Hong Kong: Crowdfunding (Equity-Based) In Asia-Pacific: Legal And Regulatory Ambiguities Without An Analogous Us JOBS Act Exemption

Crowfunding has become a popular equity raising method since its legal acceptance in the U.S. in 2012, although such techniques are used much less widely in APAC.  Certain Singaporean exemptions to conventional securities laws may work better than those in other APAC jurisdictions--especially Hong Kong's--although Shanghai has some innovative SPV structures in place that could provide a model for financing startups regionally.  InsightLegal Asia Consulting ( www.insightlegalasia.com) specializes in 'clarifying complexity' and herein we (i) consider the U.S. legal framework and how crowdfunding investments (pursuant to the JOBS Act) avoid the otherwise stringent U.S. SEC rules for raising equity and debt capital from retail investors.  We then (ii) turn to Singapore and see how the securities framework offers limited exemptions for equity crowdfunding.  Finally, we (iii) examine Hong Kong and (iv) China to determine how crowdfunding arrangements are proceeding in the absence of clear regulatory treatment.

Introduction

The viral growth rate of social media has enabled a new form of business funding known as equity-based crowdfunding¹, which is in essence a collective effort by a large network of individuals who each contribute a small amount of capital to finance a new speculative business venture.  Individuals pool their money to support a project or an activity.  In the United States, crowdfunding is expressly permitted by way of an exemption from securities registration after the implementation of the Jumpstart Our Business Startups Act ("JOBS Act") in April 2012.  Since then, the use of crowfunding in the U.S.--and globally--has grown exponentially, despite the fact that the legality of various structures being used in APAC is quite unclear.  Therefore, this analysis is driven by the following question:

In order to address this question, we seek to (i) better understand the nature of the U.S. crowdfunding exemption, (ii) look at Singapore's securities laws with regards to crowdfunding and (iii) also consider the legal and regulatory outlook for crowdfunding in Hong Kong and (iv) China.

PART ONE: EMERGENCE OF CROWDFUNDING IN THE U.S. - SEC EXEMPTIONS

Crowdfunding Background

The practice of crowdsourcing is a broader concept of obtaining services, ideas or content by soliciting and leveraging small contributions from a large group of people.  Crowdfunding applies this concept to the collection of funds from parties to finance a wide variety of projects and ventures.  Although debt-based crowdfunding is also available (mostly in the form of convertible notes), equity-based arrangements offer more significant potential sources of capital and are the focus of our current discussion. 

Crowdfunding potentially increases entrepreneurship by expanding the pool of investors from whom funds can be raised to a global audience, moving beyond the traditional sources of owners, relatives and venture capitalists.  It makes use of the easy accessibility of vast networks of friends, family and colleagues through websites and social media like Facebook, Twitter, Google+ and LinkedIn to spread the word about a new business and attract potential investors.  In short, crowdfunding is a hybrid technique that combines both social media and VC/Angel investing techniques to access a much broader pool of investors and investees.

Importance for Startups

Beyond securing seed money, crowdfunding offers startups a wide variety of non-financial benefits such as effective, low-cost ways of receiving market feedback and word-of-mouth marketing, including:

• The success of a crowdfunding campaign serves as a good indication of the viability of the business idea and as a test for initial market reaction;
• Leveraging social media allows for more intimate audience engagement and a deeper sense of participation among individuals and potential consumers;
• Start-ups are able to disseminate information and publicity campaigns more efficiently through online communities; and
• Businesses may continue to gather feedback from contributors by offering pre-release access to content, services or products as a part of the funding incentives.

Equity-Based Crowdfunding

Traditional crowdfunding platforms treat funds as donations (a.k.a. 'rewards'), but entrepreneurs prefer to use crowdfunding as a means of securing investments.  Selling investments via crowdfunding (a.k.a. equity-based crowdfunding), enables broad groups of investors to fund startup companies and small businesses in return for actual equity ownership.  Investors give money to a business and receive ownership of a small piece of that business in the form of equity.  As with any other type of equity, the value of their ownership increases or decreases along with the success of the business.

U.S. Securities Approach

The crowdfunding process is similar to the public offering process, where a company offers securities for public ownership and secondary trading.  This similarity extends to the potential risks to the public that crowdfunding could present.  The extensive regulatory requirements surrounding a public offering, such as:

• requiring the issuing company to publish a prospectus detailing the terms and rights attached to the offered securities;
• information about the company and its finances; and
• the prohibition against soliciting investments from the general public unless a prospectus has been filed and approved by the appropriate securities regulatory authority (almost invariably the U.S. Securities and Exchange Commission ("SEC")),

are normally too onerous, time consuming and expensive for start-ups or smaller enterprises.

