Topic 3 - Digital Financing PDF

Leading Future Minds PROF MADYA DR MOHD FAIZAL BASRI, 2024  TOPIC 3: DIGITAL FINANCING PROF MADYA DR MOHD FAIZAL BASRI, 2024  Contents What is digital financing? Peer-to-peer (P2P) financing C...

Leading Future Minds PROF MADYA DR MOHD FAIZAL BASRI, 2024  TOPIC 3: DIGITAL FINANCING PROF MADYA DR MOHD FAIZAL BASRI, 2024  Contents What is digital financing? Peer-to-peer (P2P) financing Consumer financing Alternative financing Crowdfunding 3 PROF MADYA DR MOHD FAIZAL BASRI, 2024  What is Digital Financing? 4 PROF MADYA DR MOHD FAIZAL BASRI, 2024  What is Digital Financing? Definition: Digital financing involves financial services delivered through digital channels. Purpose: Aims to enhance accessibility, convenience, and affordability. Example: PayPal – initially created as a digital payment platform, now a global financial solution. The biggest change has probably been the introduction of peer-to-peer lending. A significant amount of funds have gone into this space over the last decade, and even though the business model of these companies is still fluctuating. The use of advanced analytics to inform credit scoring and eligibility for lending is another significant innovation. 5 PROF MADYA DR MOHD FAIZAL BASRI, 2024  Evolution of Financing Early Lending Practices Pawnbrokers: First lenders, used collateral to secure loans (origin of "secured lending"). Middle Ages: Christians barred from charging interest; Jews permitted to lend to non-Jews with interest. Origins of "Bank": Moneylenders sat on benches ("banca"); broken bench ("banca rupta") led to "bankrupt." 6 PROF MADYA DR MOHD FAIZAL BASRI, 2024  Evolution of Financing Growth of International and Residential Lending Rothschild Family: Mayer Amschel Rothschild's sons created an international banking network in the 18th century, becoming incredibly wealthy. Building Societies: Emerged in 18th-century UK taverns; Ketley’s Building Society (1775) pooled funds for housing. Philadelphia Savings Fund Society: Established in the early 1800s for savings and loans for Americans. 7 PROF MADYA DR MOHD FAIZAL BASRI, 2024  Evolution of Financing Key Innovations in Lending and Credit (20th Century) Federal Home Loan Bank System (1932): Created a foundation for U.S. residential mortgage lending. Credit Card Invention: Frank McNamara introduced the Diners Club Card (1950). McNamara came up with the idea after forgetting his wallet at a restaurant and realising he needed a way to pay at multiple establishments. BankAmericard (now Visa) and American Express followed in 1958. The First American National Bank of Nashville created the MasterChargecard, now known as MasterCard (1967) Credit Scores: FICO scores adopted in 1959 to help lenders assess creditworthiness. 8 PROF MADYA DR MOHD FAIZAL BASRI, 2024  Evolution of Financing Advances in Mortgages and Online Lending First Reverse Mortgage (1961): Offered to Nelly Young by Deering Savings and Loan. Freddie Mac (1970): Established to create a secondary market for traditional mortgages. Online Lending Growth: Quicken Loans introduced online mortgage applications in 1985; First Internet Bank launched in 1999 as the first online-only bank. 2000s: Rise of digital wallets. 2010s: Introduction of blockchain and FinTech platforms. 9 PROF MADYA DR MOHD FAIZAL BASRI, 2024  Peer-to-Peer (P2P) Financing 10 PROF MADYA DR MOHD FAIZAL BASRI, 2024  Definition of P2P Financing Description: Direct lending between individuals through online platforms. Peer-to-peer (P2P) is an interaction between two parties with no intermediary. This was a term originally used in computer networking, but it now has various uses, from peer-to-peer file sharing to peer-to-peer lending. P2P lending or financing seeks to become a solution for the lack of access to financial services to achieve financial inclusion through synergy with other financial institutions an technology companies. 11 PROF MADYA DR MOHD FAIZAL BASRI, 2024  The Birth of P2P Financing In general, banks want to provide the lowest possible return to depositors, while charging higher interest or profit rate to borrowers. Increasing their profit margin; taken advantage of poor people P2P financing has emerged as alternative, bring together customers including SMEs who seek capital injection. Simply connect people who are seeking funds at a lower rates with investors/depositors seeking above average returns compared to the banks. Flexibility of P2P financing allows it to channel capital to anyone, in any amount, efficiently and transparently, at a lower rates. Effective credit scoring and diversification are crucial to manage risk. 12 PROF MADYA DR MOHD FAIZAL BASRI, 2024  Financing Appeal Higher Profit Potential: More profitable for investors than standard savings. Perceived Social Responsibility: Seen as having better social value compared to traditional banking. Risk Factor: Higher risk than traditional savings, requiring careful consideration. 