China crowdfunding: The madding crowd

In the battle between China's e-commerce giants to corner equity-based crowdfunding, JD.com appears to have stolen a march. JD Equity Crowdfunding launched at the end of last month, while a platform supported by Alibaba Group affiliate Ant Financial is said to be still in its preparatory stages.

The two companies already have reward-based systems, with JD Crowdfunding holding a 31.6% market share to Taobao Crowdfunding's 8.9%. Reward-based crowdfunding in China grew by 123.5% to reach RMB440 million ($71 million) and it's expected to hit RMB15 billion this year, according to iResearch Consulting Group.

While the reward-based model sees investors receive small gifts in return for supporting projects, an equity-based system involves taking stakes in start-ups. It is a natural point of call for traditional venture capitalist firms seeking deals. With JD.com and Alibaba now focusing on the market, will these platforms become scalable mechanisms through which entrepreneurs can secure funding at seed and pre-A stages?

"Equity crowdfunding platforms are controversial in China. There are a bunch of these platforms operating at small scale and I think most of them are doomed to fail," says Harry Wang, a founding partner at early-stage VC firm Linear Ventures. "JD.com could be an exception as it might attract deals of higher quality. However, the best firms won't go to these types of platforms to raise money."

Regulatory uncertainty

Equity crowdfunding is a new to China but there are a few homegrown platforms. AngelCrunch was an early entrant, launching in 2011, and it has been joined by the likes of AngelClub and Dajiatou. Ping An Insurance has also registered a crowdfunding subsidiary.

They operate in gray area from a regulatory perspective. Raising capital from individuals for unqualified investment products could be seen as illegal fundraising. In 2013 online video distributor Media.V turned to Alibaba's C2C e-commerce site sell a 25% stake to the public after failing to win support from VC firms. A total of 1,194 investors committed RMB3.87 million, prompting an investigation by the Chinese Securities Regulatory Commission (CSRC).

Then last November Premier Li Keqiang said the State Council would allow equity crowdfunding pilot programs. He emphasized that these platforms should be seen as a new financing channel for start-ups.

"I don't think the regulators will open equity crowdfunding for everyone, because it involves complex shareholding structures and post-investment portfolio management," says Raymond Wang, managing partner at Beijing-based law firm Anli Partners. "A limited numbers of qualified investors will be allowed to participate in these transactions, which aren't really in line with the concept of crowdfunding."

In December, the Securities Association of China (SAC), an agency under the CSRC, published draft rules for equity crowdfunding. To qualify as an accredited investor, an individual must: invest at least RMB1 million in a single project; have net assets of RMB10 million; and have financial net assets of at least RMB3 million or an average annual income of RMB500,000 for the past three years. The total number of investors in a single project is capped at 200.

"These platforms are required to carry out background checks on investors. JD.com has been cautious to make sure investors meet certain standards, which will bring more public credibility," Wang adds.

To build up investor confidence, JD's Equity Crowdfunding has introduced a lead-and-follow mechanism. Institutional VC firms and angel funds will source deals - around 10 in each batch - and lead the investment rounds. Individual investors can participate alongside them.

Capital Today, ZhenFund, Sequoia Capital and Gobi Partners are among the VC firms to introduce deals. Gobi suggested two - snack food brand Jacky's Shrimp and an travel portal Directions Travel - and tried to raise RMB6.5 million. Each deal was over-subscribed.

"Crowdfunding will become an important component of the Chinese start-up community. However, only JD.com has come up with a solution in terms of motivating high net wealth individuals, start-ups and VC investors to participate, as well as generating exits," says Don Jiang, a partner at Gobi.

Start-ups publicize their products through JD.com's retail channels, and VC players factor the market response into their investment decisions. When a start-up reaches its crowdfunding target, the individuals sign agreements mandating the lead investor to manage the deal. They then exit alongside the VC firm at the appropriat time.

In China, more angel investors want to put money into start-ups but it is usually difficult for them source quality deals. They may also not have sufficient capital to invest in a clutch of start-ups consecutively.

"Seed round valuations have risen to RMB2-5 million from below RMB1 million a few years ago. Crowdfunding allows people to invest smaller amounts across multiple deals and build portfolios - ideally with 20 start-ups," Jiang says.

Limited access

However, won't have access to a wide range of sectors. The VC firms will favor consumer goods-related businesses on the basis that non-professional investors are unlikely to fully understand more complicated, technology-focused companies, making it harder for those start-ups to get traction. Furthermore, not every founder would want to try crowdfunding if a traditional VC round is available.

To this end, VCs not directly involved in the platform are skeptical about its potential as a source of deals for them. Indeed, for the lead VC investors, the primary function might not be to raise capital as much as use the publicity to market their portfolio companies' products.

"Unlike online P2P lending and group-buying platforms, which can be standardized by selling products at certain prices, early-stage investments can't be standardized. It's a personal choice," says Linear's Wang. "Crowdfunding platforms to me could only serve as an information broker. Start-ups need investors to provide supports beyond capital. How can these platforms provide any additional helps?"

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• Topics
• Greater China
• Venture
• Early-stage
• Technology
• Consumer
• China
• Venture
• seed
• Crowdfunding
• JD.com
• Alibaba Group
• TMT
• Consumer