Monday 15 Jul 2024
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This article first appeared in Personal Wealth, The Edge Malaysia Weekly, on January 23 - 29, 2017.

 

It has been 1½ years since the Securities Commission Malaysia (SC) implemented a legal and regulatory framework for the equity crowdfunding (ECF) industry. The framework was seen as a step towards democratising finance, helping small and medium enterprises (SMEs) grow and spurring the local economy. 

As at October last year, 11 local SMEs had raised a total of RM8 million via ECF platforms. However, the platform operators say more could be done to develop the nascent industry.

The six registered platform operators are currently discussing the setting up of a secondary market that will allow ECF investors to sell their equity to interested buyers. This is expected to create more liquidity for this asset class and promote greater participation in these platforms. 

“There is a problem of liquidity in ECF. Investors have to wait at least four years to see returns. That is probably why there is low participation among retail investors. If there is an option to sell or top up their investment, surely there will be more participation and investing via ECF will seem more attractive,” says Catapult Asia CEO Gustav Liblik.

The Singapore-based company, which specialises in blockchain technology, is a developer of secondary markets for start-ups and securities. It uses blockchain tokens as legal proof of ownership for the equities that are traded. 

“For example, I am an investor in a company and I want to sell my investment. It is up to me to sell it at a premium or a discount, but I have to find a buyer who is willing to pay the price. When I have found a buyer, I can transfer my blockchain token to him and conclude the trade,” says Liblik. 

The possibility of a secondary market for the local ECF industry had been envisioned by the SC. Under its Guidelines on Recognised Markets, applicants who wish to operate an ECF platform need to complete Form 2A. And one of the questions on this form is whether the applicant intends to offer a secondary market.

Will a secondary market create volatility in the ECF space and affect the risk and returns of investments? Bryan Chung, pro tem chair of the Registered Digital Markets of Malaysia, an association for ECF and peer-to-peer (P2P) platform operators, does not believe this will happen. 

“The intention here is not to create a bourse. You cannot trade equities. While you are able to sell and buy equity, it may be only a one-time thing. We will not allow investors to sell their equity to buyers, who then sell it to other buyers, who then sell it back to me. We will take the necessary measures so that speculation does not occur,” he says. 

A secondary market will be welcomed by investors as it will allow them to cash out early if they want to. But some are concerned that there could be system abuse.

“Some investors may treat it like a gamble — selling their equity at a premium and waiting for potential buyers so that they can get a better deal. I think some clear ground rules should be set so that this and other negative possibilities do not happen,” says Andy Yeap, a sophisticated ECF investor and director of Flygosh.com. 

 

Commendable performance

Despite the growing pains of this nascent industry, the platform operators are satisfied with their fundraising activities thus far. Crowdplus.Asia, for one, has helped seven companies raise more RM2.9 million (as at Jan 9). 

Chung, its chief operating officer, describes its performance as commendable as none of the companies that issued on the platform had failed to raise their targeted amount. Crowdplus.Asia was the first ECF platform to launch in Malaysia in November 2015. 

“I would say that we have done well by raising the amount of funding needed even though we had to face countless hurdles, such as a lack of understanding of how ECF works among investors and finding and reaching out to investment-worthy companies,” he says.

The platform currently has more than 2,000 registered users, with 100 new users added each month. They consist mainly of millennials. These figures are in line with those presented by the SC in its ECF in Malaysia Report Card 2015-2016, which states that Gen Y makes up 58% of all ECF investors. Gen X makes up 36% and baby boomers, only 6%. 

Chung says the typical investment amount is RM5,000 per company. Also, investors tend to put up about 30% of the amount to be raised. 

PitchIn, meanwhile, has helped three companies raise RM2 million on its platform. The first, vocational college KRU Academy, managed to raise RM285,000 in 28 days. Delivery service RunningMan.my and human resources platform Kakitangan.com raised RM175,000 and RM1.55 million respectively in just 24 hours. 

“It is very exciting to know that despite ECF being a new concept, investors have come onto our platform to invest in the companies we listed. Kakitangan.com, for example, was funded purely by the crowd, with 63 investors putting in money in less than a day. There could have been a lot more investors for the deal, but the company could not give away more equity at the time,” says PitchIn co-founder and chief information officer Kashminder Singh. 

He adds that more than 5,000 investors have expressed interest in funding companies via PitchIn, 50% of whom are retail investors, 40% angel investors and 10% sophisticated investors. Its youngest investor is 18 while the oldest is 70.

