Can you really earn 21% on investments?

“Earn up to 21% pa on your investments.” In an era of falling share prices and interest rates on deposits below 2 per cent, the offer sounds too good to be true. Yet this promotion from Singapore crowdfunding company Moolahsense is real, and other crowdfunding companies here advertise similar returns. Capital Match, for example, says investors will “enjoy net APR (annual percentage rate) of 15-25%.”

Clearly, investing in crowdfunding sounds like it could be far better than putting money in a bank deposit or investing in shares.

MORE THAN A DECADE OF HISTORY

Crowdfunding, which refers to funding a project or a company by raising small amounts of money from a large number of people, has actually been around for more than a decade.

Some crowdfunding firms enable many individuals to each fund part of a loan to a company and earn interest on their investment. Zopa started offering crowdfunded loans in the UK in 2005, for instance, and Lending Club in the US was founded in 2007.

Other crowdfunding companies such as Kickstarter or Indiegogo enable funders to receive a product or service in return for their investment, or simply to make a donation.

Globally, crowdfunding is growing rapidly. Research firm Massolution reported that crowdfunding totalled more than US$16 billion globally in 2014 and forecast a rise to US$34 billion in 2015, potentially exceeding the amount of venture capital funding globally. In the UK, according to innovation charity NESTA, equity crowdfunding accounted for 15 per cent of total UK seed and venture-stage equity investment.

Here in Singapore, more than half a dozen crowdfunding firms have opened up over the past several years. They offer companies an easier loan application process and sometimes lower costs than bank funding, making them very attractive for SMEs and start-ups in particular. As Singapore Venture Capital and Private Equity Association chairman Jeffrey Chi told TODAY, “crowdfunding is going to disrupt ways in which companies raise funds.”

Crowdfunding is also starting to make its way into mainstream financial services. UOB, which announced a strategic collaboration with a global equity crowdfunding platform OurCrowd earlier this month, said the venture pairs its experience in serving SMEs with OurCrowd’s expertise in equity crowdfunding.

As the industry has grown, regulators have also started to weigh in. MAS published a Consultation Paper in February 2015 proposing to allow securities-based crowdfunding to accredited investors and institutional investors initially, and also said crowdfunding sites in Singapore can advertise.

THE RISKS OF CROWDFUNDING

Individuals who want to jump in and start making loans to companies to take advantage of those higher returns can do so quite easily.

Most crowdfunding is done on the Internet, so consumers can sign up to make a loan by inputting their details into an online application at one of the crowdfunding websites. The crowdfunding company will evaluate the applicant and approve or decline the application within a day or so. Approved individuals can then go online crowdfunding firm’s website to look at information about companies that need loans and make loans to companies that need their funds. Investors usually receive monthly payments from the borrower.

While the potential returns are high, it is essential for anyone considering crowdfunding to realise that there are significant risks. As MAS describes it, the risks of crowdfunding include loss of capital, lack of liquidity, fraud, and platform closure. If a company that an investor loans to runs into difficulties or goes bankrupt, or if the crowdfunding platform shuts down, the investor could lose all their money. Indeed, Moolahsense requires investors to confirm the potential for loss by agreeing that “I understand that if the issuer defaults on the note, I may not be able to recover any or all of the invested amounts.”

The potential for losses in some cases can be significant. Data from Lending Club, for example, shows that although investors have averaged about a 7.2 per cent return on US$15 billion in loans they have made since 2007, about 4 per cent of loans have been charged off.

A study in the UK by AltFi found worse results. Data showed that about 28 per cent of companies that were crowdfunded between 2011 and 2013 either failed or were showing signs of difficulty, and the portfolio return was only 2.17 per cent.

While crowdfunding companies in Singapore have said that some companies have not paid back their loans, there is very little in any actual data about losses. Investors here too need to realise that although the returns can be quite good, there is a chance that they could lose everything they invested.

For investors without the inclination or resources to absorb potential loss, deposits with lower returns may still be preferable. For investors who have the resources to sustain a loss here or there, on the other hand, crowdfunding could be an attractive investment.