Equity crowdfunding

Equity crowdfunding is the offering of securities in a business to a group of people for investment. Because equity crowdfunding involves investment into a commercial enterprise, it is often subject to securities and financial regulation. Equity crowdfunding is also referred to as investment crowdfunding and crowd investing.

Equity crowdfunding is a mechanism that enables broad groups of investors to fund startup companies and small businesses in return for equity. Investors give money to a business and receive ownership of a small piece of that business. If the business succeeds, then its value goes up, as well as the value of a share in that business—the converse is also true. Coverage of equity crowdfunding indicates that its potential is greatest with startup businesses that are seeking smaller investments to achieve establishment, while follow-on funding (required for rapid growth) may come from other sources.^[1]

History of Equity Crowdfunding

Investment crowdfunding can be debt-based or equity-based, or can follow other models, including profit-sharing and hybrid models. The term equity crowdfunding is often used to describe crowd investing into both debt and equity based instruments when they are offered on an equity crowdfunding platform. One of the first operational equity crowdfunding platforms in the USA was EquityNet,^[2] other early platforms include CrowdCube and Seedrs in the UK.

Selling investments via crowdfunding has been called crowdfund investing,^[3] hyperfunding,^[4] crowdinvesting,^[5] or even simply crowdfunding, as in "legalize crowdfunding".^[6] Some have called for standardization of the terminology in a way that distinguishes the practice from other forms of crowdfunding.^[7]

Debt crowdfunding allows a group of lenders to lend funds to individuals or businesses in return for interest payment on top of capital repayments. Also known as Peer to peer lending or Peer to business lending. Borrowers must demonstrate creditworthiness and the capability to repay the debt, making it unsuitable for NINA or startups. ^[8]

Regulation of Equity Crowdfunding

Investment crowdfunding can breach various securities laws, because soliciting investments from the general public is often illegal, unless the opportunity has been filed with an appropriate securities regulatory authority, such as the Securities and Exchange Commission in the U.S., the Ontario Securities Commission in Ontario, Canada, the Autorité des marchés financiers in France and Quebec, Canada, or the Financial Conduct Authority in the U.K. These regulators have different ways of determining what is and what is not a security but a general rule one can rely on (at least in the U.S.) is the Howey Test. The Howey Test says that a transaction constitutes an investment contract (therefore a security) if there is (1) an exchange of money (2) with an expectation of profits arising (3) from a common enterprise (4) which depends solely on the efforts of a promoter or third party. Any crowdfunding arrangement in which investors are asked to contribute money in exchange for potential profits based on the work of others would be considered a security. As such, the applicable investment contract would have to be registered with a regulatory agency, unless it qualified for one of several exemptions (e.g., Regulation A or Rule 506 of Regulation D of the Securities Act of 1933, or the California Limited Offering Exemption – Rule 1001 (also known as S.E.C. Rule 1001)). The penalties for a securities violation can vary greatly and depend on the amount of profit obtained by the "promoter," the damage done to the investors, and whether a violation is a first time offense. According to Section 5 of the Securities Act, it is illegal to sell any security unless such a sale is accompanied or preceded by a prospectus that meets the requirements of the Securities Act.^[9]

International approaches to the regulation of equity crowdfunding

Australia

Crowdfunding as a discrete activity is not prohibited in Australia when raising funds with donations. The provisions of the Corporations Act need to be considered if raising funds with either debt or equity.^[10] The Corporations and Markets Advisory Committee (CAMAC) issued a report into proposed changes to the Australian regulatory environment for Crowd Sourced Equity Funding in May 2014. It is anticipated that Treasury will follow with a subsequent request for comment later in the 2014.^[11]

Belgium

Local crowdfunding sites have been active in Belgium since 2011, and the legislation was adapted to cover them in April 2014. This made it possible to raise up to 300k€ per projects via crowdfunding as long as crowd investors' individual investments remained below €1000. Since this law adaptation was limited, regional governments have confirmed that further improvements of the legislation would remain a priority to address before 2019, and this was officially confirmed by the Flemish government in a published act.^[12]

New Zealand

New Zealand enacted the legal framework for equity crowdfunding in 2013 ^[13] and corresponding regulations in 2014.^[14] The regulations allow each New Zealand company to raise up to $2 million in any 12 months from the New Zealand public through a licensed equity crowdfunding platform without the usual offer document prescribed under securities law. Snowball Effect launched New Zealand's first equity crowdfunding offer in August 2014, with craft brewery Renaissance Brewing successfully raising $700,000 in 13 days.^[15]

Canada

Canada's first equity crowdfunding portal is Optimize Capital Markets which launched in Ontario on September 2009.^[16] In June 2013, the Ontario Securities Commission announced that it was allowing an Ontario-only portal for accredited investors.^[17] The province of Saskatchewan made equity crowdfunding legal in December 2013.^[18]

Ireland

Crowdfunding remains unregulated in Ireland. The law with regard to crowdfunding, and in particular equity based crowdfunding is complex. Issues to be resolved and regulations to be reviewed include:

• The Prospectus Directive (Directive 2003/71/EC) as transposed into Irish law by the Prospectus (Directive 2003/71/EC) Regulations 2005 (as amended) (the “Prospectus Regulations”).
• The Markets in Financial Instruments Directive (MiFID) (Directive 2004/39/EC) as transposed into Irish law by the European Communities (Markets in Financial Instruments) Regulations 2007 (the “MiFID Regulations”).
• The Investment Intermediaries Act 1995.
• The Consumer Credit Act 1995.