13 PROF MADYA DR MOHD FAIZAL BASRI, 2024  Introduction to Peer-to-Peer (P2P) Financing Origins: Zopa (UK) and Prosper (US) launched as the first P2P platforms in 2005. How it Works: Borrowers apply and receive a risk classification. Interest rates are based on the borrower’s risk level. Loans are funded by private investors, offering better rates for both sides. 14 PROF MADYA DR MOHD FAIZAL BASRI, 2024  Key Metrics and Growth Prosper (2016): 2 million members, $6 billion in loans. (2023): The platform has funded more than $21 billion in loans. Zopa (2016): £1.4 billion in loans, 114,000 members. Customer Base: Zopa's customer base surpassed 1 million in 2023, reflecting its expanded product offerings. Loan Originations: The bank's total loan balance reached £2.7 billion in 2023. Trend: Rapid growth in P2P lending with expectations for continued expansion. 15 PROF MADYA DR MOHD FAIZAL BASRI, 2024  Other Key Players of P2P Platforms Founded in 2006, Lending Club raised $10.26 million from Canaan Partners and Norwest Venture Partners. It became a peer-to-peer lending company in 2007. In December 2014, after several rounds of investment, Lending Club completed its initial public offering (IPO) at $900 million. In June 2015, it collaborated with Opportunity Fund and the Clinton Global Initiative to provide $10 million in funds to small businesses in California. In April 2016, it collaborated with Funding Circle and Prosper to build the Marketplace Lending Association. 16 PROF MADYA DR MOHD FAIZAL BASRI, 2024  Other Key Players of P2P Platforms Established in London in October 2010, RateSetter has at least 33,000 active lenders who have lent at least £2.7 billion. Their default rate, quoted at 0.71%, is extremely low, and none of their lenders have lost money. Lenders do not pay a fee, but borrowers have to pay a risk-weighted fee that covers costs and management of loans, as well as contributing to a provision fund against bad debts. Lenders can earn as much as 4.56% on a minimum investment of £10. They can lend money for whatever period they choose. If they choose to lend for a longer period, they receive a higher return on their money. 17 PROF MADYA DR MOHD FAIZAL BASRI, 2024  Other Key Players of P2P Platforms Lufax is a Chinese P2P lending marketplace with official name of Shanghai Lujiazui International Financial Asset Exchange Co. It was founded in 2011 and raised almost $500 million in 2015. It is owned 49% by Ping An, China’s largest insurer. It’s got an American CEO, Gregg Gibb. Lufax already has partnerships with Saxo Bank and with eToro, a social trading platform. It also hired five banks (Citic Securities, Citigroup, JP Morgan, Morgan Stanley and Goldman Sachs) as joint sponsors to work on a forthcoming IPO. In May 2018 they had $24.55 billion in loans on their books. 18 PROF MADYA DR MOHD FAIZAL BASRI, 2024  Other Key Players of P2P Platforms Established in 2012, Seattle-based LendingRobot is a loan comparison engine that uses algorithms to help lenders search for the most profitable loans. As a cloud-based service, LendingRobot has at least 40 various filtering criteria for Prosper and LendingClub. It automates and simplifies peer-to-peer lending investments so that lenders can increase their profits while saving time. It aggregates various data and evaluates different loans based on each investor’s criteria. It offers a unique proposition to individual investors due to its automation services. In January 2017, LendingRobot launched an automated hedge fund to facilitate investment exclusively in loans on P2P platforms. 19 PROF MADYA DR MOHD FAIZAL BASRI, 2024  Other Key Players of P2P Platforms Malaysia’s first P2P asset-based financing platform registered with Securities Commission Malaysia It's financing using assets or other forms of collateral as security. This added measure enables them to provide low interest financing to SMEs and gives the investor community the confidence to back businesses they believe in. Through the unique offering, they take pride in providing accessible financing that enables SMEs from various industries to grow while empowering investors to expand their portfolio with a peace of mind. 20 PROF MADYA DR MOHD FAIZAL BASRI, 2024  P2P Financing in Malaysia P2P enables businesses to borrow and investors to lend capital through online platforms registered with the Securities Commission Malaysia (SC). The SC launched the P2P Framework in May 2016. As at end-December 2022, about RM3.87 billion of P2P financing had been raised through 54,791 successful campaigns and 6,913 issuers. On a related note, almost half (49%) of the investors were aged below 35 years, with 89% of the invested funds stemming from retail investors. The P2P segment notably flourished in 2022, boasting 3,732 issuers that raised RM1.58 billion via 24,455 campaigns (2021: 1,998 issuers, RM1.14 billion raised and 14,301 campaigns). Campaign sizes stayed small, with 70% of the issuers raising RM50,000 or less – almost all (99%) of which was targeted as working capital. 