Tag: crowdfunding

Financial Crowdfunding and the law

Before focusing more deeply on the subject that concerns us, it’s worthwhile to distinguish the differences in kind between financial and non-financial crowdfunding activity. The activities corresponding to the latter (which include donation and reward Crowdfunding) fall mainly under consumer protection. There is also a more ambiguous form of reward based crowdfunding, which is one based on royalties’ attribution. In the countries where it has appeared, it is usually not regarded as a financial product.

The regulatory complexity considerably increases for the financial forms of crowdfunding (equity or debt). In this field, Crowdfunding’s fundamental logic resides in the involvement of the mass – which means anyone interested in the proposal – which clashes with the financial laws developed in the past 80 years: the willingness to protect private investors, being less qualified than professional ones to understand the risks of financial products.

The result of this conceptual clash between traditional financial laws and crowdfunding needs is causing sudden changes in the Law throughout the world and it is not yet fully stabilized. For these reasons, we will focus on the laws applied to crowdfunding within the financial activity.

Crowdfunding’s fundamental logic resides in the involvement of the mass – which means anyone interested in the proposal – which clashes with the financial laws developed in the past 80 years: the willingness to protect private investors, being less qualified than professional ones to understand the risks of financial products.

Due to the USA’s leadership in crowdfunding, we will start by quickly reviewing its evolution in this field. The Jumpstart Our Business Startups (JOBS) act of April 5th 2012, one of Obama’s first administration flagship legislation, provided, inter alia, the possibility of creating exemptions applicable to crowdfunding to facilitate access to financing for small and medium enterprises.

The SEC (Security and Exchange Commission), has been mandated to write the implementing provisions of the law. Being by definition the defender of the traditional view of investor protection law, it is understandable that it considerably delayed the finding of a formula for the implementation of the Crowdfunding section, called title III (The Jobs Act has 7 parts called titles) due to its intrinsic antagonism with the Crowdfunding logic. The result has been the development, as in the case of blue sky laws of the early 20th century about market regulation, of some intrastate exemption in most US states. In late May 2015, the web crowdfundinglegalhub.com had counted 24 states with approved exemptions, 13 awaiting approval, 12 without such process and California that denied its exemption law without creating an alternative. The delay not only put the US in a competitive disadvantage compared with the most developed countries of Europe (especially the UK), but it also worsened by the operational complexity with multiple local laws.

The big surprise came from the same SEC, on June 19th, 2015, when it implemented the title IV of the JOBS act on capital formation for small businesses. Under this section, it opened the door for American start-ups to raise up to $ 50 million of accredited and non-accredited investors. This means a Copernican revolution from the financial Law of the last 80 years. Although it opens the door to many doubts and risks, it creates, for those companies that will know how to use it, a formidable opportunity of extremely competitive direct financing (in comparison to the laws elsewhere in the world).

The big surprise came from the same SEC, on June 19th, 2015, when it implemented the title IV of the JOBS act on capital formation for small businesses. Under this section, it opened the door for American start-ups to raise up to $ 50 million of accredited and non-accredited investors.

The situation of the laws applicable to crowdfunding activities in Europe is following a slightly different evolution than the one in the USA, although with similarities. Unlike the US government will (which has set a precursor path with the JOBS act probably anticipating the need perceived by the majority of the market more or less a year), the desire to promote this new type of company financing set by the European Union and its representatives did not even reach the European regulatory field.

In the slowness of its operation, several enquires were launched to try to channel the process. One of the latest ones was the public consultation on the revision made by the directive of the prospectus that was carried out in May and reaped a large number of responses.

Some national governments did not wait for the emergence of a community framework and were much more proactive in promoting Crowdfunding. The UK is the paragon of this attitude, followed by France in a less efficient manner. Both have structured this new market in recent years. In the first half of 2015, several countries have chosen to try to enter into this group. It is clearly the case of Austria, to a lesser extent of Germany and, much less, of Spain.

