SMEs lured to risky pre-IPO financing

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  • Sunday, 05 Jun 2016

Pre-IPO funding method is very popular lately but poses high risks, Leong opines. — AZMAN GHANI/The Star

The financing method is innovative, but poses high risk to SMEs and unprotected investors, warns HO WAH FOON.

DUE to tighter control over financing by banks, many small and medium enterprises (SMEs) are turning to the innovative but unregulated pre-IPO funding method to raise funds for expansion purposes, according to SME funding expert Datuk Leong Kin Mun.

A pre-IPO fund-raising scheme involves the owner of an SME issuing shares of his company to private investors. These new shares are valued at several times the par value of the original share, with a promise of high ROI (return on investment) when the SME goes for initial public offering (IPO) within one to three years.

“This Pre-IPO fund-raising method has become very popular lately among SMEs that fail to qualify for IPO, or can’t get bank financing. In the past, venture capitalists were actively involved in this, but now, individuals have become targets of promoters in such pre-IPO deals,” says Leong in an interview with Star SMEbiz.

Also the president of Malaysia Biomass Industries Confederation whose members are mainly SMEs, Leong says he has recently come across five SMEs that have opted to go for pre-IPO financing scheme as it has proven to be a faster way of raising funds.

One of these is a three-year-old biomass technology company that has been waiting fruitlessly for the disbursement of a grant from a government agency for more than a year.

Even established non-listed groups, especially in the property sector, turn to pre-IPO deals to raise funds. A property development company is raising RM22mil via 88 tranches of RM250,000 from “qualified investors only”, according to its slide presentation. “Pre-IPO financing is very innovative. But this financing method could pose high risks to SMEs and unprotected investors if the planned IPOs don’t materialise,” states Leong, who owns Premier Capital Sdn Bhd which advises SMEs on funding solutions.

A successful SME food products manufacturer and exporter recently revealed that he has been approached by several venture capitalists (VCs) to enter into a pre-IPO arrangement, but he declined because his family-run company is cash rich. Leong discourages cash-strapped SMEs to deal with investment-savvy VCs.

“Due to the stringent conditions they impose, I would advise SMEs to avoid entering into pre-IPO arrangement with VCs. Going for listing is not as easy as one thinks and when the arrangement turns sour, the SMEs will suffer more,” says Leong.

In two recent cases, the High Court judges had ruled in favour of VCs in their claims for original investment cost and financial remedies when the SMEs failed in listing bids.

In the case of Muamalat Venture Sdn Bhd’s suit against Transturbo Engineering Sdn Bhd’s directors Khoo Koay Hock and Khoo Tong Lip, the Kuala Lumpur High Court ruled on June 30, 2014, that venture capitalist Muamalat was entitled to its claim for the return of RM6mil in investment and remedies amounting to RM1.2mil from the Khoos.

And in the case of Malaysia Venture Capital Management Sdn Bhd versus Teang Soo Thong and Bsmart Technology Sdn Bhd, the High Court ruled on Sept 7, 2015, that the plaintiff was entitled to its claim for RM7.5mil in cash investment and an internal investment return of 25% after Bsmart failed to go for listing.

Leong observes that lately, smaller SMEs have also been enticed by promoters to raise fund from cash-rich individuals looking for high ROI.

He notes that these SMEs normally lack a good tax record, or strong profit record or reasonable paid-up capital. And this pre-IPO funding concept is introduced to local SMEs by eloquent and persuasive speakers from Hong Kong and Taiwan via advertising in the Chinese media.

“I hope our investors will be more careful as the ROI promised by some promoters at such forums are ridiculously high, at least five to seven times more.

“As there is no prospectus to give the entire picture of the SMEs and warn investors of future risk, investors will have to check whether the agreements they sign offer any legal protection. I hope the authorities will impose certain corporate governance standard on these promoters,” says Leong.

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