21 PROF MADYA DR MOHD FAIZAL BASRI, 2024  Eligibility Criteria for P2P Platform Providers Any person or entity that seeks to operate a P2P financing platform must apply to be registered as a P2P operator under the SC’s Guidelines on Recognised Markets (or RMO Guidelines). All P2P operators must be locally incorporated and have a minimum paid-up capital of RM5 million. A P2P operator must also adhere to the following: Ensure there is an efficient and transparent risk-scoring system in place relating to the investment note or Islamic investment note. Conduct a risk assessment on prospective issuers intending to use its platform. 22 PROF MADYA DR MOHD FAIZAL BASRI, 2024  Eligibility Criteria for P2P Platform Providers Ensure the issuer’s disclosure document lodged with the P2P operator is verified for accuracy and made accessible to investors through the P2P platform. Inform investors of any material adverse change to the issuer’s proposal. Have in place processes or policies to manage any default by issuers, including using its best endeavours to recover outstanding amounts owed to investors. Ensure that its rules set out a rate of financing that is not more than 18% per annum. A P2P operator must consult the SC if it wishes to impose a rate of financing that is more this stated rate. 23 PROF MADYA DR MOHD FAIZAL BASRI, 2024  24 PROF MADYA DR MOHD FAIZAL BASRI, 2024  25 PROF MADYA DR MOHD FAIZAL BASRI, 2024  Who Can Raise Funds Through P2P? Notably, only locally registered companies can raise funds through P2P platforms. The crowdfunding exercise is only considered successful if it reaches at least 80% of its target, and can only accept up to the targeted amount. P2P is slightly different from equity crowdfunding (ECF) in that an issuer can be hosted concurrently for different purposes on multiple P2P platforms. The issuer is must disclose to the P2P operator its intention of seek concurrent funding from other P2P operators. 26 PROF MADYA DR MOHD FAIZAL BASRI, 2024  Who Can Raise Funds Through P2P? Only the following issuers can be hosted on a P2P platform: Locally incorporated or registered entities: Sole proprietorship Partnership Limited-liability partnership Private company Unlisted public company Any other type of entity as may be permitted by the SC. 27 PROF MADYA DR MOHD FAIZAL BASRI, 2024  Who Can Raise Funds Through P2P? The entities below are prohibited from raising funds through a P2P platform: Commercially or financially complex structures (i.e. investment fund companies or financial institutions). Public listed companies and their subsidiaries Companies with no specific business plan or its business plan is to merge or acquire an unidentified entity (i.e. blind pool). Companies that propose to use the funds raised to extend loans or invest in other entities. Any other type of entity as may be permitted by the SC. 28 PROF MADYA DR MOHD FAIZAL BASRI, 2024  Eligibility Criteria for P2P Investors 29 PROF MADYA DR MOHD FAIZAL BASRI, 2024  Market Development In 2020, the SC launched a secondary trading framework for ECF and P2P, to provide an exit mechanism to investors. This permits early investors to exit from deals they have invested in and also offers new investors the chance to participate in the ones they may have missed earlier. The Government of Malaysia had initiated the Malaysia Co- Investment Fund (MyCIF) for ECF and P2P financing under Budget 2019 – to improve access to financing for micro as well as small and medium-sized enterprises (SMEs). 30 PROF MADYA DR MOHD FAIZAL BASRI, 2024  Market Development Such businesses usually find it a challenge to obtain financing for growth. The SC administers this fund, which was first announced in 2018 with RM50 million. The success of this fund prompted the Government to increase it by another RM50 million in 2020. MyCIF invests in ECF and P2P campaigns on a 1:4 ratio – for every RM4 invested by others, it will pump in RM1. Its co-investment scheme is open to micro enterprises and SMEs but limited to a maximum of RM1 million per campaign. In addition, RM10 million has been earmarked for the cofunding of social enterprises, with a maximum of RM500,000 per campaign. 31 PROF MADYA DR MOHD FAIZAL BASRI, 2024  Registered and Recognised P2P Operators in Malaysia 32 PROF MADYA DR MOHD FAIZAL BASRI, 2024  Benefits of P2P for Borrowers Advantages: Easier Access to Funds: Flexible Eligibility: Unlike traditional banks, P2P platforms often have less stringent credit requirements, making it easier for individuals with lower credit scores or those lacking credit history to access funds. Convenient Application Process: Borrowers can apply online from the comfort of their homes, often with a simplified process that reduces paperwork. 