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Don't Lose The "Crowd" In Crowdfunding...

Don't Lose The "Crowd" In Crowdfunding...

With small and medium sized enterprises struggling to attract funding through traditional methods, the popularity of “crowdfunding” has soared over recent years.

In the UK, investors provided £480 million in loans and bought £28 million in unlisted securities through crowdfunding platforms in 2013 (up 150 per cent on 2012).  In the US, Kickstarter, a US-based crowdfunding platform, recently announced that it had raised $1 billion for projects since it began in 2009, with more than half of that being pledged in the last 12 months.  Crowdfunding is a rapidly growing industry and appears to be here to stay!

Crowdfunding offers a means for businesses (often early stage) to raise money through online platforms, often based on a model involving a large number of private investors investing relatively small amounts of cash.

A key part of crowdfunding’s growing appeal to smaller, often inexperienced, investors is that in return for investing there are often rewards on offer, linked to your investment, such as discounts on whatever product is being funded. Take BrewDog for example, where investors get discounted beer and an invitation to an annual "piss-up in a brewery" (aka the AGM!).

Despite crowdfunding’s increasing popularity, concerns have been raised over the lack of protection for the unwary investor, especially given the stark reality that between 50% and 70% of businesses fail in their infancy.  In the wake of these concerns, the UK Financial Conduct Authority (the “FCA”) has published a number of new rules to take effect from April 2014.

The new rules are concerned with consumer protection and seek to afford investors participating on crowdfunding platforms the same level of protection given to investors participating off-line as a result of direct marketing or telephone selling.

For loan-based and equity-based crowdfunding, the new rules focus on ensuring that would-be investors have access to clear information, allowing them to assess the risks and to understand who will ultimately be spending their money.  The rules also place an obligation on firms running loan-based crowdfunding platforms to have procedures in place to ensure loan repayments continue to be collected in the event that the web-based platform suffers technical difficulties. From 1 April 2014, loan-based crowdfunding platforms will be required to hold regulatory capital of at least £20,000, increasing to £50,000 from April 2017. This is important as investors who lend money through such platforms will not be able to claim compensation through the Financial Services Compensation Scheme.

Importantly for equity-based crowdfunding, the FCA will be placing a cap on the amount individual investors can invest in unlisted equity and debt securities equal to 10% of their net investible financial assets. Self-certified sophisticated investors and high net worth individuals will continue to be able to invest more.

In addition, crowdfunding platforms will need to consider an appropriateness test in cases where no  professional advice is being provided to the investor.  It will be a requirement that all platforms check that investors have the knowledge and experience needed to understand the risks involved before being invited to respond to an offer.  Equity-based crowdfunding platforms may therefore need to gather certain data on potential investors in order to undertake the appropriateness test.

The introduction of these new rules was inevitable and the FCA is clearly attempting to strike a balance between adequate investor protection and over-regulation which could damage this increasingly important industry.  Time will tell whether this balance has been achieved.  Considering the difficulties that small and medium enterprises are encountering in raising fresh capital, it would be a great shame were the new rules to take the “crowd” out of crowdfunding.

Chris Gotts