In 2012, Palmer Luckey embarked on a Kickstarter project to fund Oculus Rift—a virtual reality headset that allowed gamers to step into video games rather than play them on-screen. The Kickstarter campaign raised US$2.4 million, a striking 974 percent more than it set out to, with absolutely no strings attached. Back then, supporters were driven mainly by an affinity with the idea and the opportunity to receive items like posters, t-shirts and developer kits in return for their contributions. When Facebook acquired Oculus for US$2 billion, perhaps some of Oculus' early supporters wished that they had gotten more than a developer kit.

Crowdfunding allows individuals and companies to obtain funding (usually in small amounts) from several investors or supporters. There is nothing particularly innovative about that. What is innovative is that the rise of this alternative source of funds has been fueled by technological advancements. With dedicated social media and crowdfunding platforms emerging rapidly, small entrepreneurs are able to reach out to pretty much anybody with Internet access to garner support for their product or business.

Crowdfunding is usually a straightforward process if people are willing to support an entrepreneur in return for nothing (donation crowdfunding) or for a small reward, such as the final product to be made by the entrepreneur (rewards-based crowdfunding).

However, crowdfunding is not a straightforward process, at least in Singapore, if people are willing to support an entrepreneur in exchange for shares issued by the startup (investment-based crowdfunding). At that point, entrepreneurs would be making an "offer of securities." Depending on the structure of the entrepreneur's business, even more complex regulations relating to collective investment schemes may also be triggered.

Investors vs. Entrepreneurs

In Singapore, any person making an offer of securities must issue a prospectus unless the offer falls within a safe harbour (private placements, small offers, offers to institutional or accredited investors, etc.). This is because, at least in theory, a prospectus contains all the information that investors require to make an informed decision.

This may be less-than-favorable news for investment-based crowdfunding. Issuing a prospectus is expensive and cumbersome, and none of the existing safe harbours are suitable to facilitate investment-based crowdfunding.

The consultation paper on crowdfunding published by the Monetary Authority of Singapore (MAS) earlier this year did not have any indication that prospectus requirements would be relaxed to allow for investment-based crowdfunding. The proposal is to simply limit investment-based crowdfunding to accredited and institutional investors. This would basically eliminate the possibility for startups to use investment-based crowdfunding in Singapore as a viable fundraising tool.

The MAS acts responsibly when it protects investors. Investing in any company is risky. But it is extremely risky if the company is a startup: It is estimated that over 90 percent of startups fail in the first three years of being established.

However, the law should encourage entrepreneurs and innovation without leaving investors to their own devices. Easier said than done, of course. But times have changed and so should the law.

Finding the Right Balance

A number of countries, including the United States, the United Kingdom, New Zealand and Canada, have found or attempted to find some balance between protecting investors and allowing startups to use crowdfunding as an effective fundraising tool.

Drawing from the experience in other jurisdictions, Singapore could consider creating a flexible investment-based crowdfunding regime, including the following principles:

1. Crowdfunding should be open to anybody with legal capacity and not just to accredited and institutional investors.
2. The total amounts to be raised under crowdfunding campaigns should be kept small, for example, up to S$2 to S$3 million.
3. Non-accredited investors should be subject to maximum investment limits both in respect to a single crowdfunding campaign and on a consolidated basis. For instance, limits of up to S$2,000 per campaign and up to S$20,000 for all campaigns annually.
4. No prospectus or similar document should be required for a crowdfunding campaign. Platforms should decide the minimum information to be disclosed in respect to a campaign and conduct some basic due diligence on the company that intends to raise funds.
5. Platforms should make it abundantly known to investors investing in any crowdfunding campaign that the risks involved are exceptionally high.
6. Platforms should also keep investors' monies safely and release them only once a campaign is successful.

Great Expectations

Even if a good and flexible capital markets and regulatory environment is created, startups, investors and platforms should understand the complexities of this global phenomenon. They should consider at least a few points:

• Traditional early investors, such as venture capital funds, provide important support, knowledge and contacts to startups. The importance of these traditional early investors should not be underestimated and startups without that kind of support may find it more challenging to succeed.
• Startups that successfully raise funds through investment-based crowdfunding may end up with a large number of shareholders at an early stage. If the number of shareholders exceeds 50, a Singapore startup would need to be converted into a public company. A public company has to comply with a relatively stricter regulatory regime and is more costly to maintain.
• Securities issued under a crowdfunding campaign are not listed on any stock market. This illiquidity may pose difficulties in finding a willing buyer for those securities. Investors may therefore need to wait for an IPO or a trade sale to cash out on their investment, but that may never happen.
• Platform operators will need to have in place robust compliance systems (as they should be licensed) and perform their own basic due diligence in an attempt to run campaigns for reliable and promising startups only. But the business flow may be slow and as the amounts at stake are not high, it may be challenging to cover the costs of running a relatively sophisticated operation. They also need to be prudent about what they say or do, lest they end up being subject to additional licensing requirements under the Securities and Futures Act or the Financial Advisers Act of Singapore.

Embrace Change

Investment-based crowdfunding may not become a significant means of fundraising. Its donation or rewards-based cousins may remain more relevant, as it has been proven that people are happy to simply support a business idea they believe in or give a chance to a bright entrepreneur. Venture capital funds and traditional early-stage investors are not going anywhere and will remain as relevant as ever in providing support to startups.

However, Singapore should embrace all types of crowdfunding. If people are willing to invest small amounts in startups and they wish to have the opportunity to potentially benefit from it, that should be their prerogative. Practical safeguards that will not make it overly expensive to raise funds, as discussed above, should be put in place.

About Duane Morris & Selvam LLP

Duane Morris & Selvam LLP provides compliance solutions to companies around Asia in the areas of anti-bribery, anti-money laundering and anti-tax evasion, among others. Look out for our complementary compliance training sessions.

The content of this update is of general interest and is not intended to apply to specific circumstances. The content should not therefore, be regarded as constituting legal advice and should not be relied on as such.