Crowdfunding Grows Up — How European Regulations will shape crowdfunding’s development in Ireland
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Speed Read: Following publication of European Crowdfunding Service Providers Regulation (EU) 2020/1503 (the “Regulations”) in November 2020, crowdfunding platforms are gaining credibility as an alternative source of business finance but will need bear regulatory burdens to continue to provide their service from November 2021 onwards.
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In the last decade, crowdfunding has matured from novelty finance, a website for a friend to raise money to bottle and distribute her new home-brew, to a sustainable finance model for businesses seeking to accelerate growth or, in the past 12 months, to weather unprecedented forced business closures.
Crowdfunding has become increasingly creative and visible during the Covid-19 pandemic. Reward crowdfunding is one example which was typically utilised in the development phase by project owners. Backers would fund the initial costs of a product or project in the expectation of receiving a reward once the project was realised.
Shuttered venues in the hospitality sector are now turning to reward crowdfunding to offer customers the opportunity to buy a meal for their future selves, or tickets to an unknown show in 2022 to help offset their dramatic drop in revenue generation. An expansion of the voucher model of yesteryear, businesses see matured crowdfunding as a way of tapping into their community for support while their doors are closed.
Crowdfunding is an alternative source of financing for companies or individuals seeking to finance a project or grow a business.
- Types of crowdfunding
There are presently four popular methods of crowdfunding:
- Lending; and
From an investor perspective, crowdfunding is disrupting traditional investing for both sophisticated and retail investors. Crowdfunding opens opportunities for investors that would otherwise be under their radar. Crowdfunding provides direct access for small scale investors to invest in companies rather than going through a private investment business. Lastly, crowdfunding offers investors greater access to information and often direct communication with the campaigners, projects, and companies they are investing in.
From a project owner perspective, crowdfunding also disrupts traditional bank lending by allowing SMEs, startups and social entrepreneurs access unsecured finance directly and on demand from investors or other businesses.
Notwithstanding the benefits for investors and businesses, the expanding crowdfunding ecosystem warranted caution for consumers in its unregulated early days.
Crowdfunding was often seen as a fringe form of finance not warranting regulation. The Central Bank of Ireland went so far as to issue a Consumer Notice in 2014 which simply warned consumers about the unregulated nature of crowdfunding investments and to exercise caution when investing.
Crowdfunding has proved itself to be a sustainable form of finance however and has grown to become a mature and accessible finance option for many businesses in a broad range of sectors. Eye-catching headlines now regularly showcase businesses completing large funding rounds sourced through crowd funding platforms in very short turnaround times.
All this may be about to change however as Crowdfunding has now attracted the attention of the European regulators with the introduction of the Regulations in Autumn 2020.
- NEW REGULATORY LANDSCAPE
The Regulations set out a framework for the authorization, operation and supervision of crowdfunding service providers (“Platforms”) in Europe.
For the companies or individuals (excluding consumers) who propose the crowdfunding project (“Project Owners”), there are new information and disclosure requirements. Importantly, liability also attaches to the Project Owners in respect of the information disclosed by Project Owners.
For both sophisticated and non-sophisticated investors (“Investors”), new investor protections are introduced. The distinction between these two types of investors is set out in the Regulations and broadly falls into professional investors and retail investors. Sophisticated Investors are described in Annex II of the Regulations, and anyone not meeting these requirements is then considered a “non-sophisticated investor”.
- What type of Platforms do the Regulations apply to?
The Regulations apply to share purchases on equity Platforms and loans on lending Platforms.
Equity Platforms facilitate orders for transferable securities and admitted instruments for crowdfunding purposes issued by Project Owners. These types of Platforms have become increasingly prevalent in recent years, with seed investments in particular utilising them. One popular UK based equity platform has already reached £1 billion worth of investments in start-ups and SMEs.
Loans include peer-to-peer loans such as SME or business loans, and other types of financing where an Investor makes an amount of money available to a Project Owner with an unconditional obligation of repayment with interest. As consumers are excluded from the definition of “project owner” in the Regulations, the Regulations do not apply to crowdfunded loans for consumers.
- What is excluded from the Regulations?
