Tapping into Crowd Power with Website Finance

Investing like an angel now costs no more than an average duck dinner in Beijing.

The force driving China’s growing ranks of small-scale angel investors are crowdfunding websites, which offer individuals access to business financing pools for as little as 100 yuan each.

But these websites are operating in a regulatory gray area in China. And investors are called to give money for flimsy returns: In one case, they were rewarded for their financial backing with scarves in lieu of cash.

Online crowdfunding started in China last year and since then has dramatically lowered thresholds for entry in an investment realm usually dominated by venture capital firms with deep pockets.

Website companies such as Demohour and Dreamore popped up with funding platforms to serve small business owners with big ideas. They’ve built money pools via electronic networks linking small investors, and then doled out cash to businesses.

The scheme, pioneered in the United States, lets complete strangers collaborate to support an entrepreneur whose bright idea they like. Because each contribution is small, individual investors bear little risk.

But unlike crowdfunding in the United States, where the networks were formally legitimized in May when President Barack Obama signed a new law for business fund-raisers, China’s small-investor websites have yet to receive regulatory attention.

Some legal experts have suggested the websites may violate Chinese laws against illegal fund-raising in the financial sector.

“Determining whether an act constitutes illegal fund-raising depends on whether it raises money from unspecified persons and also on the types of returns,” said Tao Yusheng, a lawyer at the Beijing Dacheng Law Office.

Popular Funding

Dreamore officials say their website has raised more than 200,000 yuan combined for more than forty start-up businesses and entrepreneurial projects since it was established in September 2011. An average investment is 114 yuan.

Altogether, Dreamore has approved platforms for seventy fund-raising requests. Some are still waiting for investors, and about a dozen failed to raise enough from interested investors to meet the system’s minimum requirements, said website founder and chief Du Mengjie.

Demohour, which celebrated its first anniversary in July, boasts a better record. The company has to date raised nearly 3 million yuan for 150 of the 318 businesses that it approved for platforms. And it has gotten more than 5,500 financing requests, said website co-founder and CEO Zhang You.

The average contributed by each angel was 107 yuan, Zhang said, and the highest amount raised for a single project was 339,480 yuan.

Dreamore, Demohour, and other Chinese crowdfunders have followed the business model crafted by operators of a website called Kickstarter. Founded in New York in 2009, Kickstarter says it has raised about US$350 million for some 30,000 initiatives from more than 2.5 million people.

Like their U.S. counterpart, Demohour and Dreamore officials review each project proposal but approve and launch a crowdfunding platform only for those with solid potential. They weigh factors such as company’s goals and the intended use of the financing before giving a green light.

Demohour, like Kickstarter, collects a commission equal to 10 percent of the money raised on a platform. Dreamore plans to start charging commissions after the business gets bigger, Du said.

Yet Dreamore has yet to turn a profit: It reported having lost more than 100,000 yuan since its establishment last year.

“Right now, we are fully concentrating on improving the business,” Du said. “Size brings status.”

Legal Twists

Legal doubts are also affecting the planning process at crowdfunding website companies, in part because so far Chinese government regulators have kept the phenomenon at arm’s length.

Indeed, not a single regulator has openly addressed crowdfunding issues. And Du said he’s gotten mixed signals from the several lawyers he’s consulted.

An official at the China Securities Regulatory Commission said that in his opinion limited-finance crowdfunding websites meet legal requirements.

“I don’t think there would be any problem as long as the financing remains on a small scale,” the official said. “It boils down to risk management” at these companies.

“At present,” he added, “we plan to leave them alone.”

Yet website operators including Du and even heavy-hitters in the nation’s financial community have expressed hope that regulators will eventually get behind this increasingly popular form of investing.

China Investment Corp. Vice President Xie Ping, for example, has called on regulators to openly support crowdfunding as a valuable financing trend for the Internet era. He especially likes the schemes because they can reduce business fund-raising costs.

Du, meanwhile, has set the stage for formal government backing by refining his business model and improving risk controls. For example, his company is now distributing platform funds to start-ups in stages instead of all at once: An installment is paid after performance goals are met.

But returns for crowdfunding investors in China can be remarkably unlike the cash and shares earned by most traditional investors.

A film industry start-up, for example, may pay dividends to small crowdfunding supporters in the form of movie tickets, or by adding their names to a movie’s credits.

Two young women who attend Fudan University in Shanghai recently used a Dreamore platform to raise money for an environmental protection project. After its success, they rewarded each investor with a handmade scarf.

Small investors typically respond to project proposals if they sympathize with the entrepreneur’s motives, Du explained.

Indeed, Du can relate to the youthful passions that can rally small investors around start-ups such as the Fudan students’ project.

“I took a year off when I was a senior in college, full of traveling dreams,” he said.

“But my family was against the idea,” Du said. “So I went online for help” and raised 60,000 yuan from a group of strangers. He used the money for an overseas journey, and after coming home founded Dreamore.

“When others share a dream with you but don’t have the time or energy to realize it themselves, there’s a chance they’ll support you,” he said. “Then you can go for it.”

Start-Ups, Investment