LEGALLY SPEAKING Equity Crowdfunding – a new way forward for start-ups?

CROWDFUNDING is exactly what its name suggests – funding by a crowd. This method is where small amounts of money are pooled from a large number of individuals to fund a business venture, project, cause or any other need.
There are four types of crowdfunding: donation crowdfunding, reward crowdfunding and peer-to-peer lending in addition to equity crowdfunding ("ECF").
Donation crowdfunding is where the public donates resources, typically money, to a project or a cause which is usually charitable in nature, without expecting any financial return.
Reward crowdfunding involves the contribution of money by the public to a business in exchange for rewards such as coupons or certain services or products that that particular business or company provides.
Peer-to-peer lending is a type of debt funding where the company or business intending to raise capital borrows money from the "crowd" in return for a commitment to repay based on a certain timeframe and an interest rate. In principle, this operates much the same as the issuance of bonds by listed companies.
In ECF, instead of giving a "bond" to the investors, the company sells its shares. The investor will become a shareholder in the company, hence the "equity" funding. The investors can expect a return on their investment in the form of dividends if the company performs well.
In recent years, the use of social media and the internet has greatly increased connectivity which has been one of the main drivers for the proliferation of crowdfunding. The Securities Commission of Malaysia ("SC") proposes to regulate ECF to ensure that this new market will develop in an orderly fashion and provide a regulatory safe harbour by which small businesses may raise capital.
Further to this, the SC published a public consultation paper on Aug 21, 2014 outlining proposed regulatory requirements on three main areas, namely: operations of the ECF platform, issuers who can seek funding on the ECF platform and investors who can participate in the ECF platform. The response paper to this consultation paper was published on Sept 22, 2014.
Operations of the ECF platform
ECF platforms are categorised as a type of stock market under the Capital Markets and Services Act 2007, being a "registered electronic facility". Operators of such platforms will be required to be registered with the SC. Such platforms will be permitted to host offerings, provide a channel for discussions on the offering and manage investor relations. Prohibited activities include featuring trending pitches, offering investment advice, negotiating terms for and on behalf of third parties and offering compensation to its employees for the solicitation/sale of securities. Operators will also have the responsibility for screening issuers to ensure adherence to regulations.
It is also proposed that the "all-or-nothing" model for ECF be adopted, whereby the issuer will not be entitled to any proceeds of the funds raised unless a certain threshold of funds is raised. This would enhance investor protection as the investors will know the minimum amount of proceeds that will have to be raised and provide some comfort to investors that the issuer will not start the project with unrealistically low funding.
Issuers
Only locally incorporated private companies with a paid up share capital of RM5 million and below will be allowed to offer their shares on the ECF platform. After consultation, SC has decided to allow microfunds on the platform. Each microfund will have to be registered with the SC as a venture capital company, have a specified investment objective and may only raise finds from sophisticated investors.
Only common shares, that is, ordinary and preference shares, and not options or convertible securities, will be allowed to be offered. SC has also proposed a limit of RM3 million to be raised from the ECF platform within a 12-month period.
Investors
Both sophisticated or retail investors (which form the bulk of the general public) may invest on the ECF platform. The SC has also decided to allow angel investors to invest, commonly high net worth individuals who must be registered with the Malaysian Business Angels Network. To encourage diversification in investments, limits proposed are RM5,000 per issuer up to a limit of RM50,000 per year for retail investors and RM5,000 per issuer up to a limit of RM500,000 for angel investors. Sophisticated investors are not subject to any investment limit.
This proposed regulatory framework will encourage the growth of innovation, productivity and competitiveness in Malaysia through the bridging of the capital gap between small to medium enterprises and listed companies who typically raise funds from traditional sources of financing such as equity or debt capital markets. With such improved access to funds and capital, the cost of capital will foreseably decrease and in just a short few years, new business start-ups may be commonplace and we may see a large category of medium to larger businesses.
Contributed by Cheryl Lim of Christopher & Lee Ong (www.christopherleeong.com).