Raising money from the crowd just got easier, or did it?

Day one thoughts on the rules and regulations governing crowdfunding (CF)

Late 2017, the Philippine Securities and Exchange Commission (SEC) released the draft rules and regulations governing crowdfunding in which I have written an initial opinion piece in Tech in Asia. After almost two years of waiting, the SEC released today (signed 8 July 2019) the official rules and regulations governing crowdfunding (the CF Rules) through SEC Memorandum Circular №14 series of 2019.

With capital raising being raised as the primary challenge for startups in the Philippines in the 2017 Philippine Startup Survey published by PwC Philippines, many startups, and even micro- small- and medium-sized enterprises (MSMEs), are looking forward to the final rules on CF to be released by the SEC.

As the CF Rules have just been released today, this is an early stage opinion on how the CF Rules will potentially affect startups and MSMEs. Companies that are currently operating as crowdfunding intermediaries will be given three (3) months to comply with the said regulations [Section 60].

So what’s the scope of the CF rules?

Under the CF Rules, crowdfunding is defined as the “offer or sale of securities of a limited scale usually for startup, micro, small and medium enterprises (MSMEs) done through an online electronic platform.” It is explicitly indicated in Section 1 of the CF Rules that only crowdfundings conducted through a crowdfunding platform is covered within the scope of the CF Rules.

Of course, when capital raising is done other than through a crowdfunding platform, traditional rules of the SEC will apply which includes a complex securities registration requirements in accordance with Section 12 of the Securities and Regulations Code (SRC).

Crowdfunding covered by the CF Rules covers a wide array of securities including the following:

• Shares of stocks
• Notes evidencing indebtedness
• Investment contracts

There’s a complete list of securities identified in the Section 2J of the CF Rules, however, the above mentioned items are the more likely securities that a company might be interested to raise capital for. For companies that plan to raise more complex securities such as asset-backed securities, derivatives and warrants, raising the funds through crowdfunding might not be the most ideal way to go.

Does this mean I can easily raise capital now?

The requirements for capital raising through crowdfunding under the CF Rules for issuers are pretty straightforward as long as the amount raised within a 12-month period is less than Php 50 million and the crowdfunding is performed through an online intermediary.

For companies that are looking to raise capital beyond the Php 50 million mark, the complex securities registration requirement in accordance with Section 12 of the SRC will apply — thus, technically outside the scope of the CF Rules.

Other than the capital raising cap of Php 50 million, there are other requirements for registration exemption stated in Section 3 of the CF Rules such as the investor qualification and investor investment cap. However, taking practicality into consideration, these other requirements should already be part of the internal control of the crowdfunding platform being used by the business.

What do I need to get started?

Assuming that the company will qualify within the scope of the CF Rules, then Section 45 of the regulations will require the submission of the following initial information:

• Name and other details of the intermediary [the term other details is not explicitly identified within the CF Rules, thus, this will likely depend on the specific requirements of the crowdfunding platform indicated in its operational framework]
• Nature of its business, financial condition and historical reports of operation
• Business plan with respect to CF offering
• Risk factors of investing in its project
• Procedures on how to return funds if target offering is not met
• Procedure to complete or cancel investment commitment

These information basically forms part of an abridged prospectus to solicit investments from potential investors. Other than these base requirements, most crowdfunding platforms will likely require more information to be presented on their respective platforms and uniformity of prospectuses.

Similar to existing crowdfunding platforms like Kickstarter and Indiegogo, when the designated crowdfunding target is not met during the fundraising period, the committed investments will be returned to the investors. What this means is that the fund raised during the fundraising period will not be accessible to the issuer by the intermediary until the fundraising process is completed.

Where do we go from here?

With several existing crowdfunding platforms already operating in the country for some time now, we are still looking forward to the official list of crowdfunding platforms that will be accredited by the SEC as part of the CF Rules. Crowdfunding platforms will be allowed a three-month window to register and comply with these rules and regulations.

Once the operating frameworks are released by the accredited crowdfunding platform, then it would be possible to see how companies can begin to leverage the benefits of this new regulation. So for now, we are still awaiting to see how these platforms will comply and present investment opportunities to the general investing public.

Is this really beneficial?

From an overall perspective, the CF Rules will benefit a platitude of companies that plans to raise capital other than through private or public investments. Further, the placement of regulations into the existing quasi-legitimate crowdfunding sites will enable better protection to the existing and prospective investors

Self-regulations

The CF Rules provides for a self-policing mechanism for crowdfunding platform providers (i.e., intermediaries) where the crowdfunding intermediaries are required to notify the SEC for any potential violation of the CF Rules. As indicated in Section 8, intermediaries shall conduct review and due diligence including:

• Conducting background checks on the issuer to ensure fit and properness of the issuer, its board of directors, senior management and controlling owner (e.g., requirement for NBI clearance of the issuer)
• Verifying the business proposition of the issuer
• Carrying out assessment on the issuer’s creditworthiness
• Ensuring the issuer’s disclosure document lodged with the crowdfunding intermediary is verified against public records and any available third-party sources

Considering the low barrier to entry under Section 34 of the CF Rules for potential intermediaries (e.g., Php 5 million capitalization), the cost of complying with the requirements for registration as a platform and the ongoing obligations (listed above) is unlikely to be within the capabilities of most registrants. This would likely defeat the purpose of the self-policing regulation introduced by the CF Rules.

Legitimizing schemes

While self-policing is a good control, a lot of fraudulent investment schemes will likely be legitimized as part of this regulation considering the low barrier to entry of both the issuer and the intermediary. With a good story, a good promise and a good prospect — potential scams might flourish under the CF scheme.

Conclusion

This is definitely a good first step and we believe that the SEC will be careful in the registration of legitimate intermediaries to avoid the abuse of this regulation and circumvention of other securities regulations in the country. Overall, startups and MSMEs that aim to raise financing should begin considering crowdfunding as an alternative to raise low value capital.

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.