Crowd-funding has emerged as an innovative entrepreneurial idea at a time when many start-up businesses have struggled to raise finance. A credit crunched economy, near-zero growth, non-existent interest rates and easy communication of ideas across the internet have conspired to create an ideal environment for this alternative form of financing to evolve. Popularized in the US, it has made its way to the UK but it is not without its legal complexities.
What is crowd-funding?
Crowd-funding provides an alternative to the traditional methods of raising finance for a start-up such as bank loans or venture capital. An entrepreneur attracts a ‘crowd’ of people to fund their business through an online crowd-funding website.
A charismatic pitch and some form of potential reward for their investment entices small, generally non-professional investors to put up the necessary funds. Instead of one investor providing a large lump sum, each person usually pledges a small amount. If the required total is reached, the project goes ahead.
How Does it Work?
Crowd-funding is done by individual investors pledging their contributions towards the idea to help it meet an online funding target by offering to:
- Invest money for some non-financial reward such as discount on future product purchases from the business.
- Lend money in the form of a loan.
- Buy equity (a stake of the business).
The different approaches entail a number of risks for investors and potentially complex legal issues for both entrepreneurs and crowd-funding providers.
What Platforms Exist?
Entrepreneur’s use online platforms like websites Seedrs.com and Crowdcube.com to showcase their business ideas, create a strong network of support along with a buzz and awareness about their start-up.
Is Crowd-funding Regulated?
Generally the investment model of crowd-funding is as-yet unregulated. Currently only the two websites mentioned, Seedrs and Crowdcube, have been authorized and regulated by the Financial Services Authority (“FSA”), soon to be the Financial Conduct Authority (“FCA”).
Being authorized and regulated by the FSA means investors using those two websites are able to claim compensation from the Financial Services Compensation Scheme and have access to the Financial Ombudsman Services.
What are the Legal Implications of Crowd-funding?
The legal implications for crowd-funding are threefold being split between investors, entrepreneurs and crowd-funding providers.
Investors – Certain crowd-funding models escape most financial services regulation and are not regulated or authorized under existing consumer protection regulations. This means that ordinary individuals who opt to become crowd-funding investors are at an increased risk of being victims of unscrupulous activities such as fraud.
Entrepreneurs and Providers – As it stands, the current regulatory regime does not permit the promotion of business financing via a fund to the general public, particularly outside a corporate structure. This is due to the prohibition on promoting investment funds (“unregulated collective investments schemes”) to the general public. In addition, the activity of arranging equity investments falls within the scope of FSA regulation. Companies seeking to sell shares directly to the public must be registered as public companies.
Crowd-funding structures that seek to circumnavigate corporate and financial regulations are likely to see operators and the businesses that use them heavily scrutinized by authorities.
Whether you are a potential investor, entrepreneur or operator; it is essential that you seek legal advice. For more information please contact James Crichton via e-mail jcrichton@rollingsons.co.uk or by telephone on 0207 611 4848.