However, there are a number of websites that offer various types of crowdfunding services. Fund it was set up in 2011 to finance creative arts related projects, supported by Bank of America Merrill Lynch, The Arthur Guinness Fund and a technology grant from the Department of Arts, Heritage & the Gaeltacht. iCrowdFund founded in 2014 supports donation and reward based crowdfunding. Linked Finance is a crowd lending site.

Italy

Italy has several well-functioning reward-based crowdfunding websites since 2011 (e.g. www.eppela.com, www.produzionidalbasso.com). In July 2013 Italy became the first country in Europe to implement a complete regulation on equity-crowdfunding, which applies only to innovative startups and establishes, among other rules, a national registry for equity crowdfunding portals and disclosure obligations for both issuers and portals.^[19] The first platform for equity crowdfunding went online on December 12, 2013 ^[20] and two more followed.^[21][22] The first equity crowdfunding campaign launched in Italy was a success, raising a total of €157,780 in three months, exceeding its initial target of €147,000.^[23]

Israel

Israel has yet to enact legal framework for equity crowdfunding. Therefore, any equity crowdfunding activity is currently regulated under the Israeli Securities Law which permits the offering of securities to 35 non accredited individuals and an unlimited amount of accredited investors as defined in Israel Securities Law. The Israeli Securities Authority has proposed a new regulatory framework for equity crowdfunding in Israel, which has not been adopted yet. Some of the main terms are:

• An aggregate financing amount of up to ILS2 million over 12 months
• Limitation of the amount to be invested by each individual to ILS10,000 unless the investor is “wealthy”
• A sophisticated investor (as defined in the regulations) must contribute 10% of the total financing amount
• Office of Chief Scientist approval

There is an equity crowdfunding platform called iAngels

Finland

An Equity Crowdfunding portal was launched in Finland in May 2012 by Invesdor.^[24] The legal issues around donation-based crowdfunding have been under debate in Finland as its legislation^[25] around this is different from most countries. However the legislation about Equity and Rewards-based Crowdfunding is more similar to the rest of Europe, and the legal situation is clear.^[26] Invesdor has also started operating in Sweden^[27] and has additionally opened its service to Danish and Estonian companies.^[28] The Sweden-based FundedByMe also launched their Equity Crowdfunding portal in Finland in January 2013.^[29]

Germany

After two smaller projects in 2010, 2011 can be considered the first successful year for crowdfunding in Germany. The largest crowdfunding project was launched by the company Brainpool in December 2011. For the movie of the successful TV series Stromberg, the company wanted to collect one million euros by March 2012,^[30] and the total amount was reached within one week.^[31] Since then, various national, but also regional, platforms were founded, such as Crowd Berlin, Nordstarter for Hamburg and Dresden Durchstarter.

Additional specialized niche sites, mainly for games^[32] and musicians,^[33] are entering the market. At the end of 2013, a new crowdfunding platform was launched called Dreamojo,^[34] which lets you collect money from anyone, for anything. Dreamojo also helps you collect money through social networks.

Singapore

Crowdfunding currently falls under the Collective Investment Scheme which is regulated by the Monetary Authority of Singapore. Despite being an Asian financial center, crowdfunding platforms are illegal in Singapore.^[35] There is no provision in the legislation specially for crowdfunding.

Sweden and Norway

Crowdfunding portals have also launched in Scandinavia supporting both local language crowdfunding and English language crowdfunding. The oldest active crowdfunding platform in Sweden today is crowdculture launched in 2010. The system works with a unique hybrid mechanism where crowdfunding works as abase to crowdsource public investment decisions.^[36] The donation-based CrowdFunding portal FundedByMe has been active in Sweden and Norway since 2011,^[37] and Swedish crowdfunding activity is evolving in parallel to Crowdfunding in the USA with Equity-Based CrowdFunding becoming active in Sweden late in 2012.^[38] Invesdor also started operating in Sweden in February 2013.^[27]

Turkey

Turkey's crowdfunding platforms are Fonlabeni, Fongogo and Biayda.^[39]

United Arab Emirates

The first crowdfunding site in the United Arab Emirates (UAE) is Aflamnah, the Dubai-based platform launched in July 2012. Aimed at extensively supporting Arab-produced film projects, its operational model is based on a hybrid form of Kickstarter and Indiegogo.^[40]

