Crowd funding: pushing the FMSA boundaries?
14 September 2011
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Business Secretary Vince Cable announced recently what we have known for a while: “There is a serious problem with lending to good, small companies”. It is a catch 22: the Government sees entrepreneurship as essential to longer-term economic recovery, but the funding is not available to facilitate this.
So what can companies do if they are struggling to raise the funds that they require? One possible solution coming to the fore is a concept known as crowd funding.
Crowd funding uses the platform and reach afforded by the Internet and social networking to enable small and early stage companies to seek funding. The companies are generally looking for a large number of smaller investors to raise relatively small sums of money, instead of the more conventional approach to fundraising of targeting a smaller number of larger investors.
Crowd funding is not a new concept. In 1997, British rock group, Marillion, raised £60,000 from US fans to cover the entire cost of their US tour following an internet campaign. The concept is however growing in popularity and there are now several crowd funding intermediary websites in the UK, such as SoLoCo, Crowdcube, WeDidThis, GrowVC and Buzzbnk.
Companies use these intermediary websites to facilitate their communications with potential investors through various means, including, presentation downloads, links to their own websites, online chat rooms, FAQ forums and webinars.
Crowd funding is clearly caught by the UK’s financial promotion regime, which is governed principally by the Financial Services and Markets Act 2000 and related legislation, and which is designed to protect the smaller, less sophisticated investors; just the type of investor that crowd funding is targeting. The law in this regard is clear: a person must not in the course of his business communicate an invitation or inducement to engage in an investment activity unless (i) he is an authorised person, (ii) or the content of the communication is approved by an authorised person, or (iii) the communication is covered by an exemption.
It would appear that many companies participating in crowd funding have taken legal advice in relation to compliance with the law. However, there appears to be a number of different practices emerging. In some cases the investee company’s communications are flagged as having been approved by an authorised person, but in other cases there has clearly been some creative lawyering. For instance, one of the crowd funding intermediary websites requires users to agree to subscribe for a 1p share in a company limited by guarantee before they can access any of the investee company offerings. The offer to subscribe for such shares is flagged as being an approved financial promotion. By agreeing to subscribe for a share, users confirm that they understand that the investment opportunities on the website are not authorised by FSA authorised persons and it is their responsibility to perform all due diligence prior to making an investment. It is not clear to me how these investee companies are complying with the law, given that their communications appear to be neither approved nor fall within one of the exemptions.
Leaving legalities aside, investors undoubtedly take a big risk when investing through this medium. The old adage of “only invest what you can afford to lose” most definitely applies in this case. Save for information in the public domain, there looks to be very limited scope for due diligence (although investee companies appear willing to deal with online questions) and there is no scope for warranties or a shareholders’ agreement containing even the most limited investor protections. In some cases, it is not clear at what stage investors would be given sight of articles of association - perhaps obtaining a copy of them is considered to be part of the due diligence, but one suspects that many investors may not know what articles of association are.
All that said, the UK regulators have not publicly challenged this form of fundraising, although it will be interesting to see if they, like many others, are just behind the game and in time will take issue with the practice that is evolving.
Chris Gotts is a corporate finance partner at Burness LLP