The European Crowdfunding Network has published a whitepaper explaining the state of crowdfunding regulation in the UK, Spain, Italy and Germany. The document explores how all four countries are simultaneously taking their own unique approaches to implementing crowdfunding while clearly learning from one another as they do so.
… only 30% of businesses are using bank loans while some 40% rely on short-term bank credit or overdraft facilities. On the investment side, venture capital, according to industry statistics, invests in less than 5,000 high-growth businesses a year and business angels in around 1,000. Of the millions of SMEs that are not accessing this formal supply of finance, some will be able to benefit from organic growth and profitability, others will be able to smooth income fluctuations – which are normal in seasonal businesses – through supplier credits or factoring, for example.
As a result, a very large number of SMEs, maybe as many as 10 million, rely on their own wealth, their family, friends and fans to invest in growth, support them through economic difficulties or help to purchase new equipment, finance stock and other operational needs. Crowdfunding is proposing to formalise this part of the financial services sector, to make it transparent and therefore accessible, and to combine it with aspects of cocreation and collaborative open innovation.
Italy leads the way as far as implementation of equity crowdfunding is concerned with a proposed rule already subject to public comment, beating even the US to that point as we hand-wring over the JOBS Act. Spain has yet to create a viable equity framework, but the UK and Germany have by taking an iterative approach by dealing with each platform on a case-by-case basis. Below we go into more detail on each country’s efforts. If you’d like to read the entire document it is embedded at the bottom of the article.
Equity Crowdfunding in Germany
Equity crowdfunding is currently operational and regulated in Germany. An example of a German equity platform would be Seedmatch. Equity platforms in Germany can either operate as licensed or unlicensed platforms. BaFin, the German financial authority, issues licenses to entities participating in the sale of securities. However, an exemption is made for entities participating in the sale of equity via silent partnerships, or agreements where the stakeholder claims no say in the day-to-day operation of the business. Therefore, equity platforms in Germany often participate solely in the brokerage of silent partnerships.
… where an online Crowdfunding platform facilitates the offering of securities or investment products (Vermögensanlagen), the operator of the platform provides financial services within the meaning of the German Banking Act (Kreditwesengesetz) and therefore, as a general rule, requires a licence by BaFin. Exemption stands for offering silent partnerships.
Silent partnerships come with a €100,000 cap on funds raised. Seedmatch circumvents this cap by offering something called a “profit participating loan.” WhiteboardMag has a great interview with Seedmatch’s head of operations that explains how this works…
In human language: it’s debt that talks, walks and quacks like equity. And for those who worry: the German financial and banking authorities gave its blessing to allow this new contract called ‘partiarisches Darlehen’ to go through the 100k barrier, says Reinsch.
There is one complicating factor in Germany having to do with an EU-mandated European Alternative Investment Fund Managers Directive, or AIFMD. Project companies in particular carry the most risk of being deemed AIF’s. The ECN explains the implications of this phenomenon on associated costs…
The application of the AIFMD regime to companies seeking funds by means of Crowdfunding platforms (which appears likely if they are Project Companies) would make any attractive cost-reward ratio impossible. Projects like movies or games are likely to be completely prohibited under the German implementation of the AIFMD since they do not qualify as “material assets” (Sachwerte) within the meaning of the Capital Investment Act.
Equity Crowdfunding in Spain
The model for equity crowdfunding in Spain drives site like Bihoop. The model is based on Joint Accounts, which the ECN explains…
In Spain this model is based on Joint Accounts which implies a form of cooperation between individuals and companies, through which an account-participant contributes an amount of money to carry out an activity, foreign trade or business by receiving the participation-manager in property and its exclusive direction of the operation or activity, becoming participants in both prosperous and adverse outcomes in the proportion agreed upon.
Without leveraging the model provided by joint accounts, Spain’s equity platforms are left subject to much more prohibitive financial regulations that place them under the jurisdiction of the Bank of Spain or the CMNV, Spain’s financial regulatory authority.