To deal with these legal restrictions and to actively promote startups, the JOBS Act was enacted, which lifted restrictions on companies from selling shares to the general public via crowdfunding platforms.  Among other things, the legislation mandates funding portals that offer crowdfunding services to register with the SEC as a broker-dealer or as a "funding portal".  Thus, the JOBS Act expressly allows equity-based crowdfunding when such fundraising is conducted by a licensed broker-dealer or via a funding portal that is registered with the SEC. 

Since the enactment of this legislation, many crowdfunding services have been launched to fill this rapidly evolving space.   For example, FundersClub² was one of the early players to clear US regulators and helped to pave the way for other such sites to flourish.

Established U.S.-based crowdfunding platforms such as Kickstarter³ and Indiegogo⁴ have proved to be important sources of finance for entrepreneurs in the United States and Europe.  They have helped startups to reach a large audience of potential investors who have funded their businesses. 

What about the situation outside of the U.S. and EU?

PART TWO: SINGAPOREAN CROWDFUNDING FRAMEWORK

Background of Crowdfunding in Singapore

As is the case for most of Asia, the concept of crowdfunding is still relatively new and in its early stages of development.  As one might predict, the legal and regulatory frameworks are also undeveloped and several creative platforms and structures have been devised to work-around the existing grey areas.

Singapore-based projects have successfully demonstrated the potential of using existing U.S.-based equity crowdfunding platforms, such as:

• Project Silverline, which provides senior citizens with second-hand smartphones with healthcare and personal safety apps, raised US$36,000 with four days remaining in their campaign on Indiegogo, and successfully raised a total of US$54,001 by the end⁵.
• Bamboobee's campaign on Kickstarter raised a total of US$63,879, which was almost 60% more than the initial pledged US$40,000 goal⁶.  More impressively, the project, which is a business venture to produce handcrafted bamboo-made bicycles, received US$39,000 with more than 2 weeks to go in their 33-day long campaign.

Additionally, the crowdfunding scene in Singapore has begun to take root and is growing fast in popularity.  There are several notable Singapore-based online sites, such as Crowdonomic⁷, and Cliquefund⁸.  Local website Crowdonomic is slowly gaining speed with small wins such as PixBento, a virtual shared photo album, successfully raising US$3,220⁹.

Singapore's Securities Framework

In Singapore, equity-based crowdfunding could trigger an "offer of securities", which must then comply with the regulations set forth by the Securities and Futures Act (Cap. 289)("SFA"). There is no law that expressly allows or disallows equity-based crowdfunding, and it is not clear in all instances whether equity-based crowdfunding does in fact violate the SFA.  Nevertheless, this risk appears to have been avoided by Singapore crowdfunding platforms that prohibit the offer of "equity" in return for financial contributions from the public.  These platforms specifically exclude "securities" that can be offered to the public and istead use 'rewards'.  However, most investors seek to obtain an equity interest in the investee (i.e., startup), so the economic viability of such non-equity crowdfunding platforms would seem to be quite limited.

Depending on the actual form or method of fundraising, entities that raise funds through a crowdfunding platform may be deemed to have made a securities offering.  Under the SFA, entities that make an offer of securities to investors in Singapore are required to lodge and register a prospectus with the Monetary Authority of Singapore ("MAS"), unless an exemption applies.

In addition, where the platform facilitates any securities offerings or provision of advice relating to the securities offerings, it may be deemed to be dealing in securities or advising on corporate finance and—thus--may be subject to licensing requirements under the SFA.

Equity Crowdfunding in Singapore

Asian companies are able to sell equity (and debt) to the public using the popular crowdfunding system on a Swedish site called FundedByMe¹⁰, which also has a Singaporean presence.  FundedByMe, one of the first of its kind in Asia, allows the public to enter the world of VC/Angel Investing for the first time. 

FundedByMe began in Sweden in 2011 and launched its equity crowdfunding portal the following year.  Key features of its platform include:

• Participating companies have to pay the site a 6% cut of funds raised;
• Participating companies need to hire their own legal and financial advisers to deal with the implications of taking on more shareholders;
• Each funding campaign has three stages:
• • pre-round, in which entrepreneurs gauge feedback, decide whether or not to proceed, and in which investors can make commitments;
  • open round, during which investors can buy shares and those who committed in the pre-round are automatically given allocations; and
  • closed round, when a campaign hits its funding target and closes.