Of the other SC-licensed platform operators, Alix Global (in partnership with Sweden-based FundedByMe) has raised RM1.7 million for two companies, Crowdo has raised RM2.9 million for two companies, while Eureeca and Ata Plus were issuing live deals on their platforms at the time of writing.

Ata Plus is a shariah-compliant platform that only issues companies with halal businesses and sell halal products. It is also the first in Malaysia to accept investments in cryptocurrency, specifically bitcoin. 

“We have migrated the entire platform to a blockchain back-end. Hence, we are able to raise funds via cryptocurrencies. We have had firm interest from at least two foreign companies to list on our platform because of that, so surely we will be able to get global investors who are cryptocurrency users to invest as well,” says Ata Plus co-founder and director Elain Lockman.  

Eureeca is a global ECF platform regulated not only by the SC but also the UK Financial Conduct Authority, the Netherlands Authority for the Financial Markets and Dubai Financial Services Authority. As a multi-market platform, the companies it issues are able to leverage its huge investor base, which hail from 44 countries. Its Southeast Asian hub was launched in Malaysia a few months ago. 

“We have more than 12,000 certified global investors on the platform and the typical investment amount is US$5,900. Our minimum investment ticket is a bit higher than the rest of the SC-registered platforms as we have a lot of sophisticated investors from developed countries,” says Eureeca co-founder and co-CEO Sam Quawasmi. 

“We are currently issuing two companies and will issue another in March. So, we will only assess the type of investments we get then and see whether we need to adjust the minimum investing ticket.”

In other parts of the world, ECF as an asset class has grown rapidly. According to a CrowdfundingHub report published in October last year, an estimated US$2.5 billion was raised via ECF platforms globally in 2015. 

According to research by the University of Cambridge’s Centre for Alternative Finance and UK-based non-governmental organisation Nesta, ECF has grown rapidly in the UK, up 295% in 2015 and represents 15.6% of all seed and venture funding in the country. 

 

Managing expectations

Although investing via ECF platforms is risky, as it is an illiquid long-term investment with the possibility of capital loss, investors could see handsome returns if the company is acquired or listed on a stock exchange.  

Typically, investors are not charged any fees. Only the companies that successfully raise their targeted amount during the campaign period are required to pay the platform operator a fee. If a company fails to raise the targeted amount, the fundraising is cancelled and the money is returned to the investors.

The minimum investment amount varies, depending on the company, while the maximum amount depends on the type of investors participating on the platform. Under the SC’s regulatory framework, retail investors may only invest up to RM5,000 per company and not more than RM50,000 over a 12-month period. Angel investors are allowed to invest up to RM500,000 over a 12-month period while sophisticated investors can invest any amount.

Whether the companies have a dividend policy or not, the platform operators conduct stringent due diligence so that they only list those that are high growth and have good potential of being acquired or listed. 

A common misconception is that failing companies tend to use ECF as a last resort to raise capital. But this is definitely not the case, according to the platform operators.

“Crowdplus.Asia is venture capital-backed. So, we adopt a venture capital methodology to evaluate companies. We do not just list companies for the sake of it. We have to be convinced that they can be successful. The companies are required to provide a quarterly report to inform investors of their progress,” says Chung. 

The platform conducts due diligence covering three areas — legal and financial (by external parties) and commercial (by Chung and his team). The operator also gauges investor interest in the company before the deal goes live.

Sam Shafie, co-founder and CEO of PitchIn, says platform operators do their best to ensure that the deals are of certain quality and are able to give good returns to investors. “Once we put these companies on the platform, we are telling the crowd that this is a really good company. We are very strict when it comes to curating deals because at the end of the day, we are putting ourselves on the line.”

The companies usually have different exit strategies. “They come on board at different stages. RunningMan.my, for example, is a start-up. So, there is no way for the company to promise dividends,” says Sam. 

“But the more mature companies, such as KRU Academy, have a dividend policy and are looking to list in a few years. Investors go for deals that suit their risk appetite.”

The platform operators do not expect investors to take them at their word and encourage them to do their own due diligence and identify the type of companies they are willing to invest in. The operators also organise pre-launch events for the issuing companies so that the founders can present their business plans and answer any questions on the projected returns. 

