Crowdfunding is just one of many innovations to have taken off rapidly from the technology sector but new regulations have just been introduced as regulators catch up.
Well-known crowdfunding websites including the likes of Kickstarter, Indiegogo and RocketHub are now subject to the Financial Conduct Authority (FCA) policy on crowdfunding in the UK which came into force on 1 April 2014.
Policymakers have been very keen to promote the tech sector in the UK; Old Street’s ‘Silicon Roundabout’ has received huge political support and press attention. However, seasoned financial professionals have always seen crowdfunding’s skirting of existing financial legislation as a magnet for greater regulation.
What is Crowdfunding?
Crowdfunding is simply the democratisation of the fundraising process for new projects or businesses. Rather than having to go to an intermediary such as a bank or other financial institution, new technology platforms have created the opportunity for businesses to reach out directly to individual investors via the internet.
There are three types of investment that investors can make – donations based, debt based - also known as peer to peer lending, and equity investing. Donations are often made on the basis the investors will receive something non-financial in return such as input into designs or first productions runs of goods. Debt investments are where money is lent to the business and is repayable with interest. Equity investors receive shares in the company in exchange for their investment.
Crowdfunded investments can be as little as £10.
What are the Issues?
Fundraising for businesses has traditionally been highly regulated for good reason. Many business ventures, particularly start-ups, have significant failure rates and the opportunity for fraud is high. Equity fundraising in particular has therefore had substantial hurdles to prevent ordinary members of the public from financial abuse.
Companies wishing to raise money from the public by issuing shares to the public must be typically by registered as public companies under the Companies Act 2006. This means complying with strict reporting requirements. The Financial Services and Markets Act 2000 requires that a detailed prospectus is issued and promotion restrictions are complied with. Exemptions do exist for certain non-public companies wishing to raise limited funds directly from individual investors. Those investors must normally certify that they are high-net worth individuals or sophisticated investors.
Crowdfunding websites have used a number of tactics such as creating paid members clubs that actually do the investing to get round the latter regulation.
What is the FCA’s Approach to Regulating Crowdfunding?
The two areas that are affected by the FCA rules are debt and equity based crowdfunding; donation based crowdfunding is not caught by the new regulations.
Crowdfunding websites must have strict systems in place to ring-fence investors’ money from that of the crowdfunding business. A central plank of the equity crowdfunding rules is that inexperienced investors will have to certify that they will not invest more than 10% of their net investible assets in unlisted businesses.
In both cases marketing must be fair and not misleading with the risks properly highlighted. Investors will also have a 14 day cooling off period.