FundedByMe chose Singapore as its first Asian hub because of its status as a financial centre, the stability of the government and the city state's high penetration of social media and technology.  FundedByMe is trying to attract Asian investors, including European expats based in Singapore, to European companies on the platform.  It also seeks to bring early-stage Asian companies to an international audience.  

China, Hong Kong, India and Australia are the next likely locations for expansion if the Singapore venture goes well.

FundedByMe also offers debt-based crowdfunding (or crowdlending), in which investors would buy convertible notes that startups issued.

Unlike Kickstarter, which focuses on supporting single projects, ranging from films to gadgets, FundedByMe focuses on companies.  The firm screens potential applicants and allows only about 8% of companies to raise funds.  Participating companies have the choice of giving investors shares, convertible debt or rewards.  The largest fundraising size FundedByMe permits is U.S.$1m, and the typical investment amount is about U.S.$1,000–$5,000.

It is important to note that FundedByMe is open to retail investors.

Like other crowdfunding platforms, FundedByMe does not handle the funds raised.  Instead, investors use a third-party payment portal and participating companies pay FundedByMe a 6% cut of the funds raised.  If companies do not reach their fundraising targets, no money is collected.

Securities Law Exemptions

The MAS has yet to clarify if such platforms can operate without a licence.  As a rule, VC and angel investments are not regulated in Singapore, but these are typically private transactions limited to a handful of professional investors aware of the risks involved.

The SFA exempts offerings of up to S$5m (U.S.$3.9m) within a 12-month period as long as they are not advertised.  Since crowdfunding sites generally require investors to join as members, even though there may be no membership fee or eligibility requirement, an argument could be made that distributing a message to a closed membership group does not constitute advertising. 

However, equity crowdfunding in Singapore is still fraught with many legal uncertainties, and it is always advisable to read the Terms and Conditions of any crowdfunding platform. 

Until Singapore provides clearer guidance or better legislation (analogous to the JOBS Act in the U.S.), it would appear that startups are unable to offer securities, shares, or any other form of direct equity interest to the "public" as part of any overt equity crowdfunding campaign targeting Singaporean investors.  

Without the legal clarity of an exemption, there are many inherent risks involved in offering an equity interest in your business through equity crowdfunding structures.  A successful reward-based crowdfunding campaign can be a great tool for sourcing potential customers, as well as marketing and building the public profile of a start-up company.  However, if your equity-based crowdfunding project will potentially involve any offer of "monetary rewards" to the "public", it is imperative that proper legal guidance is obtained before embarking on such campaign. 

Non-equity Crowdfunding Platforms in Singapore

For most of the Singapore-based platforms, the crowdfunding system is rewards-based, and they help start-ups raise funds from the public by rewarding their supporters in various ways that do not include the issuance of equity in the business. For instance, if someone decides to support a particular start-up, they could be granted specific privileges in return for their support, such as early access to the next release of a popular game or a new product or service, promotional material, invites to launch events, &c.  It is up to the start-up to determine what they can offer to make their solicitation of funds attractive to the public. 

However, rewards-based crowdfunding do not grant the provider of funds with any equity interest and it is difficult to see how such campaigns can reach the economic importance of equity or debt-based campaigns that actually vest legal and economic rights with investors.

Part Three: Hong Kong's Crowdfunding framework

Crowdfunding in Hong Kong

Hong Kong-headquartered Decision Fuel¹¹ was the first fund to be listed on Shanghai's SeedAsia¹². The company offers a mobile platform to deliver short consumer surveys.  It had $1.25 million in seed funding in 2011, according to AngelList¹³, and boasts bluechip clients such as P&G, Nike, Colgate.  

The Hong Kong realty-based crowdfunding platform Crowdbaron¹⁴ recently secured funding from Grow VC Group, and are planning to help investors make substantial investments in real estate.  The innovative idea behind Crowdbaron is that, unlike timeshares, you will not actually own the right to occupy the premises.  A pool of investors will own a property, which will then be rented out.  Investors earn periodic rents based on their stake and may profit from price appreciation.  Crowdbaron hopes that people who either can't or do not wish to purchase whole properties will be able to use their service to gain from the potential further appreciation of Hong Kong's real estate market.

Securities Framework

In Hong Kong, there is no equity or debt-based crowdfunding exemption equivalent to the U.S. JOBS Act.  Further, Hong Kong's Securities and Futures Commission ("SFC") has no specific rules on equity crowdfunding and any offering of investment products to the public is regulated by the SFC.

