repay the crowdfunded amount other than through refinancing their debt with another crowdfunded debt. Many investors do not have access to financial information of issuers — which is a requirement of the Regulations — to make sound lending decisions.

A balance due diligence should be conducted by platforms to ensure the veritability of the issuer financial information and make these historical financial information available to investors as part of the offering. Further, companies with history/ies of default within or outside the crowdfunding mechanism should be flagged and disclosed to ensure investors are aware of the escalated default risk.

Clear and concise disclosures

The currently over-concise disclosures made by crowdfunding platforms does not provide sufficient information to make a sound investment decision. Ensuring that disclosures provide a fair and factual representation of the issuers financial history, a business performance and business plan provides a better gauge for diligent investors in making better investment decisions.

Better investor education

With almost no barrier to entry for retail investors planning to invest in crowdfunding opportunities, crowdfunding platforms have an obligation to educate investors on the risks of investing in crowdfunded securities considering that crowdfunded debt are inherently riskier compared to traditional fixed income securities.

About UpSmart

UpSmart is the premier financial consultancy firm in the startup, SME, and social enterprise industry. UpSmart specializes in strategic finance (e.g., structuring and restructuring of legal entities, valuing and modelling companies, serving as chief financial officer of companies) and operational finance (e.g., optimizing business processes and controls, accounting and bookkeeping support, financial reporting and analysis).

About Filbert

Filbert is the co-founder and managing director of UpSmart. He leads the consulting practice of UpSmart and specializes in handling corporate structuring and financial transformation projects. He was previously a consulting manager at Ernst & Young in the UK. He writes for Tech in Asia, Business Mirror and serves as a mentor at The Final Pitch on CNN.