A product of the internet age and triggered by the financial crisis, crowdfunding has become an increasingly popular way of raising finance over recent years. It has helped many small and medium enterprises to raise capital using online platforms, where investors can offer funding in respect of a particular business or activity alongside a group of other investors.
However, the rapidly growing market of crowdfunding is on the radar of the Financial Conduct Authority (FCA) and last year the FCA consulted on regulating crowdfunding in a bid to protect investors. The FCA recently published its rules on crowdfunding and these came into effect on 1 April 2014, subject to certain transitional provisions.
Loan-based lending
From 1 April 2014 “operating an electronic system in relation to lending” will be a regulated activity. Loan-based lending (also known as peer-to-peer lending), where individuals lend money to borrowers via an online platform, will only be possible if borrowers meet minimum capital standards and have arrangements in place to administer the loan if the platform fails. The minimum financial resources to be held will be the higher of:
- £20,000 (increasing to £50,000 from 1 April 2017); or
- the sum of:
- 0.2% of the first £50m of total value of loaned funds outstanding;
- 0.15% of the next £200m of total value of loaned funds outstanding;
- 0.1% of the next £250m of total value of loaned funds outstanding; and
- 0.05% of any remaining balance of total value of loaned funds outstanding above £500m.
Investors should be aware that loan-based crowdfunding will not be covered under the Financial Services Compensation Scheme.
Investment-based lending
The FCA is of the view that given the risks investors face when investing in unlisted securities, investment-based crowdfunding (where consumers buy investments such as equity or debt securities) should only be promoted to a restricted category of investors.
Accordingly, the FCA has put in place rules that investors must either be sophisticated or high-net worth, or have received advice from an appropriate adviser in respect of their investment or be investing no more than 10% of their net assets (excluding homes and pension). Investors who have not been advised will need to pass an “appropriateness test” that they have the knowledge and experience to understand the risks associated with crowdfunding.
But not all forms of crowdfunding will be regulated. Crowdfunding platforms that are backed by donations or where rewards are given as opposed to an equity stake are exempt from the rules.
Regulation of crowdfunding has received mixed reviews but for a market that continues to soar, the rules are a necessary step. It will be interesting to see how the new rules affect the way capital is raised online. In any event investors, lenders and borrowers should familiarise themselves with the requirements for participating in crowdfunding under the new rules, which are available here.