Startups, Listen Up: SEC Lays Down Rules for Crowdfunding

Many entrepreneurs have struggled with getting bank loans and traditional funding to get their businesses off the ground, but startups and small and medium enterprises can now look to crowdfunding as a means to fulfill their ventures. 

The Securities and Exchange Commission (SEC) has approved the Rules and Regulations Governing Crowdfunding (CF Rules) on July 4, which gives startups and SMEs the opportunity to finance their businesses through online crowdfunding platforms. 

“Securities-based crowdfunding can offer an alternative source of private financing for startups and SMEs,” said SEC Chairperson Emilio B. Aquino. Should a business’ crowdfunding campaigns succeed, Aquino notes that the market’s validation of a business’ value could encourage even more funding opportunities for entrepreneurs. 

What is crowdfunding?

Crowdfunding, as determined by the CF Rules, is the act of raising funds for a business or project through an online platform. Three parties must be present for it to be considered fundraising: the issuer (entrepreneur), the investor (supporters), and the intermediary (platform). The platform connects entrepreneurs to supporters, who then contribute a certain amount of money to an entrepreneur’s business using the online platform.

Most people have probably encountered donation-based crowdfunding, where individuals donate their funds to support a charitable cause, and reward-based crowdfunding, in which individuals get a “reward” in return for their monetary contribution to a company.

These two types of crowdfunding will not be subject to the CF Rules as the nature of their fundraising does not promise securities or financial returns. Instead, it will be the two other types of crowdfunding that will be subject to CF Rules.

These are lending-based crowdfunding, in which individuals loan money to a company who must then, in a legally-binding commitment, promise to repay the loan at a specific time and interest rate; and equity-based crowdfunding, in which individuals invest in shares sold by a company and receive a portion of the profits in the form of a dividend or distribution. 

Breaking down the CF Rules

For issuers

• CF transactions must be done exclusively through registered CF intermediaries, which may be a registered broker-dealer, investment house, or funding portal.
• The amount of securities that can be sold by an issuer within a 12-month period is limited to P10 million to any investor and P10-50 million to qualified investors.
• Issuers must submit annual reports and progress updates on the issuer’s development in achieving the target offering amount

For investors

• The amount of total investments of any investor across all issuers within a 12-month period is limited to a maximum value of five percent of the total annual income of investors with an annual income of up to P2 million; and a maximum value of 10 percent of the total annual income of investors with an annual income of more than P2 million.
• An investor must be allowed to cancel an investment until 48 hours prior to the issuer’s deadline 

For intermediaries

• CF intermediaries must maintain a capital amount that exceeds its annual operational expenditures
• CF intermediaries must disclose and display on its platform any relevant information relating to its crowdfunding activities, such as issuer information, fees, charges, information on investor rights, etc.
• CF intermediaries must deliver educational materials to investors on the process of investing on their platform, the types of securities available, restrictions on the resale of securities, and all the risks associated with the entire process
• CF intermediaries must provide a channel for investors and issuers to communicate with each other
• If an issuer does not complete an offer, an intermediary must issue refunds to the investors

Why was it necessary to set up rules?

In a press statement, SEC explained that in an effort “to promote capital market development and access to finance, the CF Rules provides an exemption from registration of CF securities provided the issuer, intermediary, and investors comply with the CF Rules.”

Without the CF Rules, entrepreneurs pursuing lending-based and equity-based crowdfunding activities would have to abide by Section 8 of the Securities Regulation Code which states that securities shall not be sold or offered for sale or distribution within the Philippines, without a registration statement duly filled with and approved by the Commission.

The CF rules also protect investors from abuse and fraud that might come about with unregulated funding activities. 

With crowdfunding now regulated and monitored, startups and SMEs that once struggled with bank loans and traditional funding can take full advantage of the opportunity that crowdfunding offers.