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February 17, 2015 | 5-minute read (865 words)
This guest post was contributed by Richard Heap, Partner at Kingston Smith.
New UK regulations for equity-based crowdfunding
While the U.S. market waits for the Securities and Exchange Commission (SEC) to complete its rulemaking, new rules brought in by the UK's Financial Conduct Authority (FCA) have divided the opinion of its peer-to-peer lenders and crowd-funding websites. While some feel the ‘crowd’ of possible business investors may wane, others consider the new measures do not offer backers enough protection.
In light of banks’ increasingly frugal lending behaviour, crowdfunding has become a proven and feasible method for small companies to raise finance. It involves large numbers of people contributing small amounts over online platforms as equity investment or cash loans to support new business initiatives.
The FCA’s new regulations were formulated to find a middle ground between accommodating the growth of finance ventures and protecting those investing in them. A key goal within this is to reduce the chance of investors running into financial trouble by ensuring that clearer information is given about the risks of crowdfunding.
A new ‘10 per cent’ rule means investors must now prove they are not putting more than 10 per cent of their net investible assets on the line, excluding their home, pensions and life insurance. ‘Sophisticated’ investors (with more experience and knowledge) will be able to put in larger quantities of finance. The rule does not apply to peer-to-peer loans.
Some websites and peer-to-peer lenders feel the new regulation won’t go far enough to protect investors, whereas others consider the rules will heavily stunt the number of investors. Equity- based crowdfunding puts individuals’ capital at risk; supporters of this method of finance-raising claim that the rules disbar small investors in an unfair way.
Slightly different to equity-based crowdfunding, peer-to-peer lending (also known as loan-based crowd-funding) involves individuals getting their capital back with interest after a specified term.
Christian Faes, co-founder of peer-to-peer lending platform, Lendivest, told the Financial Times that he fears the measures will “not protect the public from loan defaults in the peer-to-peer sector, which is crucial for long-term sustainability of the industry.” Mr Faes also expressed concerns over the FCA regulations’ ability to prevent individuals from incurring inevitable bad debt.
Co-founder of the Aim and Plus equity markets, Stephen Hazell-Smith has also pointed out that the FCA had taken “the crowd out of crowd-funding by putting in place rules on just who may be permitted to be an investor.”
While peer-to-peer lending has grown rapidly in the UK, such platforms account for only 1 per cent of the UK lending market. Providers such as LendingClub and Funding Circle feel regulation will help generate the legitimacy they need to be accepted in mainstream financing, something peer-to-peer lenders have spent many years working towards through consistent setting of high standards of loan underwriting and risk management.
Wherever your startup is based, it’s key to be prepared when heading into the equity crowdfunding arena. Here are our tips for ensuring you’re ready:
1. Get social
Crowdfunding relies heavily on getting your idea out there and engaging with people. In this digital age, social media could be one of the best tools to do so.
2. Once you’re social, interact!
Ideally you should be engaging with people and creating a buzz about your project before the campaign launches. It takes time to build up a following, and if you wait until you launch the campaign, your posts could be lost, ignored or weak against competition.
3. Writers and bloggers are your friends
Whatever your business idea, there will be someone writing about it. Find these people and befriend them. Develop a relationship with them and they could help ‘break’ your project, and at least expose it to important communities.
4. Write a strong business plan
This is not only key, but crucial. Unlike rewards based crowdfunding, equity crowdfunding is an investment in a business. Investors aren’t going to invest because you sent a funny tweet or made a ‘cool video’ – a proper business plan will set you in good stead on your road to finance.
As with any type of finance and investment, being prepared and understanding what you’re getting into is vital. Ensure you’ve done adequate research and considered all your options, whether you’re investing or looking for finance.
Do you need help formulating a startup funding strategy? Tell us in the comments section below or contact us at Early Growth Financial Services for a free 30-minute financial consultation.
Richard Heap is a Partner in Kingston Smith's Technology, Media & Telecoms practice in London where he provides accounting, audit, tax and general business advice to clients ranging from startups to SMEs to large public companies. His clients operate in a range of segments including: digital, mobile, social, data analytics and marketing services. He also leads the firm’s North American practice, where he supports clients moving into or expanding from the U.S. He is a Chartered Accountant.
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