33 PROF MADYA DR MOHD FAIZAL BASRI, 2024  Benefits of P2P for Borrowers Lower Interest Rates: Reduced Overheads: P2P platforms often operate without the physical infrastructure and regulatory overhead of traditional banks, allowing them to offer competitive interest rates. Transparent Fee Structure: Borrowers often receive a clear breakdown of fees and interest rates, which are typically lower than credit cards or personal loans from banks. Customisable Loan Terms: Borrowers have access to various loan terms and repayment options, allowing them to choose a plan that best suits their financial situation. Quick Disbursement of Funds: Many P2P platforms disburse funds within a few days after approval, which is beneficial for borrowers in urgent need of cash. 34 PROF MADYA DR MOHD FAIZAL BASRI, 2024  Benefits of P2P for Lenders Advantages: Potentially High Returns on Investment: Competitive Yields: P2P lending platforms offer attractive returns, often higher than traditional savings accounts or certificates of deposit (CDs). Risk-Adjusted Returns: While P2P lending carries risk, investors can choose loans with different risk ratings, allowing them to balance risk and return according to their preference.. 35 PROF MADYA DR MOHD FAIZAL BASRI, 2024  Benefits of P2P for Lenders Diversified Investment Options: Loan Variety: Lenders can invest in a broad range of loans, from personal loans to business loans, allowing for portfolio diversification. Flexible Investment Amounts: P2P platforms often allow investors to fund small portions of multiple loans rather than investing large amounts in a single loan, reducing the impact of any single borrower defaulting. Access to a Growing Asset Class: As P2P lending continues to grow, it provides lenders with access to an innovative asset class that was previously unavailable to individual investors. 36 PROF MADYA DR MOHD FAIZAL BASRI, 2024  Benefits of P2P for Lenders Transparency and Control: Platform Transparency: P2P platforms typically provide lenders with detailed information on borrowers, including credit scores and financial history, allowing for informed decision-making. Investor Control: Lenders have control over which loans to fund, giving them a direct say in their investment choices and risk levels. 37 PROF MADYA DR MOHD FAIZAL BASRI, 2024  Credit Risk in P2P Lending Risk of Borrower Default: Definition: Borrower default occurs when a borrower is unable to repay the loan, resulting in a loss for the lender. Impact: Unlike traditional banks, P2P lenders don’t have collateral from borrowers or government protections, making defaults a significant risk. Statistics: Default rates in P2P lending can vary based on loan type, borrower creditworthiness, and platform practices. For example, higher-risk loans may carry default rates of 5-10% or higher. 38 PROF MADYA DR MOHD FAIZAL BASRI, 2024  Credit Risk in P2P Lending Influencing Factors: Creditworthiness: A borrower’s financial history and credit score are primary indicators of their ability to repay. Economic Conditions: Economic downturns can increase default rates as borrowers face financial challenges. Loan Type: Personal loans tend to carry higher default rates compared to business loans, as they are often unsecured. 39 PROF MADYA DR MOHD FAIZAL BASRI, 2024  Credit Risk in P2P Lending Mitigation Strategies: Risk Grading Systems: Example: LendingClub uses a risk grading system that categorises loans from A (lowest risk) to E (highest risk). This allows investors to choose loans that match their risk tolerance. Functionality: Risk grades are based on borrower credit scores, income, debt-to-income ratios, and other financial indicators. Outcome: Investors can diversify by mixing low- and high-risk loans to balance potential returns and risk. 40 PROF MADYA DR MOHD FAIZAL BASRI, 2024  Credit Risk in P2P Lending Diversification: Approach: Investors are encouraged to spread their funds across multiple loans instead of funding a single loan entirely. Example: Prosper allows lenders to invest as little as $25 per loan, enabling them to diversify their portfolio with minimal exposure to any one borrower. Benefit: By diversifying, lenders reduce the impact of individual borrower defaults on their overall portfolio returns. 41 PROF MADYA DR MOHD FAIZAL BASRI, 2024  Credit Risk in P2P Lending Technological Solutions: Automated Credit Scoring: P2P platforms use algorithms and data analytics to evaluate borrower profiles accurately, incorporating data like payment history, employment status, and other behavioural indicators. Example: Upstart utilises AI-driven models that consider education and employment information along with traditional credit data to assess risk. Provision Funds: Some P2P platforms establish provision funds to cover potential losses in case of borrower defaults, especially for high-risk loans. Example: RateSetter in the UK offers a provision fund that compensates investors if a borrower defaults, helping to manage risk and provide peace of mind to lenders. 42 PROF MADYA DR MOHD FAIZAL BASRI, 2024  Platform Risk Reliance on Platform Stability: Definition: Platform risk in P2P lending refers to the dependence of lenders and borrowers on the operational and financial stability of the P2P platform itself. Vulnerability: Unlike traditional banks, P2P platforms are often newer companies and may lack the robust financial backing or regulatory safeguards that banks have. This increases their vulnerability to market fluctuations, liquidity issues, and management challenges. Risk for Lenders: If a platform becomes insolvent or ceases operations, lenders may lose access to their funds or face delays in repayments. 