It is little wonder that investors are always on the lookout for other means of increasing their wealth when interest rates for fixed deposits are meagre to say the least, and the stock market has not been performing too brilliantly of late.
Enter Equity Crowdfunding and Peer-to-Peer Lending.
It is clear that the popularity of crowdfunding is rapidly growing, judging by the number of queries I have received. Coming from a professional standpoint, I see an urgent need to make sense of what this means to you as an individual investor, and offer some guidelines to follow, especially when investing in this brave new world of investment opportunities.
Crowdfunding – In brief
To briefly sum it up, crowdfunding is the practice of funding a project or venture by raising small amounts of money from a large number of people, typically via the Internet. The 2 pertinent forms of crowdfunding that have gotten investors all excited are Equity Crowdfunding (ECF) and Peer-To-Peer Lending (P2P).
ECF is essentially a fundraising campaign where people invest in a company (commonly SMEs) in exchange for shares in that company. As a result, the investor becomes a partial owner of the company and has an opportunity to partake in the profits of the company should it do well. The investor also stands to gain from the eventual sale of the shares in the company if it continues to be successful and goes public in the future.
P2P on the other hand is the practice of lending money to individuals or businesses through online services that match lenders with borrowers. The lender (investor) will be repaid his loan back at fixed intervals with interest included.
In Malaysia, equity crowdfunding and P2P financing platforms are regulated by the Securities Commission, making us the first country in the ASEAN region to put in place a regulatory framework for both. Currently, there are six equity crowdfunding platforms and six P2P platforms registered with the Securities Commission.
The Pull of ECF And P2P
Equity crowdfunding has become an increasingly popular way for early-stage and early-growth companies to tap investors attracted by the potential for high returns. An investor who has spent the last couple of years lamenting over the lacklustre performance of his stocks sees ECF as an investment channel that claims to offer even better returns. Moreover, as the ECF investment companies are unlisted on the stock exchange, there is lower correlation between the performance of these companies and that of the stock market. While it is likely that some ECF investments can go bust or not even give back the original investment, the right companies for the lucky investors could also become extremely successful in which case the returns can be multiple times the initial amount.
From an investment standpoint, ECF investments do allow investors to achieve portfolio diversification by spreading their investments across a myriad of opportunities.
P2P investors on the other hand, are not so much looking to own a share of the company but rather, they want a regular payback of their money plus some interest.
P2P investing is garnering a lot of interest from would-be investors who are looking for something different and better than bank fixed deposits. P2P offers investors the ability to diversify and enter in many different loan opportunities with a relatively low minimum amount. They are also persuaded by higher returns than fixed deposit investment, less volatility compared to shares or unit trust funds and ultimately the promise of fixed monthly payments with more certainty of return.
But as with any form of investment, investors need to be mindful of what they are getting into no matter how attractive the package looks.
ECF means investing in very early stage businesses and as such, there are inherent risks to be aware of such as the likelihood of bankruptcy, in which case, you will not be able to recover your original investment. A case in point would be the Rebus Group collapse. Noted as the largest crowdfunding failure in the UK to date; Rebus’ investors are liable to lose their entire stakes as crowdfunded investments are not covered by the Financial Services Compensation Scheme.
Further, those who are hoping to see their investments in ECFs pay off within the short term may be in for a disappointment as returns will not be immediate. This is because companies will tend to reinvest any profits back into the business for growth rather than pay out dividends to shareholders. If you invest in ECFs, you may also be faced with liquidity issues as it may take a long time to sell your shares.
While ECF offers an opportunity to gain access to company equity ownership, it is not a substitute for listed shares as the latter is directly regulated or governed by Bursa Malaysia. In addition, listed shares has a ready market to trade your stock holdings anytime, subject to the market price of course.
With P2P investing, the most obvious risk that comes attached is of course the possibility of the borrower defaulting on the debt. As the reasons for not being able to repay the loan are typically financial, any subsequent attempts to recover your investment may prove futile if the business indeed has gone under.
Despite its offer of fixed potential return over an agreed tenure, P2P investments are not a substitute for fixed deposits. The risk profile and certainty of capital and interest payments are different. Moreover, while banks are backed by BNM and deposits protected by PIDM, no such framework exists for companies soliciting P2P.
Key Tips to Investing
At the end of the day, it boils down to personal choice. As with any new investment scheme that is yet untried and untested, the warning of caveat emptor should always apply. Nonetheless, from a professional standpoint, I wish to impart a few precautionary measures for investors out there before they make the plunge.
- Know where ECF and P2P stands in your strategic asset allocation. Be mindful that they are considered high risk investments for the mere fact that the SC has categorised investors into 3 classes – sophisticated, angel and retail; each with its respective criteria and investment cap. As a rule of thumb, it is advisable to invest not more than 2% your total investable capital in crowdfunding.
- Ensure you are investing in best of breed by comparing apple to apple when it comes to risk vs returns. This requires a fair bit of homework but your diligence may save you a lot of pain and heartache down the line.
- a) Ensure the platform is approved by SC; subsequently research each platform to compare their track record.
- b) Research each scheme on the platform as not every one is the same. While the platform operator conducts background checks on companies using the platform, it does not hurt to dig for further information on your own.
- c) Read the fine print in the platform operator’s agreement and know the rights and liabilities of each party. Pay particular attention to the risk warnings in the agreement with regards to potential loss of invested capital and the unsecured nature of the investment (for P2P).
- Diversification is key. To reduce the risk, diversify your investment into different schemes on different platforms.
- Monitor how your investments are performing. Even though there is not much you can do to recall your investment immediately, at least prepare yourself mentally for possible scenarios.
- Consider the time required before you see your investments come to fruition. Dividends are rare from start-ups and you may only see return on your capital when you are able to sell your shares in the business which may take a number of years. Is the investment worth the waiting and the risk, considering so much time and effort is needed to research on it?
One cool judgement is worth a dozen hasty councils – Thomas Woodrow Wilson, 28th President of the USA
Investment opportunities come and go all the time. It is logical for investors to be on the lookout for alternatives to their existing investments which have been producing less than impressive returns lately. However, do not lose sight of your own investment goals while in pursuit of the proverbial pot of gold at the rainbow’s end. A certain investment scheme may be all the rage right now but it may not necessarily be suited for everyone. Remember how thousands of unsuspecting individuals succumbed to peer pressure and threw their life savings into money games? Herd mentality is bound to rear its head every time something new comes into the market. This is where rationale and self- discipline differentiates a prudent investor from the crowd.