The Regulations do not apply to the following crowdfunding services:
- Donation and Reward Platforms;
- Crowdfunding with consumers as the Project Owner;
- Services related to crowdfunding services. These are services that might be carried out in connection with a Platform such as analytics; and
- Crowdfunding services in respect of offers over €5,000,000, calculated over 12 months per Project Owner. These offers will be regulated by separate national provisions or EU regulations, namely Directive 2014/65/EU (“MiFID II”) and the Prospectus Regulation 2017/1129/EU.
- Key Dates
The key date for the application of the Regulations is 10 November 2021. For Platforms existing before this date, they will have until November 2022 to comply with the Regulations as part of a transitionary period. For Platforms created after 10 November 2021, they must comply with the Regulations from the outset.
Transposition of the Regulations by the Irish government is awaited, notwithstanding that 10 May 2021 is the cut-off date for national adoption of the Regulations. The Spring 2021 Legislative Programme does not forecast the adoption of the Regulations into Irish law.
- The primary takeaway for Platforms is that the Regulations introduce an authorisation for Platforms to operate EU-wide.
Once a Platform is authorised under Article 12 in their home Member State, they have a full license to operate in any other Member State. This authorisation is a step above a passport as it does not require a physical presence, approval or acceptance in the second Member State. The Platform must simply make an informational submission to the supervising authority of the new Member State, as set out in Article 18. Member States do retain a power to intervene and stop Platforms operating there under Article 37.
- Platforms will be required to operate as a neutral intermediary between Investors and Project Owners. There should not be any discrimination between Project Owners or Investors within the Platform;
- Platforms are prohibited from participating in any crowdfunding offer on their own site;
- Prudential requirements for Platforms have been introduced which include a safeguard of at least €25,000 and the requirement for the Platform to hold liability insurance;
- secondary markets are allowed on Platforms through the operation of a bulletin board. Platforms that offer more than a bulletin board and start to match buyers and sellers would appear to fall outside the scope of the Regulations and may need to seek approval under MiFID II; and
- there are new requirements for marketing communications, most notable of which is that such communications shall be consistent with the information provided by the Project Owner in the key investment information sheet.
- Project Owners are subject to heightened informational requirements under the Regulations;
- Project Owners are prohibited from amending the terms and conditions of a project until either the project expires, or the funding target is hit. In practice, this means that Project Owners must be comfortable agreeing to the same terms with all Investors until they reach their desired funding target;
- Project Owner are required to provide a detailed information sheet to the Platform and to Investors. The form of this information sheet is set out in Annex I of the Regulations and contains specific wording for a disclaimer and a risk warning; and
- the Regulations place liability for the content of the information sheet with the Project Owner. It will be interesting to see where the balance of liability between Project Owners and Platforms lies when the Irish Government enacts legislation to bring the Regulations into Irish law.
Chapter IV of the Regulations establishes new protections for Investors.
- Platforms must enable an effective and transparent complaints procedure;
- Platforms must clearly label marketing communications to Investors as marketing communications, and it must not include marketing of individually planned or pending crowdfunding projects;
- Platforms will have an obligation to assess non-sophisticated Investors to ensure their services are appropriate for the non-sophisticated Investors before providing them; and
- non-sophisticated Investors are required to simulate their ability to bear loss, calculated at 10% of their net worth to Platforms.
While the Regulations won’t change life as she knows it for my friend and her home-brewery, they will go a long way to build trust among Platforms, Project Owners and Investors, and help a maturing alternative finance industry flourish.
Crowdfunding will no doubt continue to grow as we slowly rebuild our businesses and government back and pandemic finance packages are withdrawn. If crowdfunding is to thrive as sustainable alternative finance, it requires the credibility that these Regulations bring and an emphasis on accurate information sharing that is the core responsibility set out in the Regulations. It remains to be seen if the ability for Platforms to operate on an EU-wide basis without the expense of co locating will drive greater access by SMEs and start-ups to crowd funding platforms to the ultimate benefit of consumers. The future for crowdfunding looks bright.
 Consumer Notice on Crowdfunding, including Peer-to-Peer Lending published on 17 June 2014
 Article 4 of the Regulations
 Article 8 of the Regulations
 Article 11 of the Regulations
 Article 25 of the Regulations
 Articles 27 and 28 of the Regulations
 Article 22 of the Regulations
 Article 23 of the Regulations
 Article 23.9 of the Regulations
 Article 7 of the Regulations
 Article 19 of the Regulations
 Article 21 of the Regulations
 Article 21.5 of the Regulations