43 PROF MADYA DR MOHD FAIZAL BASRI, 2024  Platform Risk Key Issues Leading to Platform Risk: Liquidity Problems: P2P platforms need liquidity to manage cash flows and handle demand from both borrowers and investors. Insufficient liquidity can lead to a freeze on funds or an inability to pay investors promptly. Operational Risk: Poor internal controls, lack of regulatory compliance, or insufficient oversight can lead to platform failure. Dependence on Investor Confidence: Platforms rely heavily on investor trust. If confidence wanes due to negative news or defaults, investors may withdraw funds en masse, destabilising the platform. 44 PROF MADYA DR MOHD FAIZAL BASRI, 2024  Platform Risk Collapse of Lendy (UK): Background: Lendy was a UK-based P2P lending platform that focused on property-backed loans. The platform faced issues with high default rates and insufficient capital reserves. Outcome: In 2019, Lendy entered administration due to liquidity problems and regulatory scrutiny from the Financial Conduct Authority (FCA). Thousands of investors were left with uncertainty regarding the recovery of their investments. Lessons Learned: Lendy’s collapse highlighted the importance of strong regulatory oversight, risk management, and transparency in P2P platforms to maintain stability and investor confidence. 45 PROF MADYA DR MOHD FAIZAL BASRI, 2024  Regulatory and Market Risks Regulatory Risk: Definition: Regulatory risk in P2P lending arises from the fact that platforms operate under various legal frameworks in different regions. These frameworks can change, impacting how P2P platforms conduct business and comply with local laws. Complex Compliance Requirements: Different countries have different regulations for P2P lending, such as minimum capital requirements, disclosure obligations, and restrictions on borrower-lender interactions. Impact on Operations: Sudden regulatory changes or strict regulations can disrupt operations, increase costs, or even force platforms to shut down or exit certain markets. 46 PROF MADYA DR MOHD FAIZAL BASRI, 2024  Regulatory and Market Risks Example: China’s Tightening of P2P Regulations: Background: China’s P2P lending sector grew rapidly, but faced numerous cases of fraud and platform mismanagement. Thousands of P2P platforms collapsed, causing significant financial losses for investors. Regulatory Response: In response, Chinese authorities imposed stricter regulations, including mandatory licensing, caps on loan amounts, and enhanced scrutiny of P2P platforms. Outcome: Many platforms shut down or transformed into licensed financial institutions, with only a handful of P2P platforms remaining under strict oversight. 47 PROF MADYA DR MOHD FAIZAL BASRI, 2024  Regulatory and Market Risks Market Risk: Economic Influence: Market risk in P2P lending relates to how economic fluctuations, such as interest rates, unemployment, and overall economic health, affect borrowers’ ability to repay loans. Vulnerability During Recessions: During economic downturns, default rates typically increase, impacting returns for lenders. P2P platforms without robust risk management practices may face significant challenges during recessions. Impact on Investor Confidence: Negative economic conditions can lead to a loss of investor confidence in P2P lending, causing lower capital inflows and impacting platform liquidity. 48 PROF MADYA DR MOHD FAIZAL BASRI, 2024  Regulatory and Market Risks Example: COVID-19 Economic Impact: Background: The COVID-19 pandemic caused economic instability worldwide, leading to increased borrower defaults and stricter credit requirements on P2P platforms. Platform Response: Some platforms adjusted by raising borrower eligibility criteria, while others offered relief to struggling borrowers. Result: Although many platforms survived, the economic impact led to higher default rates and a more cautious lending environment. 49 PROF MADYA DR MOHD FAIZAL BASRI, 2024  Consumer Financing 50 PROF MADYA DR MOHD FAIZAL BASRI, 2024  Consumer Lending An unsecured loan is one that doesn’t have any assets or securities against it and so is riskier for lenders. However, it is less risky for the borrower because they have no property that serves as a guarantee if they fail to repay the loan. Because of this, the lender charges higher interest rates to offset the risk. An unsecured loan can be of many types: signature or personal, credit card, and student, financing. A borrower can secure a personal loan from credit unions and banks. They can use it for any purpose and usually pay off the loan monthly. If they have good credit standing, they can expect to pay off a loan at a lower interest rate. Key players: Affirm, Kreditech, ZestFinance, LendUP 51 PROF MADYA DR MOHD FAIZAL BASRI, 2024  Digital