Crowd-funding is an umbrella term describing the use of small amounts of capital from a large number of individuals to finance a new project, business or personal loan through an online web-based platform.
There are four types of crowdfunding which can be separated into “Community Crowd-funding” and “Financial Return Crowd-funding”. The latter category will be the focus of our overview.
References:
International Organisation of Securities Commissions Staff Working Paper, ‘Crowd-funding: An Infant Industry Growing Fast’
Hong Kong Lawyer, ‘Regulatory Insight: International Venture Capital Just Got Easier Being in a Crowd’
Notice on Potential Regulations Applicable to, and Risks of, Crowd-funding Activities
Types / Forms |
Brief Descriptions |
|
A. Community Crowd-funding |
A way of fundraising for charitable causes. |
| 1. Social lending/Donation crowd-funding |
Sums are raised for charitable causes. |
| 2. Reward Crowd-funding |
Under which returns in the form of physical goods or services are provided in return for the sums provided by the payer. |
| B. Financial Return Crowd-funding |
An internet-based fundraising which provides financial return in the form of a yield or return on investment. |
| 3. Equity Crowd-funding/Securities Crowd-funding | Under which investors invest in a business and gain in turn an equity stake. |
| 4. Peer-to-Peer lending | Under which online platforms match lenders/investors with borrowers/issuers to provide unsecured loans. |
Crowd-funding is not a new idea. Internet-based FR Crowd-funding was made viable in 2006 after the launch of ‘Web 2.0′, allowing lenders/investors and borrowers/issuers to interact and collaborate via a social media platform. FR Crowd-funding has gained popularity as an alternative and relatively inexpensive funding source.
Crowd-funding processes are intended to be less formal than other public offering processes and do not require a full prospectus or long disclosure documents that are expensive and inconvenient for small start-ups. Due to its interaction with public investors’ money, Financial Return Crowd-funding (FR Crowd-funding) is likely to be of interest to the Securities and Futures Commission of Hong Kong (SFC) and to legal practitioners.
Financial return crowd-funding
i) Equity Crowd-funding / Securities Crowd-funding
Equity crowdfunding is the online offering of private company securities in exchange for an interest in shares or debt (i.e., bonds), or an interest in participation in the profits or income of a collective scheme. Once the platform completes the equity raising, the investors hold equity stakes in the company and assume the risks associated with investing in equity.
As a relatively small sector, participation in equity crowdfunding is potentially riskier relative to the usual route of public offerings to investors. The lack of full prospectus or a credible secondary market makes equity stakes illiquid. Even if investment proposals are provided, the lack of standardization of the information disclosed in these proposals may make it difficult for investors to understand the associated risks. Furthermore, there are often many regulatory impediments as soliciting investments from the general public is often illegal unless the opportunity has been authorized by the appropriate securities regulatory authority. Equity crowdfunding is also termed investment crowdfunding or crowd equity.
References: International Organisation of Securities Commissions Staff Working Paper, ‘Crowd-funding: An Infant Industry Growing Fast’
ii) Peer-to-Peer Lending
Peer-to-Peer Lending (P2P Lending) refers to the use of an online platform whereby lenders/investors provide small fragments of the overall loan required by a borrower, in exchange for principal plus interest—the interest being set by the platform itself. The interest rate is generally higher than deposit interest rates at the banks to the lenders/investors, but lower than a typical bank loan available to the borrower, if such a loan were available at all.
The loan parts can be as small as 10 USD and are aggregated and paid back to the borrower once there is enough to cover the required loan. This type of lending is normally adopted by entrepreneurs to obtain cheaper loans as an alternative to bank funding. The risk however is that as an unsecured loan, there is no clear identification/verification of the true borrowers/issuers, so investors are prone to the risk of fraud.
Smaller P2P lending platforms can cater to niche markets such as real estate financing, venture capital, graduate financing, technological start-ups or consumer-to-consumer loans for transactions such as online retail purchases like Ebay.
References:
International Organisation of Securities Commissions Staff Working Paper, ‘Crowd-funding: An Infant Industry Growing Fast’
Verstein, A. (2012), “Misregulation of Person to Person Lending”, Lecturer and Other Affiliate Scholarships Series, Paper 8, Available at: http://digitalcommons.law.yale.edu/ylas 8
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