What about exemptions under the current regime?  Would it be possible, provided the right investors (i.e., professional investors) are targeted, to rely on Section 103 of the Securities and Futures Ordinance (Cap. 571)("SFO")?  By way of explanation, this provision exempts:

• Any advertisements, invitations or documents made in respect of securities, or interests in any collective investment scheme which are intended to be disposed to only professional investors, from authorization by the SFC.

Equity crowdfunding arrangements relying on this provision needs to be considered carefully.  Although this provision allows certain advertisements to be exempt from authorisation requirements, they do not allow such offers to be made without the appropriate SFC licences.

Part Four: China's Crowdfunding framework

Equity Crowdfunding

A platform called SeedAsia was launched in Shanghai with a minimum fundraising investment of about US$2,000 per person.  SeedAsia allows investors to buy shares in a special purpose vehicle ("SPV"), which in turn invests in a startup company.  The interest in the startup is held by the SPV, rather than providing investors in the SPV to take a direct interest in the underlying startup.  Start-up companies can sell securities, including shares or convertible notes privately in this way to the SPV without triggering an offering to the public.  As an additional measure, investors in the SPV need to demonstrate they are qualified investors in their home countries before they are accepted as members of SeedAsia.  

Therefore, SeedAsia offers accredited investors a platform to find and invest in a range of pre-screened Chinese and South East Asian startup companies in the technology sector.  

Unlike many rewards-based non-equity crowdfunding platforms in Asia (such as those discussed in the Singapore section above), SeedAsia is a true equity-based Crowdfunding platform, since investors get pro rata stakes in the startups they invest in (as opposed to some kind of reward or non-equity type of benefit).  The company screens potential investors and sets a minimum floor of US$2,000 to ensure that only serious investors get the opportunity to fund the next great Asian startup.

Importantly, SeedAsia offers stakes in selected early-stage startups to investors.  The startups listed go through an incubation program and need to have already shown promise.  The startups can apply to offer between U.S.$50,000 and U.S.$1.5 million in equity through SeedAsia's platform.

Key features of SeedAsia's crowdfunding model include:

• SeedAsia takes a 5 percent "administration fee" and another 5 percent "distribution fee" from the investor;
• Potential investors need to apply and be pre-screened, and the minimum investment commitment is U.S.$2,000 per member.

Conclusion

Until now there have been no analogous exemptions to securities laws and regulations in APAC to the U.S. JOBS Act, which actively promotes equity, debt and rewards-based crowdfunding and brings such activity into the SEC's bailiwick via broker-dealer and funding portal registration. 

No specific legal exemptions or carve-outs for crowdfunding have been enacted by legislators or regulators in APAC, which is unfortunate and leaves equity crowdfunding in a legal grey area between established securities regulations and leaves a broad pool of potential VC/Angel investors in a state of legal limbo. 

Singapore's exemptions may work better than those in other APAC jurisdictions--especially Hong Kong's—although, as we have discussed herein, Shanghai has some innovative SPV structures in place that could provide a model for financing startups in other parts of Asia-pacific. 

What is clear is that a better and more coordinated policy approach would be to expressly exempt certain crowdfunding arrangements while simultaneously ensuring basic investor protection (or other policy goals) are satisfied through licensing such platforms as intermediaries (i.e., similar to the U.S. approach of registering broker-dealers and funding platforms).  The current grey zones across APAC leave too many innovative startups (and by extension economic opportunities that are unable to raise traditional bank capital, equity or other debt financing) to flounder.  It also has the undesirable effect of pushing startup activities into more favourable economic climates.  In short, jurisdictions that actively support equity crowdfunding will continue to benefit from the considerable economic activity that startups contribute; by contrast, jurisdictions that do not can expect such activity to gravitate elsewhere along with the positive externalities they offer.

Footnotes

1 We focus our analysis on equity-based crowdfunding, although several references are made in parts to debt-based and rewards-based crowdfunding in this discussion.

2 See: https://fundersclub.com/

3 See: https://www.kickstarter.com

4 See: https://www.indiegogo.com/

5 See: https://www.indiegogo.com/projects/silverline-smartphones-for-seniors--6

6 See: https://www.kickstarter.com/projects/817362809/bamboobee-bicycle

7 See: https://www.crowdonomic.com

8 See: http://www.cliquefund.com/

9 See: https://www.crowdonomic.com/project/494-pixbento

10 See: https://www.fundedbyme.com/en/what-is-fundedbyme/

11 See: http://www.decision-fuel.com/

12 See: http://techcrunch.com/2013/05/14/equity-crowd-funding-site-seedasia-laun...

13 See: https://angel.co/decision-fuel

14 See: http://crowdbaron.com/

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