Lending for Students A category that stands on its own inside the consumer lending space is student loans. Some countries, such as the United Kingdom, have a good support system for students, as governments can fund loans at extremely low interest rates. This doesn’t mean that student loans in the UK earn a good return on investment, since student loans are about £70 billion, or 16 percent of UK’s GDP, and many of these loans are never repaid.70 For example, student loans are big business in the US, with $1.5 trillion in loans outstanding as of February 2018. After mortgages, student loans are the next largest debt market. Taking advantage of this market, many companies and start-ups have started lending to students online. Key players: SoFi, CommonBond, Earnest, Student Loan Hero, LendEDU 52 PROF MADYA DR MOHD FAIZAL BASRI, 2024  Alternative Financing 53 PROF MADYA DR MOHD FAIZAL BASRI, 2024  Definition of Alternative Financing Alternative financing includes methods that provide capital outside of traditional banks. It’s especially useful for small and medium enterprises (SMEs) that may not meet conventional bank lending criteria. Types of alternative financing: invoice financing, asset-based lending, and revenue-based financing. Importance for SMEs: offers flexibility and faster access to funds. 54 PROF MADYA DR MOHD FAIZAL BASRI, 2024  Invoice Financing Getting financing for as-yet-unpaid invoices, can consist of invoice factoring, invoice trading, or invoice discounting. With factoring, an invoice financier will manage the sales ledger to collect money owed to a company. Factoring allows companies to grow by generating funds to keep a business afloat while waiting for customers’ payments. Usually, a third party (a factor) pays between 70% and 90% of total accounts, and customers make their payments to the factor. Then the factor remits the balance to the business less its service fee. 55 PROF MADYA DR MOHD FAIZAL BASRI, 2024  Invoice Financing The factor will first assess the creditworthiness of the customers before it accepts the accounts. It is not a collection agency, but customers must have good credit standing. It may also consider yearly revenues and how many years the business has been in operation before agreeing to provide the factoring service. The factor will request payment from customers after checking the accounts receivable for completeness and accuracy. 56 PROF MADYA DR MOHD FAIZAL BASRI, 2024  Invoice Financing Upon receiving payment, it will move the balance of the invoices back to the business owner. Other factors charge fees and pay a business owner 100% of the total value of the invoices. Some factors allow the business to collect payments and receive the repayments plus fees when customers pay. Key players: Kabbage, OnDeck, PayPal Working Capital, Square, Lendio, Ant Financial 57 PROF MADYA DR MOHD FAIZAL BASRI, 2024  Asset-Based Lending Asset-based lending involves loans secured by assets such as inventory, accounts receivable, or equipment. This is useful for businesses with substantial assets that need funding Example: Credibly offers asset-based loans to small businesses. Benefit: Allows companies to leverage their existing assets to access financing without diluting ownership. 58 PROF MADYA DR MOHD FAIZAL BASRI, 2024  Revenue-Based Financing n revenue-based financing, businesses receive funding in exchange for a percentage of their future revenue. This is popular among companies with recurring revenue streams. Example: Clearbanc, which funds e-commerce businesses based on sales projections. Flexible Repayment: Repayments scale with revenue, providing flexibility. 59 PROF MADYA DR MOHD FAIZAL BASRI, 2024  Blockchain in Alternative Financing Blockchain technology is transforming alternative financing by enhancing transparency and reducing fraud. Transparency: Transactions are secure and immutable. Example: Figure.com uses blockchain for real-time loan processing. Benefit: Faster, more reliable loan origination processes. 60 PROF MADYA DR MOHD FAIZAL BASRI, 2024  Embedded Finance Embedded finance refers to financial services provided directly within non-financial platforms, making financing options more accessible and convenient. Example: Shopify Capital provides funds to e-commerce merchants directly through the Shopify platform. User Experience: Simplified funding without needing to apply elsewhere. 61 PROF MADYA DR MOHD FAIZAL BASRI, 2024  Pros of Alternative Financing for SMEs Advantages: Faster access to capital. Quicker approval times compared to traditional loans Flexible terms for specific business needs. Example: A small business using MarketInvoice for steady cash flow amid high customer demand.. 62 PROF MADYA DR MOHD FAIZAL BASRI, 2024  Challenges in Alternative Financing Drawbacks: Higher fees or interest. Often more expensive than bank loans. Risk of asset seizure in case of default. Example: Invoice factoring’s impact on customer relationships, as customers may need to interact with third-party finance companies. 