Written by: Oscar Wong
In Hong Kong, crowdfunding is often a difficult task. For companies that intend to crowdfund, compliance with Hong Kong’s laws is burdensome, expensive, and time-consuming. Hong Kong’s laws also complicate and thus discourage lending in the crowdfunding context by requiring lenders to be licensed. As a popular and convenient way for startups and small businesses to raise capital, the importance of crowdfunding to entrepreneurship provides a solid case to introduce new legislation for crowdfunding in Hong Kong. This note will proceed in two parts. Firstly, it will explain the concept of crowdfunding and the difficulty to crowdfund under Hong Kong’s laws in capital raising. Secondly, the article will consider the benefits of crowdfunding, arguing that new laws are required to facilitate crowdfunding in Hong Kong.
What is crowdfunding
Crowdfunding is the use of a small amount of money, obtained from many individuals organisations to fund a project or a business through an online web-based forum.[1] There are four types of crowdfunding.
1) "Peer-to-peer lending" ("P2P lending"), or loan-based debt crowdfunding: individuals or companies lend money in return for interest payments and a repayment of capital over time.
2) "Equity crowdfunding", or investment-based crowdfunding: individuals or companies invest directly or indirectly in new or established businesses by investing in the company or campaign, through a variety of forms. Once the online platform completes the equity raising, each of the investors hold an equity stake in the business or project,44 for example, as shareholder.
3) Donation crowdfunding: Payer donates money to fund a project or cause.
4) Reward crowdfunding: Payer receives physical products or services in exchange for their contributions.
Crowdfunding first entered public consciousness in 1997, when a British rock band funded their reunion tour through online donations from fans.[2] In the years following the 2008 financial crisis, crowdfunding quickly emerged as a popular way for entrepreneurs and businesses to raise capital due to tightened credit standards for obtaining loan facilities from banks. Crowdfunding’s popularity must be viewed considering the increasing prevalence of social media and easier internet access, which have facilitated the promotion and use of crowdfunding platforms online. Today, crowdfunding is a booming sector-- the global crowdfunding market is set to grow by $196.36 billion in the next four years. This global growing trend, however, is somehow juxtaposed by Hong Kong’s laws, which have the effect of discouraging individuals and companies from crowdfunding.
Hong Kong’s laws on crowdfunding
Crowdfunding in Hong Kong is subject to the laws on conventional capital raising. The legal framework is set out by four ordinances: the Money Lenders Ordinance (Cap. 163) (‘MLO’), the Companies Ordinance (Cap. 162) (‘CO’), the Companies (Winding Up and Miscellaneous Provisions) ordinance (Cap.32) (‘CWUMPO’) and the Securities and Futures Ordinance (Cap. 571) (‘SFO’). Under the legal framework, companies who wish to participate in equity crowdfunding and lenders in P2P lending are subject to comply with numerous (burdensome) requirements.
Equity Crowdfunding
The requirements that a company must fulfill to lawfully participate in equity crowdfunding differ depending on the nature of the company. For a public company, it must issue a prospectus before offering shares or debentures to the public.[3] The company must also seek approval from the Securities and Futures Commission (SFC) before publishing any advertisement or invitation to the public regarding the offering of shares or debentures.[4]
Compliance with these requirements is clearly costly and time-consuming. In particular, small public companies that do not attract much public attention, the costs of equity crowdfunding would often be disproportionate to the amount of money raised.
Part of the struggle faced by public companies is that exemptions from the requirements to issue a prospectus and seek the SFC’s approval provided by the CWUMPO are inapplicable in the context of crowdfunding. A company may be exempted where the offer of shares or debenture is limited to professional investors[5] or a group fewer than 50 people,[6] or where the total consideration payable for the shares or debentures exceeds HKD 5 million. Since crowdfunding offers are made to the public through online portals, it is almost impossible to limit the number or the type of investors. It is also highly improbable that investments over HKD 5 million will be made, particularly for smaller companies and startups whose ventures are financially riskier.
As to private companies, invitations to the public to subscribe for its shares or debentures are prohibited.[7] Private companies that make invitations for its shares or debentures must take steps to ensure that the offer is not transferred by the intended recipient to any third parties. Since invitations may not be extended to the public, money raised is often limited and again often disproportionate to the costs incurred to comply with the legal requirement.
P2P lending
Lenders engaging in P2P lending are required to be licensed unless they do not ‘carry on business as a money lender’.[8] The licensing requirement is burdensome to comply with: licenses are subject to annual renewals and the conditions for the grant of a license are stringent and costly. For instance, a license applicant is required to submit a detailed business plan for the money lending business which includes, inter alia, information on its sources of funding and financial forecasts. Besides, to demonstrate that the applicant is fit and proper to lend, it must put in place procedures and controls to prevent money-laundering and terrorist-financing.
The burden of the licensing requirement ought to be considered together with the markedly limited circumstances under which lenders may be exempt from the said requirement. Since ‘carrying on business’ is not defined by statute, the inherent flexibility of the phrase has allowed the courts to adopt an expansive interpretation. To demonstrate the expansiveness, a lender may be deemed to ‘carry on business’ in money lending even if it only relates to a negligible part of its business (ie half a percent)[9] or simply on the basis that it lends indiscriminately to various types or classes of borrowers.[10] Moreover, a mere repetition or system in making loans may also be considered as evidence of ‘carrying on a business’ in money lending.[11] Since the court’s discretion is required to determine if the number of loan transactions is sufficiently numerous to suggest a repetition or system in money lending, lenders who wish to avoid the licensing requirement also face significant uncertainty.
