by Sadhbh McGrath
Online crowdfunding is the new kid on the block. A buzzword for some time now, online crowdfunding has just started to come onto the EU legislature’s radar. In March 2018, the EU announced their ‘FinTech Action plan: For a more competitive and innovative European financial sector’. This FinTech Action plan has three broad aims: Enabling innovative business models to reach EU scale, Supporting the uptake of technological innovation in the financial sector and Enhancing security and integrity of the financial sector. One way the European Commission acted on these goals was by proposing a new Regulation on online crowdfunding.
For those of you that are not that familiar with online crowdfunding we will first outline what online crowdfunding is and the different types. Next it will be set out why crowdfunding is useful. Last the various approaches taken by legislatures will be outlined.
What is online crowdfunding?
Crowdfunding can be defined as ‘the collecting of resources (funds, money, tangible goods, time) from the population at large through an Internet platform’. When a website or another online platform is used to set out an idea or project and asks for people or institutions to contribute funds to the venture.
Are there different forms of online crowdfunding?
Yes. There are four forms of online crowdfunding:
‘Donation – a donor contract without existential reward,
Reward – purchase contract for some type of product or service,
Lending – credit contract, credit [is repaid] plus interest, and
Equity – shareholding contract, shares, equity-like instruments or revenue sharing in the project/business, potential up-side at exit’.
Vitins set out that a fifth category, pre-purchase that might be added to the above list. In the pre-purchase model investors receive for example watches the production of which was enabled by the funding. However, it is thought that the pre-purchase category is overly similar to the reward class. As such this fifth category has been amalgamated into the reward category.
Does the proposed EU regulation cover all four types?
Broadly, the four types of crowdfunding may be split into two: one half being investment crowdfunding (lending and equity) and the other being patronage crowdfunding (donation and reward). The proposed EU Regulation on crowdfunding has excluded from its scope patronage crowdfunding as:
‘[t]he inclusion of those business models would be disproportionate as they do not deal with financial products and the information asymmetries that these products create. Moreover, EU consumer protection legislation already applies to reward-based crowdfunding with strict rules to safeguard consumers’.
Is online crowdfunding useful?
Online crowdfunding is a new financial product. Online crowdfunding provides a way to finance start-up companies. Obtaining financing from traditional lenders is often difficult or impossible for start-up companies ‘due to a limited track record. Crowdfunding helps fill this gap by enabling them to grow and access more sophisticated funding sources’ (see Europa).
An attractive feature of online crowdfunding is that risk is spread over multiple funders. Where a single lender provided financing for a start-up company the risk of failure was borne by one party. However, in the online crowdfunding model, the risk of failure is spread between a greater number of parties. Financing start-up companies is a high-risk enterprise.
Current opinion of the EU’s Regulation and approaches taken by legislatures
As the proposal for the Crowdfunding Regulation was announced recently, there is little to no research on this proposed Regulation. There have nevertheless been many papers that have made suggestions on how the EU should regulate (see Vitale). Overall the literature is in favour of legislation for Crowdfunding (see Vitins).
However it is noted that the UK platforms raised concerns ‘that despite good intentions of the Commission, the divergent rules and mindsets towards crowdfunding and peer 2 peer lending across Europe mean that it will not be possible to achieve a legislative outcome that facilitates rather than holds back the sector and cross- border investment’.
The US took a legislative step in enacting the CROWDFUND Act in 2012. The United States previously did not explicitly take an official stance on crowdfunding.
Although the United Kingdom is still a Member State at the time of writing, it is unlikely that the Crowdfunding Regulation will be implemented before Brexit. Currently crowdfunding is indirectly governed by the Financial Services Authority under the Financial Services Market Act 2000. The Financial Services Market Act 2000 contains ‘a number of regulations that have been loosely adapted to crowdfunding (at least for the time being, until the United Kingdom passes explicit equity crowdfunding laws)’ (see Weinstein).
Australia has taken similar approach to the UK. The Australian legislature simply stated that Australian Securities Laws applied to crowdfunding. Then, ‘Australia issued “guidance” on crowdfunding’ (see Gabison). However transparency concerns have been raised (see Vitinsand Vitale). Crowdfunding is largely of benefit to start-up companies. Start-up companies are unlikely to have the resources to safely navigate complex laws on requirements and exemptions. It will be instructive to examine the effect of this legislation on start-up company’s utilisation of crowdfunding. However, crowdfunding is not limited in its use for start-up companies. Crowdfunding platforms such as Initiative Ireland provide a means to raise capital for property development. The Regulation does not take this into account.
Investment crowdfunding is a new form of financing that fills ‘the void between patronage crowdfunding and traditional brick-and-mortar financing’ (see Burkett). It is accessible to all regardless of location and dependent only on your internet connection (see Schwartz). The current proposed EU regulation is a step in the right direction. However, the main focus is on the information that is provided to crowdfunders regarding the projects that are being crowdfunded. There are many other issues that the proposed EU Regulation is silent on such as issues relating to enforcement of a security if the situation arose.
The EU has taken a positive step but has much farther to go.