63 PROF MADYA DR MOHD FAIZAL BASRI, 2024  Crowdfunding 64 PROF MADYA DR MOHD FAIZAL BASRI, 2024  Definition of Crowdfunding Crowdfunding is a method of raising small amounts of money from a large number of people, typically through online platforms. It enables individuals, startups, or companies to gather funds for various projects, ideas, or causes. Process: Typically, an individual or company creates a campaign on a crowdfunding platform, detailing their project or need. Backers then contribute financially, usually in exchange for a reward, equity, or simply to support a cause. 65 PROF MADYA DR MOHD FAIZAL BASRI, 2024  Types of Crowdfunding Donation-Based: Supporters donate without expecting a return. Common for charitable causes. Reward-Based: Contributors receive a product or service in return, often an early version of the item being funded. Equity Crowdfunding: Backers receive shares in the company or project, making them partial owners. Debt Crowdfunding: Backers lend money with the expectation of repayment with interest. 66 PROF MADYA DR MOHD FAIZAL BASRI, 2024  Case Study: Oculus Rift Background: Oculus Rift, a virtual reality headset, started as a crowdfunding project on Kickstarter in 2012. Campaign Success: The project raised nearly $2.5 million from backers interested in VR technology. Outcome: Oculus Rift’s success attracted significant attention, leading to its acquisition by Facebook in 2014 for approximately $2 billion. This example showcases how crowdfunding can serve as a launchpad for innovative products and lead to significant business growth. 67 PROF MADYA DR MOHD FAIZAL BASRI, 2024  Comparison to Other Funding Options Less Structured Than Traditional Loans: Overview: Crowdfunding is generally less formal and more flexible than traditional loans or venture capital. Unlike loans, crowdfunding doesn’t typically require strict credit checks or collateral, making it accessible to a wider range of individuals and businesses. Funding Goal Flexibility: While loans have fixed repayment schedules, crowdfunding campaigns usually only require the project creator to deliver promised rewards or products to backers. Equity crowdfunding and debt crowdfunding may have some structure, but they still allow more flexibility compared to bank loans. 68 PROF MADYA DR MOHD FAIZAL BASRI, 2024  Comparison to Other Funding Options Ideal for Startups, Creative Projects, and Innovative Products: Target Audience: Crowdfunding is especially popular among startups, creative projects, and tech innovations because it allows them to test the market without taking on debt. Market Testing: Crowdfunding can serve as a form of market validation. Creators can gauge consumer interest in their product or idea based on how much funding they receive. 69 PROF MADYA DR MOHD FAIZAL BASRI, 2024  Case Study: Pebble Smartwatch Background: Pebble was an innovative smartwatch project launched on Kickstarter in 2012. The goal was to create a smartwatch that worked seamlessly with both iOS and Android devices. Campaign Success: Initially, Pebble aimed to raise $100,000 but ultimately raised over $10 million, becoming one of the most funded Kickstarter projects at the time. Outcome: Pebble’s success proved that there was a significant market for smartwatches, which influenced the broader smartwatch industry and attracted attention from large tech companies. 70 PROF MADYA DR MOHD FAIZAL BASRI, 2024  Popular Crowdfunding Platforms Kickstarter: Primarily focused on creative projects like technology, films, and art. Indiegogo: Supports both creative and entrepreneurial projects, with flexible funding options. GoFundMe: Known for personal and charitable fundraising. 71 PROF MADYA DR MOHD FAIZAL BASRI, 2024  Equity Crowdfunding (ECF) in Malaysia Equity crowdfunding (ECF) is an innovative form of alternative fundraising that allows small businesses to raise capital from the public, using online platforms registered with the Securities Commission Malaysia (SC). Ten ECF platforms have been registered to date. ECF allows small businesses to offer equity in their companies to investors, who in turn invest in the concept which they see potential in. Through ECF, investors can diversify their investments beyond traditional asset classes. 72 PROF MADYA DR MOHD FAIZAL BASRI, 2024  Equity Crowdfunding (ECF) in Malaysia Malaysian ECF platforms have been charting impressive growth since 2016, in line with the Government’s call for financial services providers to embrace technology and develop more inclusive, innovative and efficient capital markets. Although ECF funding had skidded during the initial stages of movement restrictions in 2020 amid the economic slowdown, it had eventually bounced back following subsequent relaxations. Since its inception, ECF had helped raise RM560.4 million of funds for 305 issuers via 330 campaigns as at end-December 2022 (end- December 2021: RM420.9 million). 