Limited availability of traditional sources of funding in recent years has led to a growth in alternative finance sources for new businesses and ventures.
One popular alternative known as “Crowdfunding” is the collection of finance through small contributions from a large pool of backers, the "crowd", usually made by means of an online platform.
The FCA (the regulator of this activity since 1 April 2014) has identified different types of Crowdfunding, which include loans, rewards schemes, and investment based funding.
In addition to the financial gains to be achieved by a business or venture, Crowdfunding campaigns can also provide a number of non-monetary benefits for a business such as profile boosting and audience engagement. There are, of course, a number of risks that
also ought to be considered by borrowers and investors alike. Those risks include:
· Reputation – failure to meet campaign goals or to generate interest on a particular venture could negatively impact reputation.
· IP protection – digital media developers and content producers may be reluctant to publicly announce the details of a project before production, due to concerns about idea theft and IP plagiarism.
· Donor exhaustion – there is a risk that a network of investors may eventually cease to supply necessary support if approached on numerous occasions.
· Fraud and money laundering – investors risk potentially being defrauded by the recipient of the finance or an investor could launder money through the platform.
· Loans might not be repaid – this could be as a result of a number of factors, such as a failure to carry out proper credit checks on the borrowers, borrower fraud or firm failure.
· Start-up business failures – traditionally, Crowdfunding is used as seed funding for new companies. Research indicates that around 50% to 70% of business start-ups fail. Consumers may underestimate the risks of investing in such companies. Managing communications
with a large number of possibly disappointed investors can also be a substantial task
Many investors on Crowdfunding platforms may not receive advice and might not understand the potential risks involved. In order to manage the risks, the FCA propose a number of regulatory requirements which will come into effect between 1 April and 30 September
2014. Such proposals include disclosure of the following information to potential investors:
· expected and actual default rates based on past and future performance;
· a description of how loan risk is assessed;
· details of the creditworthiness assessment;
· details of likely actual rates of return;
· exit options for investors; and
· the impact of the failure of the firm, including the lack of FSCS cover.
Although still a relatively new concept, it is hoped that Crowdfunding can both protect those participating whilst also providing innovative ways to further promote competition in the finance sector.
Berg does not provide tax or investment advice.
The information and opinions contained in this article are not intended to be comprehensive or to provide legal advice. No responsibility for article’s accuracy or correctness is assumed by Berg or any of its partners or employees. Professional legal advice
should be obtained before taking, or refraining from taking, any action as a result of the contents of this article.