A joint report published in December 2013 by the Universities of Berkeley and Cambridge estimated that investment-based crowdfunding platforms raised £28 million in 2013, representing an increase of 618 per cent compared with 2012.
Given the significant growth in the crowdfunding market and research from the Office for National Statistics, which suggest that around 50 per cent to 70 per cent of start-up businesses fail, it is unsurprising that the FCA has sought to regulate online crowdfunding platforms.
Following on from its October 2013 consultation paper, the FCA published new rules relating to crowdfunding earlier this month, with rules due to come into effect on 1 April 2014.
Firms offering investments in so-called ‘non-readily realisable securities’ on crowdfunding platforms will be restricted to offering and promoting such securities to the following types of investors:
- Investment professionals
- Retail clients who confirm that they will receive regulated investment advice or investment management services from an authorised person
- Retail clients classified as venture capital contacts or corporate finance contacts
- Retail clients who are certified or self-certify as sophisticated investors
- Retail clients who are certified as high-net worth individuals
- Retail clients who certify they will not invest more than 10 per cent of their net investible financial assets
Interestingly, the US is also looking to adopt limits on the amount that retail investors can invest in crowdfunding and in this way the FCA has avoided any risk of regulation arbitrage whilst at the same time protecting investors.
The regulations have also amended the description of the securities to which the rules apply, replacing ‘unlisted share and unlisted debt security’ in favour of the new term ‘non-readily realisable security.’
Investor protection is at the heart of this rule clarification, as shares in private companies have no obvious secondary market in which they can be traded. The FCA has further clarified that the regulations do not restrict the promotion of securities which are about to be admitted to an investment exchange such as AIM.
More on crowdfunding:
Most significantly, crowdfunding platforms will be able to make direct offers to retail clients for a period of 12 months so long as the investor signs a Restricted Investor Statement. Therefore if a suitable statement is in place, firms will likely not be required to ensure that the individual continues to satisfy this investment criterion on an on-going basis.
The FCA provides general guidance as to what information should be included when making a financial promotion to retail clients. Crowdfunding platforms therefore need to ensure that they (a) include the name of the firm; (b) provide accurate information on the firm and not emphasise potential benefits of the investment without also giving a fair indication of the risks; (c) present the information in an easily understandable way; and (d) not disguise or hide any important statements or warnings.
However the FCA does not prescribe the level of due diligence which needs to be undertaken by crowdfunding platforms to assess the benefits and risks involved with each particular investment. The FCA has however left the door open, stating that greater prescription as to due diligence requirements is a factor it may consider in the future.
At first glance the obligations on crowdfunding platforms do not appear to be too onerous and the fact that investors will be able to self-certify will reduce the burden on crowdfunding platforms. These measures are likely to keep the channels to investment open for ‘ordinary individuals’ whilst at the same time ensuring that they are aware of the inherent risks involved in such investments. Equally this is good news for high growth companies looking for investment but they must be wary of that there is a general prohibition on private limited companies making public offers of their shares.
For now anyway it appears that the ‘democratisation of investing’, which is said by many to lie at the heart of crowdfunding, will continue to be protected.