Time to consider crowdfunding?
In this article by Walker Morris LLP, Richard Nalsh and Andrew Northage comment that UK equity crowdfunding raised £84m in 2014 and the number of UK crowdfunding platforms is growing steadily, with the trend likely to continue. As such, is it time for issuers and their financial advisers to consider the crowdfunding alternative?
If traditional methods of fundraising are not looking promising, then it may be worth considering a crowdfunding alternative. From the point of view of the issuer and its broker, there may be fewer regulatory obstacles than are likely to be encountered in a traditional equity fundraising.
Advantages of a crowdfunding
Generally, equity-based crowdfundings raise funds from a large pool of investors, often "lay" investors, who subscribe modest amounts, and indeed the overall amount raised by a crowdfunding is unlikely to be large, often being used to supplement a more "traditional" fundraising. The comparatively modest amounts involved mean that a prospectus will not usually be required for the crowdfunding as the total "consideration" for the securities being offered (over a rolling 12-month period) is likely to be less than €5 million, the current threshold. The fact that a prospectus can be dispensed with should save time and money.
Although a prospectus may not be needed the issue will still be an offer of shares to the public and therefore, under section 755 of the Companies Act 2006, the company will need to be a public company as private companies are prohibited from making public offers for their securities.
Another advantage of an equity-based crowdfunding is that the existence of a large number of small investors should improve the liquidity of the stock, overcoming the problems that can arise where the stock is held by a handful of institutional investors who are reluctant to sell. An attendant downside is the potential increase in the cost of printing and distributing a large number of sets of reports and accounts and AGM notices, although this burden can be alleviated by getting the new shareholders to consent to website communications when subscribing (after first ensuring the company's articles of association permit this).
Other regulatory considerations
There are, however, other regulatory considerations if an equity crowdfunding is to be considered.
Non-readily realisable securities
First, Financial Conduct Authority (FCA) rules regulate and restrict the issue of "non-readily realisable securities", including shares or debt securities in new or established businesses that are not traded on regulated stock markets and which carry significant risks. A crowdfunding platform or an authorised firm must apply an "appropriateness" test to ensure prospective investors have the requisite knowledge and experience to understand the risks associated with a crowdfunding issue, and must not communicate or approve a direct-offer financial promotion relating to such securities to a retail client unless that client is either:
· certified as a "high net worth investor"
· certified or self-certified as a "sophisticated investor"
· certified as a "restricted investor" (i.e. an individual who has not invested more than 10 per cent. of their net investment portfolio in non-readily realisable securities in the 12 months either side of the certificate being signed).
These rules have been criticised as unduly restrictive. The UK Crowdfunding Association is lobbying for the removal of the 10 per cent. limit for smaller investors, such as those investing less than £500, who, it claims, are finding that the time spent completing the necessary paperwork outweighs the benefits of subscription.
The restrictions do not apply to pledge-based crowdfunding, or where rewards are given to investors instead of an equity stake. BrewDog, for instance, famous both for its beer and for its successful use of crowdfunding - which it carries out directly rather than via a crowdfunding platform - rewards investors with a lifetime discount in its bars and online shop. Companies looking to raise funds could tailor rewards to hobbyists and fans to encourage participation.
The other principal regulatory constraint concerns "financial promotions". The usual rules on financial promotions apply to equity-based crowdfunding. Section 21 of the Financial Services and Markets Act 2000 provides that any invitation or inducement to engage in investment activity (such as buying or selling shares) communicated in the course of business must either be made by an authorised person or the contents of the communication (which is very widely defined and includes both written and oral communications) must be "approved"
Accordingly, the issuer will either need to ensure the promotion falls within an exemption, such as a communication to certain sophisticated or high net worth investors (but there is no exemption for restricted investors), or have the contents of the promotion signed off by an authorised person, who may be the provider of the crowdfunding platform. Financial promotions must be clear, fair and not misleading and the risks of investing must be fairly presented along with the benefits. This applies equally to promotions made via social media, which in the case of Twitter pretty much precludes any financial promotion in view of the constraints of the 140-character limit.
FCA authorisation of crowdfunding platform
Equity-based crowdfunding platforms have to be authorised by the FCA as making arrangements for another person to buy or sell shares is a regulated activity. (Again, donation and rewards-based crowdfunding are usually - though not always, depending on the offer – outside the scope of the requirement for authorisation). The UK Crowdfunding Association has published a code of conduct which anyone offering a crowdfunding platform should adhere to.
Other regulatory issues to be taken into account include handling personal data in a way that complies with the Data Protection Act 1998, payments processing and ensuring that the website satisfies both regulatory requirements (e.g. the FCA requirement to treat customers fairly) and more general legal requirements (e.g. cookie compliance, privacy notice, access for the disabled and structuring the website in such a way that prospective investors have to click on an "I accept" button (or similar) to show their agreement to the provider's terms and conditions – which, of course, should be in plain and intelligible language).
How we can help
If you are faced with a fundraising that is proving difficult and are tempted to consider a crowdfunding, please contact either Richard Naish, or Shubhu Patil, specialists in public fundraisings, or Andrew Northage, a specialist in financial regulation, who would be delighted to advise further. Arranging a crowdfunding may not be as difficult as you might think.