There is currently no regulatory regime that is specifically adapted to Crowdfunding in Spain. However, operating the Equity Model is subject to regulation designed for other activities…
As a matter of practice, Equity Model platforms are structured so as not to be regulated by the CNMV or the Bank of Spain. However, as a matter of law, it appears that many such platforms could nonetheless be conducting activities that fall within the scope of the Markets in Financial Instruments Directive or, when implemented, the Alternative Investment Fund Managers Directive.
Equity Crowdfunding in the UK
Equity crowdfunding web sites like Crowdcube currently operate under exemptions put in place by the UK’s Financial Conduct Authority, or FCA. (Formerly the Financial Services Authority, or FSA) It’s an iterative approach to crowdfunding that places the focus on sophisticated investors for now. These sites can avoid the cost-prohibitive fees of becoming fully registered entities by navigating this complicated web of exemptions…
Many Equity Crowdfunding platforms are structured using a combination of exclusions and exemptions from the regulated activities regime. Use of these exemptions, particularly where they apply the letter but not the spirit of the law, still carry a high degree of risk, because of the increasingly interventionist and judgemental approach to supervision and enforcement that has been adopted by regulators in the wake of the financial crisis.
A key term in the UK is a “collective investment scheme,” a regulated activity that platforms in the UK not registered by the FCA are careful to steer clear of…
Where the profit share being offered to investors is not channelled through a standard corporate issuer/shareholder relationship (e.g. the investor receives a contractual entitlement to profits from a project) the investment may be characterised as units in a collective investment scheme. Crowdfunding generally entails the pooling of investor contributions or the pooling of profits and/or income prior to distribution to the investor, with no involvement in the day-to-day management of the proposition (or project), the two key components of a “collective investment scheme”.
Requirements under the AIFMD are unlikely to be as prohibitive in the UK due to an exemption for fund managers with assets under €100 million. Platforms and associated offerings are generally exempt from providing a prospectus as long as the funding remains under €5 million in a 12-month period.
Equity Crowdfunding in Italy
CrowdfundMe is an example of an equity platform in Italy, a country hailed as one of the most progressive in the world when it comes to raising capital via online equity crowdfunding. Italian platforms operate under existing exemptions for now, but CONSOB has put forth a set of rules for public comment. The ECN shares that there is still some disagreement regarding the specifics of the pending law, but it does appear that Italy will be one of the first (if not the first) country to have a comprehensive law on the books regulating equity-based crowdfunding for everyday investors.
The CONSOB law being proposed does limit crowdfunding participation to “innovative startup companies,” but that restriction may be lightened or lifted altogether after regulators can weigh the experience gained in crowdfunding startups.
There is also some concern about a pending rule that requires participation by a financial investor. The ECN explains…
Another provision of the CONSOB draft regulation requires, as a condition precedent to commence the online offer, a 5% subscription of the share capital to be made by a financial investor. The reason behind this decision is the need to have at least one investor to professionally evaluate the business and the investment, in order to protect the other shareholders’ investment (i.e. those coming from the “crowd”).
This provision could again materially limit the raising of money, without bringing any actual protection of the public investors. The efficacy of this method of investor
protection is questionable, but the limitations it imposes on Crowdfunding do not appear consistent with the European Commission’s view.
As in the UK, prospectus requirements are waived for funding of less than €5 million over 12 months. The platforms themselves may be required to offer prospectus information in the future, but that is unclear at this time.
AIFMD implementation has not taken place in Italy to this point, but it appears that equity crowdfunding platforms and the participating companies will not be subject to additional requirements under the mandate…
Since it is a pre-requisite of the CONSOB regulation for the underlying investment under the Equity Model to be a company having the characteristics of an innovative start-up, it should follow that a Crowdfunding platform will not “manage” this underlying investment. Instead the Crowdfunding platform merely arranges investment into it. The innovative start-up should not normally constitute an AIF in the first place.