The first equity crowdfunding portal for real estate in the UAE, the GCC, and the rest of the Middle East and North Africa (or MENA) region, was launched by Abu Dhabi-based Humming Crowd Realty in May 2014. The concept, which is built on Western real estate crowdfunding fundamentals, introduces global investors to property-investment opportunities that are compliant with Islamic financing principles and Sharia standards.^[41][42]

United Kingdom

On 1 April 2014, the regulation of the consumer credit market transferred from the Office of Fair Trading (OFT) to the Financial Conduct Authority (FCA). This includes responsibility for regulating loan-based crowdfunding. The FCA has published a policy statement regarding crowd funding in March 2014.^[43]

Abundance Generation was the first debt crowdfunding platform in the United Kingdom (UK) to be regulated by the Financial Services Authority (now the Financial Conduct Authority). It was approved in July 2011 and was launched to the public in 2012.^[44] Abundance Generation provides democratic finance to UK-based renewable energy developers.^[45]

On 6 July 2012, Seedrs Limited was launched as the first equity crowdfunding platform to receive regulatory approval from the Financial Services Authority.^[46] In August 2012, Richard Branson announced his support for crowdfunding, crowdinvesting and crowdlending platform BankToTheFuture.com in the Telegraph newspaper.^[47] In February 2013, the CrowdCube equity crowdfunding platform, which was launched in 2011, was authorised by the FSA.^[48]

United States

Equity crowdfunding platforms

The JOBS Act allows equity crowdfunding when it is conducted by a licensed broker-dealer or via a Funding Portal registered with the SEC.^[49] Many Crowdfunding services have launched to fill this role, and the space is evolving rapidly. Early portal Profounder closed before SEC guidelines were released,^[50] and equity portal Earlyshares acquired charity portal Helpersunite.^[51] The first portal operating in the U.S. and geared towards small businesses was EquityNet in 2005, followed by Rock The Post in 2010,^[52] SeedInvest was founded in 2011 and FundersClub in 2012.

Federal Legislation

Thanks in part to the Crowdfunding exemption movement, the JOBS Act was signed into law by President Obama on April 5, 2012. The U.S. Securities and Exchange Commission has been given approximately 270 days to set forth specific rules and guidelines that enact this legislation, while also ensuring the protection of investors.^[53] Some rules have already been proposed by the SEC.^[54][55]

The bill went through a number of amendments and on April 5, 2012 President Barack Obama signed the JOBS Act into law.^[56] The legislation mandates that funding portals must register with the SEC as well as an applicable self-regulatory organization to operate.^[57]

The JOBS Act places limits on the value of securities issuer may offer and individuals can invest through crowdfunding intermediaries. An issuer may sell up to $1,000,000 of its securities per 12 months, and, depending upon their net worth and income, investors will be permitted to invest up to $100,000 in crowdfunding issues per 12 months.^[58] An independent financial statement review by a CPA firm is required for raises $100,000–500,000 and an independent financial statement audit by a CPA firm is required for raises over $500,000.^[59]

On October 23, 2013, the SEC unanimously approved the progress of the crowdfunding bill and SEC commissioners explained that the commission's goals are to ease online fundraising for small companies and fraud protection for investors. As of the date of approval, the proposal is open for public comment for a 90-day period that is followed by another SEC vote to enable the enactment of the proposal.^[60] In parallel to the SEC regulations, the Financial Industry Regulatory Authority (FINRA) is creating additional rules related to member firms engaged in crowdfunding.^[57]

State legislation

Some people see the federal crowdfunding legislation as unworkable, and several U.S. states have recently enacted or are considering their own crowdfunding exemption laws, to facilitate intrastate investment offerings that are already exempt from federal (SEC) regulation.^[61] These include the Invest Kansas Exemption,^[62] effective August 2011, and the Invest Georgia Exemption, effective December 2012, has $1m/$10k caps.^[63] Late in 2013, both Michigan ^[64] and Wisconsin ^[65] joined Kansas and Georgia. As of April 2013, the states of Washington^[66] and North Carolina^[67] are considering their own crowdfunding exemptions.^[68] In July 2012, the Wisconsin Department of Financial Institutions issued an advisory, about legislation proposed, intended to allow crowdfunding to raise up to $1 million from non-accredited Wisconsin investors without audited financial statements, or up to $2 million if the issuer has audited financial statements.^[69]

Crowdfunding insurance

The draft SEC rules calls for portals to purchase a fidelity bond of at least $100,000. As stated by the SEC is that a "fidelity bond .. aims to protect its holder against certain types of losses, including but not limited to those caused by malfeasance of the holder's officers and employees, and the effect of such losses on the holder's capital".^[70] A fidelity bond generally covers a corporate policyholder from first party losses arising from the theft of money, securities or other tangible property so if the portal's employees steal the funds belonging to the crowdfunding company, the bond can be useful. However, if there is a claim against the portal for negligence in providing its services as a portal, the more proper insurance policy to apply to this loss is a professional liability insurance.

See also

• Angel investor
• Comparison of crowd funding services
• Crowdfunding
• JOBS Act
• List of highest funded equity crowdfunding projects

References

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