Others are still debating between the vision of opening to a controlled risk-taking with crowdfunding, and the traditional perspective of bureaucratic regulations intended to protect investors. Several countries seem even entrenched in this attitude, such as Denmark and other northern European countries as well as several countries in Central and Eastern Europe.

We could talk about an oil spill effect, which started in the United Kingdom and is progressively spreading across the continent, often losing strength with the distance from the spill epicenter.

The result for all the parties involved in this type of transaction is more than confusing. There are differences in many aspects of the adopted laws on crowdfunding. The main ones are:

  • The statutes of Crowdfunding platforms and their activity authorizations are contradictory from one country to another. Hence, some fall under the rules of the financial services firms and plan to use the European passport (Mifid) to offer their services throughout the Union, while others have a ban on providing services abroad.
  • The levels of prospectus exemptions vary from 0 to 5 million euros.
  • The determining criteria for an accredited investor also vary significantly.

The result of the absence of best practices creates competitive regulation advantages for some and confuse everyone, especially in a world in which many investors try to hunt the best investment opportunities across the continent.

The result of the absence of best practices creates competitive regulation advantages for some and confuse everyone, especially in a world in which many investors try to hunt the best investment opportunities across the continent.

Given the pace of the crowdfunding laws and European regulatory disparity development, all the experts from the sector are invited to comment on this post with information that deepen on the subject and we commit ourselves to translating these comments into the other languages on our blog.

François-Eric Perquel

Sources:

  1. Review of Crowdfunding regulation, Tax & legal workgroup of the European Crowdfunding Network (ECN)
  2. Information from the EECA (European Equity Crowdfunding Association)
  3. crowdfundinglegalhub.com
  4. wikipedia.org

Summary of Private Investments Network response to the European Commission public consultation on the review of the Prospectus Directive

The response was articulated around The European Equity Crowdfunding Association to which Private Investments Networks is a member. The main comments were about:

The specificities of equity crowdfunding

The initial aim of equity crowdfunding is to support companies at each stage, and more specifically at early stages. The current average of the offers published on a website by European crowdfunding platforms is €250,000. The size of the offers is mainly between €50,000 and €1,500,000.

Therefore, we think that the 5,000,000 € threshold is appropriate to support the crowdfunding development in respect of SMEs at early stages or small entities out of the scope of the Prospectus requirements.

Crowdfunding isn’t really a securities offering to the public. The issuers raising capital through a platform shall be granted an exemption to the public offering rules. Nevertheless, the need to protect the investors has to remain; hence it should be made mandatory for the issuer to maintain a flow of corporate information to its investors and to find the best solution to facilitate liquidity opportunities for the investors coming from this type of funding.

Needs of harmonization

The diversity of domestic regulations is a barrier to the crowdfunding development equity within Europe. Each EU Member State has a different domestic policy regarding Prospectus requirements. As an example, the exemption threshold varies: it is €1M in Germany, France, Romania, and €5M in Spain, Italy & the UK etc.

This creates barriers within the EU for crowdfunding both for platforms and issuers. The key point to harmonize and unleash the potential of crowdfunding is that all countries adopt similar requirements. Among them:
– the same prospectus threshold of €5M,
– the same information requirements (key Issuer information document – KIID)
– the same platforms and the Issuers responsibilities regarding this documentation.

Currently, there are regulatory competitive advantages disrupting the market and some platforms are willing to transfer their principal office to other countries to address their own domestic market.

At least, the issuer using Crowdfunding should have harmonized obligations throughout Europe.

Description of the KIID

The Directive shall harmonize a Key Issuer Information Document. This documentation should have clear definitions. It should be required for companies raising capital below the threshold, but not subject to the previous authorization of a National competent authority. The issuer should provide this information under his/her own responsibility and allowed to personalize the information given in order to adapt it to its project and situation. The template provided by the directive should aim at providing a harmonized way to present each information category.

