A Crowdfunding Site-turned VC Investor?

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image credit: thestartup.eu

An apparel store on Taobao , Mirror Fun, raised 15 million yuan ($2.4 million) recently from 94 investors through Hong Ling, an online crowdfunding platform(report in Chinese). The highest contribution is 350 thousand yuan and the lowest is 50 thousand . As reported, most funders are individual investors that know little about apparel sector and got to know about the company in need of funding through the crowdfunding website.

Mirror Fun was set up on Taobao in 2008 and made eight million yuan in net profit in 2012, as disclosed. Its annual revenue is estimated to double in both 2013 and 2014. For this round of funding, the store sold 15% equity.

Being a Taobao store, Mirror Fun couldn’t borrow money from banks in 2010 when funding was needed. In the fourth quarter of 2010, the store turned to Hong Ling, where it would become one of the biggest borrowers in 2012. Some of the funders in this round of financing once lent money to Mirror Fun before.

A Crowdfunding Site-turned VC Investor

It sounds like a successful case that an online retailer who cannot borrow money through traditional channels benefits from online crowdfunding. But one thing worth pointing out is Hong Ling, the crowdfunding platform itself, also funded the Taobao store, not only in this round, but also once before.

So the Mirror Fund case is more like that an existing investor of a company’s helped it get another round of financing. It’s unknown whether Hong Ling exited this time. If it did so, it is estimated the returns would be very high.

Hong Ling acknowledges that it shifts to becoming a kind of venture capital business. Zhou Shiping, founder of Hong Ling, said they were trying to build a data base of enterprises in need of money on the platform and pick out some good ones to invest in. “Approaching one thousand enterprise borrowers are on Hong Ling each year. Hong Ling is very familiar with the cash flows and financials of those companies. That’s like a traceable data base of enterprises. It’s comparatively safe to invest in companies chosen from them”, said Zhou.

So Mirror Fun is a demonstration case to tell potential funders that Hong Ling would filter companies and select investment targets for them. Actually, before Mirror Fund, Hong Ling tried out such funding process for itself, having raised money from a total of 158 funders on its own platform.

However, belief in the platform operator’s picks cannot guarantee absolute safety or returns on investments. It could be even riskier for you cannot know whether there are dirty deals behind the web pages, given individual investors can get little information about the target company beyond whatever provided by the crowdfunding service.

Recently there came more news of frauds in the online peer-to-peer financing sector. So far there isn’t any regulation tailored to this newly merged online financing business.

Where would the rest crowdfunding sites go?

Some online crowdfunding service operators just want their websites to be a market to gather borrowers and lenders. They don’t think they should touch the money flowing through their platforms or interfere with deals. With no regulations in place yet, a bunch of such services reaches an agreement in late 2012 to self-regulate, promising not to use investors’ funds or making loans.

Before directly investing in a customer on its platform, Hong Ling had gotten involved in the deals since 2010, promising to pay for delays or defaults as fraud was a concern with customers. It even set up a credit guarantee company to take care of potential issues. Many others followed Hong Ling in order to attract customers.

So far it’s unknown how many online crowdfunding services would follow Hong Ling again to become venture capital investors that take advantage of the database of companies. But what’s sure is it’s not a fair play for borrowers any more.