“In one of the upcoming deals, Subhome Management, which is a property management company, promises dividends from year three to year six and even a capital return. For example, if you put in RM1,000, you will get back RM1,000 and your equity will be converted to ordinary shares. You will be able to enjoy a return of about 15% per year, so investors should take a look at it,” says PitchIn chief financial officer Henry Loke.

Chung says some companies promise a return of 5% to 6% per annum for three years. After that, it will depend on whether the company is acquired or listed. 

“One of our previous deals was a biogas company, Green Lagoon Technology Sdn Bhd. It was valued at RM11 million. Its price-earnings ratio was almost four times and will easily be 10 times if it goes for a listing,” he says. 

However, investors have to be realistic in terms of the returns they expect to get, says Chung. “Investors need to bear in mind that they will not see returns within a year. I am not saying that it is impossible, but it will likely take more than three years to see good returns. So, they should invest in other asset classes as well. Do not put your life savings in this because there is a chance you may not get your money back.” 

 

Keeping the momentum

Although the past year has been tough for the platform operators, there has been a steady stream of investors. Things will not get easier this year and there is still a need to raise awareness among investors. But most of the operators are optimistic that in this low-return environment, more investors will be open to the idea of buying equity in small companies for potentially high returns.

“The world is going digital and every industry will be disrupted by these small, high-growth companies. Look at the big institutional investors. They are setting up their own accelerators and venture capital funds because they know this is the next big thing,” says Sam. 

“ECF is very different from traditional fundraising. You are not investing by yourself, but basing your decision on the wisdom of the crowd. That is the beauty of ECF — knowing that more than 50 other people are also willing to invest in the company. It tells you that they have done their research and believe in the same things.” 

The platform operators are participating in meetings and events to create awareness of ECF and clear up some common misconceptions. “We participate in events and speak at every opportunity, reaching out to the players in the ecosystem, including government agencies and banks. Usually, there will be many people who want to talk to me personally because they are seriously interested in ECF. It is important to answer questions, especially to address misconceptions such as it is some sort of an unethical investing scheme,” says Chung. 

He adds that one of the challenges of running an ECF platform is handling the amount of paperwork involved, especially with Crowdplus.Asia planning to issue two companies per month. Thus, the platform operator is looking at digital solutions to increase the efficiency of its processes. 

“The documentation involved is slowing down our operations. Some of the agreements and share certificates still need to be manually signed by investors,” says Chung. 

“So, you can imagine how much paperwork is needed for hundreds of investors. That is why we are looking at the possibility of implementing blockchain technology as an alternative to physical documents.” 

The SC recently announced six registered P2P platforms — B2B FinPAL, Ethis Capital, FundedByMe Malaysia, ManagePay Services, Modalku Ventures (Funding Societies Malaysia) and Peoplender. At the SCxSC Digital Finance Conference 2016, SC chairman Tan Sri Ranjit Ajit Singh said the move to regulate the space was driven by several factors such as the strong demand for alternative financing from SMEs and new investment avenues for investors. 

Other factors include the widespread adoption of mobile devices and social media, a change in demographics towards a more technology-savvy and connected generation of consumers, and less burdensome legacy systems that allow the leapfrogging of technologies.

However, it does beg the question of whether ECF and P2P platform operators are competing for the same group of investors. Chung says although there may be an overlap, the platforms are different. The emergence of P2P lending just means that there are more options for investors in the digital economy. 

“P2P lending is a shorter-term investment and the returns are fixed, just like a bank. For equity, your returns could be five or even 10 times your initial capital,” he points out. 

“The potential for you to get much more than what you invested is a lot higher than if you put your money in listed stocks because you come in at a very low valuation. And since it is an illiquid longer-term investment, you can set it for future use. ECF and P2P lending is definitely not the same, so investors can invest in both to diversify.”

At the moment, consumer awareness activities tend to be focused on the Klang Valley area. But PitchIn’s Sam says there are many potential investors to be reached in other parts of the country. 

“I have received requests for events in other states such as Penang, Melaka, Johor, Negeri Sembilan, Sabah and Sarawak. Hopefully, we can get more investors on board this year and contribute to the growth of the local ECF ecosystem,” he says. 

The platform operators are also looking for foreign investment. Malaysia is, after all, home to several successful start-ups such as GrabCar, 123RF and JobStreet.com Bhd, all of which have captured the interest of foreign investors.

According to the SC’s ECF in Malaysia Report Card, these investors are from Australia, Finland, Germany, Iran, Singapore, Sweden, Turkey and the US. So far, the largest foreign investment in any deal has been 25%, as at October last year.