73 PROF MADYA DR MOHD FAIZAL BASRI, 2024  Equity Crowdfunding (ECF) in Malaysia In 2022, some RM140.38 million was raised by 65 issuers through 67 successful campaigns (2021: RM220.72 million and 104 issuers). Although the pace had decelerated, larger campaigns were the order of the day, with 89% raising more than RM900,000 each. The biggest sum raised by a single campaign stood at RM17 million. As at end-December 2022, the investor demographics revealed that some 37% were aged below 35 years while an overall 48% were retail investors. The SC launched a secondary trading framework for ECF and P2P in 2020, to provide an exit mechanism to investors. This permits early investors to exit from deals they have invested in and also offers new investors the chance to participate in the ones they may have missed earlier. 74 PROF MADYA DR MOHD FAIZAL BASRI, 2024  75 PROF MADYA DR MOHD FAIZAL BASRI, 2024  76 PROF MADYA DR MOHD FAIZAL BASRI, 2024  Eligibility Criteria for ECF Platform Provider An applicant that wishes to be registered as an ECF operator must be a body corporate incorporated under the Companies Act 1965. The prospective applicant must be able to demonstrate to the SC that it is able to satisfy the relevant criteria mentioned in the Recognised Market Operator (RMO) Guidelines. An ECF operator must also comply with the following requirements: Undertake a due diligence exercise on prospective issuers planning to use its platform. Ensure that the issuer’s disclosure document lodged with the ECF operator is verified for accuracy and made accessible to investors through the ECF platform. Inform investors of any material adverse change in the issuer’s proposal. Ensure that the fundraising and investment limits imposed on the issuer are not breached. 77 PROF MADYA DR MOHD FAIZAL BASRI, 2024  Who Can Raise Funds Through ECF? Only locally incorporated private companies (excluding exempt private companies) and limited-liability partnerships can raise funds from the ECF platform. The following entities are prohibited from raising funds through an ECF platform. Commercially or financially complex structures (i.e. investment fund companies or financial institutions). Public listed companies and their subsidiaries. Companies with no specific business plan or their business plan is to merge or acquire an unidentified entity (i.e. blind pool). Companies, other than a microfund, which propose to use the funds raised to extend loans or invest in other entities. Companies, other than a microfund, with a paid-up share capital exceeding RM10 million Any other type of entity that is specified by the SC. 78 PROF MADYA DR MOHD FAIZAL BASRI, 2024  Limits on Funds Raised from ECF Platform The ECF licence enables platforms to raise funding for Malaysian- registered sole proprietorships, partnerships, incorporated limited- liability partnerships, private limited and unlisted public companies. An issuer can only raise up to RM3 million within a 12-month period, through several campaigns. In total, an issuer can raise a maximum of RM20 million. Investors are allowed a cooling-off period of six business days, during which they can withdraw their entire investment amount. This excludes the issuer’s own capital contribution, or any funding obtained through a private placement exercise. 79 PROF MADYA DR MOHD FAIZAL BASRI, 2024  Who Can Invest in ECF? 80 PROF MADYA DR MOHD FAIZAL BASRI, 2024  Registered and Recognised ECF Operators in Malaysia 81 PROF MADYA DR MOHD FAIZAL BASRI, 2024  Benefits of Crowdfunding Crowdfunding provides direct access to capital and helps build a community around a product or business. Successful campaigns can double as marketing efforts. Direct Funding: Avoids traditional funding hurdles. Community Building: Creates a loyal customer base before the product is launched. Example: Coolest Cooler raised $13 million on Kickstarter, creating a ready customer base upon launch. 82 PROF MADYA DR MOHD FAIZAL BASRI, 2024  Challenges in Crowdfunding Despite its benefits, crowdfunding is competitive and requires a clear, engaging campaign to attract attention. Without a solid plan, campaigns can fail. High Competition: Many projects vie for backer attention. Intellectual Property Risks: Ideas are public, which could lead to copying. Failed Campaigns: Often due to lack of clear goals or insufficient marketing. 83 PROF MADYA DR MOHD FAIZAL BASRI, 2024  Success Factors in Crowdfunding Successful crowdfunding campaigns share key traits, such as clear messaging, transparency, and strong engagement with backers. Clear Communication: Engages and reassures potential backers. Backer Engagement: Regular updates and responsiveness. Example: The Veronica Mars Movie raised $5.7 million by engaging fans and providing clear goals. 84 PROF MADYA DR MOHD FAIZAL BASRI, 2024  Conclusion Digital financing continues to reshape the financial landscape, offering innovative solutions for both businesses and consumers. From P2P lending to crowdfunding, digital finance provides more accessible, transparent, and diverse funding options than ever before. 85 PROF MADYA DR MOHD FAIZAL BASRI, 2024  END OF TOPIC 3 PROF MADYA DR MOHD FAIZAL BASRI, 2024