Crowd-funding can connect the masses to promising investments, but beware the pitfalls, writes Benjamin Robertson
Interested in building a platform for product design and distribution, Jonathan Buford turned to a novel solution: online crowd-funding. Like many start-ups worldwide he saw the potential of crowd-funding to connect with thousands of design-conscious consumers who might help back his concept (see box).
Last year Buford took HK$7.8 million in sales and is targeting HK$39 million for 2014.
A modern-day variant on the old theme of pooled investment, online crowd-funding allows hundreds of people to come together to support a fledging company, sponsor a good cause, or launch a product.
Though still in its infancy, crowd-funding has transformational potential. Promising firms can use it to raise capital without going through expensive intermediaries. Individuals can get access to private-equity investments that would otherwise be out of bounds.
"The potential to disrupt business is huge - in a positive way," said property crowd-funder Saeed Hassan. The chief executive of Crowdbaron, Hassan has created an online platform to crowd-invest in London property.
"If you cut out the institutions and middle men we can achieve much better returns than high-net-worth individuals have been able to achieve just by grouping resources together," said Frazer Fearnhead, the founder of The House Crowd, another site focused on crowd-investing in UK property.
The forum for this is simple.
Take FringeBacker, a Hong Kong-based site that allows you to solicit the public for money to realise inspirational personal goals.
Applicants pitch an idea to the site's managers and, if approved, can upload a mini prospectus introducing themselves and their dream. In return, the backer gets public recognition and the satisfaction of helping a good cause.
In April, the site achieved a world first by crowd-funding a professional athlete, in which 104 backers gave HK$482,100 to local equestrian show jumper Jacqueline Lai to support her training.
Another is Colony88, an online home for early-stage companies to find equity investors. In this instance, a backer would give money to support a young firm hoping to cash out with profit in the future.
In both cases, the sites' curators pick only those proposals likely to succeed and charge a fee if the fund-raising target is met. "At the moment our [acceptance] rate is one for every 30 companies we screen," said Colony88 co-founder Fiona Atkinson.
Colony88 targets firms looking to raise up to US$2 million in equity funding during what Atkinson calls the fundraising "valley of death" - or the period after the initial seed capital and before the venture capital injections designed to carry a firm to an initial public offering.
When analysing a project posted on Colony88's site, investors are able to view business plans, financials and management biographies.
Zaozao takes a different approach. It provides a platform for aspiring Hong Kong accessory designers to reach a predominantly North American audience. Designs are placed online and production begins once the order target is met. Since its launch in September 2012 the site has funded 46 projects.
Though the end goals are different, all the sites utilise the same funding concept - connecting directly to strangers willing to back ideas.
Recent data from research and advisory firm Massolution, said the amount raised globally via crowd-funding rose 81 per cent in 2012 to US$2.7 billion. This is estimated to grow to US$5.1 billion this year. Most of the activity was in the United States.
Crowd-sourcing is a new concept and not everyone is comfortable committing money online to a start-up firm. Service providers have to take extra steps to gain the trust of the market.
"I see the virtue of doing a tight screening on our projects to make sure nothing funky is going on," said Maryann Hwee, executive director of FringeBacker. With a background in venture capital, Hwee said her site also conducts basic background checks into project creators.
Hwee makes a comparison with Kickstarter, a hugely successful US crowd-funding site that allows people to raise money for creative projects. Since its launch in 2009, five million people have pledged US$822 million through Kickstarter, according to its website. While there are rules to using the site, Kickstarter does not screen each project.
Offering some level of screening or due diligence is especially pertinent when it comes to crowd-investing. What role should the crowd-funding site play and what liability does it have should the investment prove a flop or a scam? Like many other investments, the onus is fully on the investor.
"Given we are at early stages, platforms that focus on quality will do better. The first few deals will set the stage for future growth. If the first few deals go badly that will make it really difficult for the platform to grow," said Tytus Michalski, a Hong Kong-based "angel" investor, or someone who contributes capital and guidance to firms at their earliest stages.
Companies and investments will fail, said James Giancotti, another angel investor who is planning to launch a crowd-funding site that also offers investors the opportunity to trade options of start-up companies.
"Everybody who invests in a start-up should be prepared to lose it all. You put your money in and you do not expect to see it again for 24 months. But if you do see it again within 24 months it's probably going to come back at a larger amount than you expect," said Giancotti.
Here in Hong Kong, the government has noted the potential of crowd-funding to connect fledging business ideas to the mass market. The concept fits the city's free-market culture. In recent months, the government-run InvestHK, tasked with promoting the city as a business destination, has launched StartmeupHK as part of a broader strategy to welcome start-ups, crowd-funding and angel investing.
One new idea is a branded start-up programme targeting recent graduates who might otherwise be wary of joining a new company with limited prospects. By working under the government-supported programme, graduates at least get some brand recognition on their résumé.
"The last thing a parent wants to hear is you are going to join a start-up," said Simon Galpin, the head of InvestHK. If the crowd-funders get their way, that view may change.
Five questions to ask before crowd-investing
1. Do I understand the idea?
2. Do I like the management team?
3. Does the management team have relevant expertise?
4. Can I help the start-up become successful?
5. Am I prepared to lose my money?
The three forms of crowd-funding
1. Crowd-investing: invest in a company or product for a financial stake
2. Crowd-product-development: invest in a new product or concept for a product sample and/or reward in kind
3. Crowd-donating: support a good cause for personal satisfaction and possible recognition
CROWD-FUNDING RULES AROUND THE WORLD
Like many great ideas, crowd-funded investing is great in theory but tricky in its application.
The platform essentially opens private-equity investing to a mass market. People will be invited to put money into unregulated, illiquid investments with no track record - the potential for scams is vast.
The Securities and Futures Commission (SFC) limits the public's access to crowd-funded investments to "professional investors" - essentially, these are people with more than HK$8 million to invest.
An exemption extends to investment offerings with a per capita investment cap of HK$500,000 sent to no more than 50 non-professional investors without the need for a prospectus or SFC approval.
Hong Kong regulators are aware of crowd-funding but so far have shown little interest to relax the rules. "It is only five years since the Lehman Brothers issues and the banks and SFC are still cleaning up the mess. If we relax [the rules] that might cause some problems. [Professional investors] understand the risk. But most people do not understand thoroughly the risks and opportunities," said Sin Chung-kai, a legislative councillor.
Italy has put in place rules to make crowd-funded investing easier. The country enacted legislation allowing the public to invest more easily in high-technology start-ups.
In the United Kingdom, regulators are considering setting a minimum amount to invest via a crowd-funding platform. The idea is this will limit access to wealthy people who can afford to lose money if the deal goes sour. Crowd-funding firms are also applying to be directly regulated by the Financial Conduct Authority, the British equivalent of the SFC.
In the United States, the Jumpstart Our Business Startups (JOBS) Act allows firms to publicly solicit for funds through media and billboards. Similar to the SFC rules, only "accredited" investors - who can show a certain level of wealth and investing experience - can put their money into unregulated schemes.
At both a federal and state level, legislators are currently drafting laws that will allow retail investors to freely inject a capped amount into a crowd-funded firm.
The JOBS law was warmly welcomed by the start-up community.
"Hey, accredited investors, we used not to be able to tell you about this, but now you have access to these types of investments," said Justin Hughes in response to the regulatory changes. The chief operating officer of Realty Mogul, a California-based and Microsoft-backed property crowd-funding site, Hughes launched his site in March this year and has so far invested US$4 million on behalf of users.