 

 

Investor expectations

In developed countries, equity crowdfunding (ECF) has been around for more than five years. As it is still a nascent industry in Malaysia, investor participation is low, even though it is growing at a healthy rate. Most of the investors are entrepreneurs themselves who are familiar with the process of building a business and know how to distinguish good companies from bad ones. 

Angel investor and technopreneur Shahab Yar, who founded a few online businesses and tech start-ups, invests in all the companies that are listed on the Securities Commission Malaysia-registered ECF platforms to “help oil up the local ECF machine”. “I want to help grow and promote ECF as much as possible. So, I put in something, however little, in all the companies,” he says. 

“They have high growth potential. So, if one of them is successful, I will be able to cover my losses in the other companies even if I only have a 0.1% stake in the company.” 

Yar has invested in food delivery service company Mammam Deliveries, property company RE/MAX and biotechnology company Polyseed. “I have also invested in Kakitangan.com and I was the last investor. I invested in whatever was left because the system would not allow me to key in anything more as the company was already overfunded,” he says. 

Yar is expecting to get 2.5 times the amount he invested from at least two of the companies to cover his losses and take some profit in the next three to five years. 

Andy Yeap, director of Flygosh.com, says he invests in ECF-listed companies because he is a fan of the lower barrier to entry for investments in high-growth companies. “Previously, this was only available to venture capitalists (VCs) and it was very difficult for individual investors to identify great deals. So, I really appreciate the fact that ECF platforms have already done their due diligence. I truly believe that companies listed on the platforms are scalable businesses.” 

Yeap invested RM50,000 in Green Lagoon Technology via Crowdplus.Asia and is looking to invest the same amount in other eligible companies as well. He says he invested this amount because he believes the company has immense potential and its business is hard to replicate. 

“I will definitely invest another RM50,000 in a company that matches my criteria. Green Lagoon Technology sells electricity so it does not matter if the economy is doing well or not. There is always a need for electricity and you will always be paying for it. Anyone can start a delivery business, but who can start a biogas business? Therefore, I am confident I can get four times my investment in that company,” says Yeap.

“When I go to the pre-launch events and meet the founders, I find out their five-year vision and history. Of course, ECF is risky. The companies have less of a track record and there is a high possibility that I might lose everything I put in. But the higher the risk, the higher the returns.” 

Yar says the problem with ECFs in Malaysia is the limited number of deals. Even after a year, there are only two deals a month, which does not allow investors to sufficiently diversify their portfolios.

“I am not worried if they are really quality deals. I just feel there are too few. Also, I feel that the minimum investment amount is still inaccessible to the larger crowd. I am hoping that one day, fresh graduates will be able to participate,” he says. The minimum investment amount currently ranges from RM500 to RM4,500, depending on the issuing companies and platforms. 

Retail investor James Yeang says the main problem with ECF in Malaysia is the poor discoverability. He points out that he would not have known about this investing option if he had not attended the event where he met issuer Effon Khoo, who was pitching his company Kakitangan.com. 

“My investment in Kakitangan.com was my first ECF investment. I feel that more can be done to attract regular, white-collar, retail investors like me,” says Yeang.

Yar concurs, saying that awareness campaigns should be targeted at non-digital investors in the upper-middle to high-income brackets who so far have only been exposed to traditional investments.

Angel investors (who have been accredited by the Malaysian Business Angel Network) can benefit from the Angel Tax Incentive for investing a minimum of RM5,000 and a maximum of RM500,000 per annum. However, no such tax exemptions are available to sophisticated investors. 

To encourage more people to participate in this space, Yeap suggests that there be tax exemptions for sophisticated investors as well. “In a way, by investing in these companies, we are helping the local economy. And I do believe that more investors will jump on board if there are tax exemptions.” 

For all three groups of investors, ECF investments make up less than 5% of their portfolios, with major allocations to traditional investments such as properties, unit trust funds and stock market equities. So far, despite the potential of overseas ECF investments, all their investments have been domestic.

“I have looked at ECF deals outside of Malaysia — in the US, for example. There are a lot of deals, but you have to do your own due diligence to choose the right ones,” says Yar. 

“Whereas in Malaysia, you know that the operators have done the lion’s share of the work. You are able to trust them because you can see the companies and get to meet the founders. It is very easy for you to learn about their progress. That is why I only invest in Malaysian deals.”

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