Thus, we think that there should always be an information document (referred to as “KIID”) stating the information that the SME can provide at its sole discretion (mainly based on existing documentation):
– The annual accounts summary (balance sheet and Income statement) for the past 3 years, stating if they are audited and by whom. (Indicative length: max 12 pages)
– A documentation stating the strengths (patents, technology, know-hows, etc.) and main threat the issuer sees (competition, obsolescence, etc.) (max 1 page)
– A short bio of the founders, the board members (if any), the advisory committee members (if any) (max 2 paragraph per bio)
– Current capital structure & dilution due to the fund raising (one table)
– In an appendix, the issuer should add any existing commercial information that he views relevant for the investor. It could be about the product/service and about the market.
When some information does not exist, the issuer should just state that he doesn’t have this information and why.

Given the level of experience/expertise of the retail investors, the complexity of such a document should aim to provide conceptually simple examples, as is now expected in medical publications for consumers.

The KIID should both remain simple as entrepreneurs lack of experience and investors sophistication, and be very explicit.

Need for a single, integrated EU filing system for all prospectuses

It can be set up at a low cost and provide a simple solution to investor’s access to information. It should be set up in a flexible way enabling investors to access to the information of the prospectuses they are interested in and be easily integrated into data feeds to enable diffusion through the intermediaries and media information systems.

François-Eric Perquel.

Is there a Paradigm change in finance?

The financial sector is changing. Up until now, fast growth in this sector was possible only through external growth. The advance of technology and innovation are changing the scene, enabling the pioneers who easily adapt to change, to quickly acquire relevant positions, as shown by the example of Transferwise in the field of international P2P Transfer.

This underlying trend is reflected in an article by Dave Michaels published in Bloomberg. It refers to the US Securities and Exchange Commission (SEC) revision of the possibility to allow stock exchanges to launch less regulated markets in order to enable small businesses to obtain liquidity. When authorities of this kind start considering such changes, it shows that the trend is coming to the turning point for the whole financial sector.

“The US Securities and Exchange Commission revision of the possibility to allow stock exchanges to launch less regulated markets in order to enable small businesses to obtain liquidity.”

Analyzing this trend in more detail, we come across the first detailed study about the Crowdfunding situation in Europe. The University of Cambridge (Cambridge Judge Business School), has managed to gather the information needed to show, in this report, some extremely revealing (recent) statistical and historic data.

This publication explains that since the global financial crisis (in September, it will have been seven years since it happened), alternative funding has considerably increased in the US and Europe. In particular, it refers to: equity crowd funding platforms, peer-to-peer lending, reward based crowd funding, donation based crowd funding, etc., all of which offer investors several ways to invest, encourage innovation, create jobs and/or finance social causes.

“since the global financial crisis, alternative funding has considerably increased in the US and Europe.”

Some of the data reflected in this study, about Crowdfunding in Europe is:

  • A 144% growth in Europe in 2014 (in comparison to 2013).
  • A total amount of transactions in 2014 of € 2,957M.
  • A specific weight of the United Kingdom with a total of transactions of € 2,337M, and a yearly growth of 159%.
  • The top down ranking of countries with the highest number of online platforms is: the United Kingdom, Spain, France, Germany and the Netherlands.
  • 9,743 SMEs have been financed in continental Europe between 2012 and 2014.

This transaction volume is still to be put into perspective as it only represents 0,4 per 1,000 so of traditional funding according to EBAN figures (European Business Angels Network). That is what traditional banks and supervisory authorities still think. However, given the crowd funding exponential growth, one can hope that SMEs, the greatest engine of our global economy, will get from it the financing needed to keep growing, to innovate and to create jobs.

“given the crowd funding exponential growth, one can hope that SMEs, the greatest engine of our global economy, will get from it the financing needed to keep growing, to innovate and to create jobs.”

This hope is very important for Europe given the drastic reduction in traditional financing for this type of businesses, which is due to the current trend to overregulate banks, in order to try to eliminate the risk from their activity.

For this reason, this way of creating closer and less restrictive collaborations is attracting companies and investors. Will crowd funding consolidate and, in such a case, how will traditional banks adapt to this new emerging paradigm?

Guillem Comi and Carmen Zamudio.