Joining the Crowd

Kok Chee Kheong examines the proposed equity crowdfunding framework.

The Securities Commission of Malaysia (“SC”) released a consultation paper on 21 August 2014 to seek feedback from the public on the Proposed Regulatory Framework for Equity Crowdfunding. After the consultation period closed on 5 September 2014, the SC issued a Public Response Paper on 22 September 2014 to respond to the feedback received on the consultation paper.
This article provides an overview of crowdfunding and the framework proposed by the SC for the introduction of equity crowdfunding in Malaysia (“ECF framework”).
Crowdfunding is a way of raising funds, primarily through the internet, by obtaining small sums of money from a large number of people. The UK Crowdfunding Association (“UKCFA”) traces the origins of crowdfunding back to 1997 when fans of Marillion, a rock band, raised US$60,000 through the internet to enable the band to perform concerts in the United States.  
According to the UKCFA, there are three types of crowdfunding: donation/reward crowdfunding, debt crowdfunding and equity crowdfunding.
Donation/Reward Crowdfunding
Donation crowdfunding is a form of crowdfunding whereby a person donates money to a cause without receiving any return, except for the satisfaction of having contributed to a cause which he believes in. On 4 June 2014, the online edition of The Straits Times reported that blogger, Roy Ngerng, raised S$81,000 from more than 1,000 donors within five days through donation crowdfunding by posting a plea on his blog for assistance to defray the legal expenses in defending a defamation suit by Singapore Prime Minister, Lee Hsien Loong.
Like donation crowdfunding, reward crowdfunding is often motivated by the donor’s desire to support a cause; the difference being that in the case of reward crowdfunding, the donor receives a form of reward, such as event tickets, gifts or coupons, in return for his donation.  
Debt Crowdfunding
Debt crowdfunding is a form of fundraising whereby investors advance money to the promoter of a project. Debt crowdfunding may be on an interest or non-interest bearing basis.
Equity Crowdfunding
In equity crowdfunding, an investor receives shares or stocks in return for his investment in the enterprise which promotes the business. The value of the investment is likely to rise or fall in tandem with the fortunes of the enterprise’s business. 
The ECF framework applies only to equity crowdfunding and not to the other forms of crowdfunding. It seeks to provide an alternative and non-traditional means of funding to small and medium enterprises, particularly those that require funding to develop innovative ideas.
The ECF operator
Equity crowdfunding will be carried out in Malaysia through an operator of a web-based platform which will host the equity offerings by issuers (“ECF operator”). An ECF operator will be regulated as a registered electronic facility (“REF”) under Subdivision 4 of Division 2 of Part II of the Capital Markets and Services Act 2007 (“CMSA”). At an appropriate juncture the ECF operator may be converted from an REF to an approved stock exchange under the CMSA.
In addition to hosting offerings, an ECF operator will provide a public communication channel to facilitate discussions about the offerings on its platform, as well as ancillary services, such as screening and preparing of standardised documents.
An ECF operator must ensure that only qualified investors participate on the platform. It is expected to carry out background checks on an issuer who will be required to provide certain financial documents to the ECF operator.
The issuer
An issuer which proposes to issue securities under the ECF framework must be a locally incorporated private company (other than an exempt private company) which may be controlled by Malaysians or non-Malaysians. Certain companies, such as listed companies and their subsidiaries, companies with no business plans and companies which have already raised RM5.0 million issued capital on ECF platforms, will not be allowed to raise funds through the ECF platform.
The shares must be a primary offering (i.e. the issue of new shares) and not the sale of issued shares by existing shareholders. The shares may be ordinary shares or preference shares and both may be offered in the same offering. However, an issuer is not allowed to raise funds concurrently on more than one ECF platform.
Limits on fund-raising
An issuer will only be permitted to raise up to RM3.0 million in a 12 month period and a total of RM5.0 million through the ECF platform. An issuer’s own capital contribution and funding through private placements will not be taken into account in determining whether the RM5.0 million threshold has been reached. Subject to the aforesaid financial limits, an issuer is allowed to accept an oversubscription provided that it has reserved the right to do so, and has disclosed to investors as to how it proposes to use the oversubscribed amount.
The above limits will not apply to an issuer which is a microfund, i.e. an entity that provides small amounts of funding to seed-stage businesses. However, the following restrictions apply to a microfund – it must be a venture capital company that is registered with the SC; it must have a specified investment objective; and it can only raise funds from sophisticated investors.
Safe harbour
The SC has stated that it is working with the Companies Commission of Malaysia to create a safe harbour provision to address the possibility that a private company may be precluded by section 15 of the Companies Act 1965 from offering its shares to the public.
Disclosure document
The offering of shares on an ECF platform will not require the SC’s approval and will be exempted from the prospectus requirements under the CMSA. Instead, an issuer must lodge a standardised disclosure document with the ECF operator when it applies to host its offering on the platform. The disclosure document will include basic information about the issuer and the offering, e.g. its objective, targeted investment amount and the offer period. The information will be provided on a self-declaratory basis.
The investor
Equity crowdfunding will be accessible to both sophisticated investors, i.e. accredited investors, high-net worth entities and high-net worth individuals, as specified in Part 1 of Schedules 6 and 7 of the CMSA, and to retail investors, i.e. those who are not sophisticated investors.
There will be no limit as to the amounts which a sophisticated investor can invest, but a retail investor will only be allowed to invest a maximum of RM5,000 per issuer and a total amount not exceeding RM50,000 in a 12 month period. An angel investor who is not a sophisticated investor is subject to the same limit per issuer but may invest a total of RM500,000 in a 12 month period.
An investor will be required to self-declare to the ECF operator that he complies with the relevant investment restrictions and to acknowledge the investment risks before he invests. To safeguard the issuer, an investor who is in breach of his investment restriction will not be allowed to withdraw his investment.
Investor safeguards
To safeguard investors, the SC proposes to adopt the ‘all or nothing’ (AON) model, whereby an issuer will only be entitled to the proceeds raised on an ECF platform if it has successfully raised the targeted investment amount, instead of the ‘keep-it-all’ (KIA) model, where an issuer will be entitled to receive the proceeds raised even if it falls short of the targeted investment amount.
A cooling-off period is proposed to enable an investor to withdraw his investment within six business days of making his investment. An investor will also be given the right to opt-out of his investment within 14 days if a material adverse change occurs which affects the issuer or the project.
To give effect to the above safeguards, an ECF operator is required to hold the amounts raised in a trust account until the specified conditions for the release of funds are met.
To provide a measure of liquidity in investments, the SC will allow investors to dispose of their shares through an ECF platform during a window period of two weeks for every six months in a year.
As acknowledged by the SC, investing in private companies comes with attendant risks; in particular, that the project or issuer may fail, the lack of an active secondary market for the issuer’s shares and the inability to obtain a return due to the issuer’s refusal to declare dividends. Time will tell whether equity crowdfunding will develop into a vibrant alternative market for private companies to raise capital in Malaysia.