The burden to apply for a license and the difficulty to avoid it chill companies and individuals who wish to lend in the context of crowdfunding. To avoid the risk of liability under the MLO, lenders ‘play safe’ and only lend very scarcely or only to a limited group of individuals or companies. The desire to ‘play safe’ in turn leads to a paucity of willing lenders which discourages P2P lending altogether.
The case for new crowdfunding legislation: The benefits of crowdfunding
Crowdfuding boasts numerous advantages over raising capital through bank loans.
Whereas the application process for a bank loan is time-consuming and complicated, a loan can be approved from a P2P lending platform within hours of completing an online application. Besides, P2P platforms provide easier access to capital. Considerations that usually deter a bank from granting businesses a loan, such as insufficient collateral or operating history, are often set aside by P2P lending platforms. The reason is that vetting, or screening processes of P2P lending platforms are less stringent because the platform does not lend their own funds and thus does not bear the attendant risks.
Further, P2P lending entails significant non-financial benefits. One corollary arising out of the public collection of funds is that businesses acquire the opportunity to connect with their investors. The opportunity to connect allows businesses to identify potential customers and test business ideas to predict their profitability.
As to equity crowdfunding, while it effectively offers equity shares to investors akin to an initial public offering, it is unburdened by the strict accounting and reporting standards required for public listing companies. Above all, equity crowdfunding is a win-win: entrepreneurs have no duty to repay a fixed sum (together with interest) and the investor has the possibility of participating in very significant value growth as the inchoate business concept progresses into a viable enterprise. Neither party bears the regulatory costs associated with a traditional public offering.
The picture that emerges is that crowdfunding is a desirable way for businesses, and in particular SMEs, to raise capital. By facilitating access to capital, crowdfunding drives entrepreneurship and encourages businesses to grow and innovate. In fact, reward and donation crowdfunding have already contributed to the realisation of several interesting business projects in Hong Kong. In 2015, visual artist Rachel Ip raised HK$25,000 to create a photobook titled 100 Self-Portraits of Hongkongese, and designer Joe Kwan raised over HK$292,000 to produce an innovative watch.[12] If the legal barriers to P2P lending and equity crowdfunding may be lifted, Hong Kong will undoubtedly see a flourishing of entrepreneurship providing inventive business ideas in the form of new goods and services.
In view of the benefits of crowdfunding, the Hong Kong Financial Services Development Council published a report specifically on reforming the regulation of equity crowdfunding in Hong Kong on 18 March 2016.[13] Recognising the burdensome requirements that exist in the legal framework, the report proposed to create conditional exemptions for public companies from the prospectus requirement. One of the exemptions is proposed to be invoked where the company provides investors with disclosure equivalent to that required at the annual general meetings of public companies under existing Hong Kong company law.[14] While the report is to be welcomed as a much-needed attempt to rework the legal framework on crowdfunding, the report provides only a partial resolution to facilitate crowdfunding in Hong Kong. Notably, P2P lending as well as reward and donation crowdfunding are overlooked in the report.
Conclusion
New legislation should be introduced to facilitate crowdfunding in Hong Kong. The existing laws have the effect of discouraging crowdfunding by imposing burdensome requirements on both companies that wish to participate in crowdfunding and lenders. A regulatory framework for crowdfunding with less stringent requirements is thus desirable and would be highly complementary to the aims of existing projects in Hong Kong, such as Cyberport and the Hong Kong Science and Technology Park. Factoring in Hong Kong’s low tax rates and the city’s proximity with the world’s second largest economy in China, Hong Kong has the potential to become a major regional hub for innovation and entrepreneurship if the existing barriers to crowdfunding were reduced.
[1] E.Kirby, S.Worner,‘Crowd-funding: An Infant Industry Growing Fast’ (Ioscoorg,2014) [2] <https://www.fundable.com/crowdfunding101/history-of-crowdfunding> (accessed 10 June 2021) [3] Sections 2(1) and 38 of the CWUMPO [4] Section 103(1) SFO [5] Section 3 of Schedule 17 of the CWUMPO [6] Section 2 of Schedule 17 of the CWUMPO [7] Section 11(1)(a)(iii) of the CO [8] Sections 2 and 7 of the MLO [9] North Central Wagon Finance Co. Ltd. v Brailsford [1962] 1 W.L.R. 1288 [10] Litchfield v. Dreyfus [1906] 1 KB 584 [11] Edgelow v Macelwee [1918] 1 K.B. 205 [12] ‘Ten great Hong Kong projects made possible by crowdfunding' (SCMP,26 August, 2015) <https://www.scmp.com/lifestyle/article/1852694/ten-great-crowdfunded-projects-hong-kong-connection> accessed (10 June 2021) [13] Hong Kong Financial Services Development Council, ‘Introducing a Regulatory Framework for Equity Crowdfunding in Hong Kong’ (FSDC paper no.21, 2016) [14] Ibid