At the end of 2014, Robert Steinhoff, a JD candidate at the University of Colorado Law School, published a comment on the investment crowdfunding environment in the UK drawing a parallel to what could occur in the United States. The interesting thesis recognized the UK as leading the securities crowdfunding space having embraced a light touch regulatory approach that foreshadows the potential in the US. While not implying that regulators should embrace “wholesale” adoption of UK rules, Steinhoff is of the opinion that “empirical evidence provided here suggests that a dynamic securities crowdfunding market might yet emerge in the United States by showing how British crowdfunding evolved within an ever-changing regulatory environment”.
In the United States today only Accredited Crowdfunding is available via Title II of the JOBS Act. Final rules regarding Title IV and Title III may usher in a new era of capital formation for SME’s in need of finance. Steinhoff notes the broad criticism of the JOBS act and current proposed rules (under Title III) but he is of the belief the industry will evolve and adapt thus following the success of what is in existence in the UK today.
“This Comment, adhering to the latter theory, asserts that securities crowdfunding provides a potential solution to entrepreneurial finance challenges. Securities crowdfunding cannot replace banks, angel investor networks, or venture capitalists, but it can fill gaps between owners’ equity and these follow-on sources of finance.”
The publication entitled, The Next British Invasion is Securities Crowdfunding: How Issuing Non-Registered Securities Through The Crowd Can Succeed in the United States, addresses both debt based (peer to peer lending) and equity based crowdfunding.
Steinfoff advocates that “American entrepreneurs, their legal and financial advisors, and other stakeholders should closely examine the United Kingdom’s securities crowdfunding market as the SEC’s implementation of the crowdfunding exemption draws near. The United Kingdom provides a robust example of both equity and debt crowdfunding markets … the United Kingdom and United States also share similar regulatory and capital market structures. The British equity and debt crowdfunding examples provided here should serve as guides for American crowdfunding stakeholders as they contemplate what a successful securities crowdfunding market might look like”.
The document references data indicating that if a startup or small business does not fit a “well defined profile” many sources of capital will not invest in these companies. Stating “the average venture capital seed stage round of financing increased from $2.8 million in 2012 to $4.3 million in 2013, with the number of deals at its lowest since 2003. This indicates that venture capital firms devoted larger sums to fewer small companies. This data also points to regional and industry biases for venture capital. Silicon Valley captured 41 percent of all deals, with the software industry leading all others at 37 percent.”
As for bank loans for SME’s Steinhoff recognizes this is simply not a viable option – both in the UK and the US. Regarding Angel Investors – a group more apt to finance early stage, riskier companies;
“many small businesses are too small and lack the growth trajectory to warrant investment by angel investors or venture capital firms … However, these companies are integral to their communities as job creators and key players in the local social fabric”.
The UK saw the investment crowdfunding industry subjected to formal regulation in the Spring of 2014. These regulations are under periodic review by the Financial Conduct Authority (FCA) and recently the regulatory body stated they saw no need to change their approach. Broadly embraced within the investment crowdfunding space, Steinhoff quotes James Meeking of Funding Circle“the FCA has shown foresight in striking the balance between enabling the industry to continue to flourish while ensuring the protection of investors and borrowers.” Continuing on this theme, David Blair, who leads the Financial Regulation Practice of international law firm Osborne Clarke is quoted, “the regulatory environment in the U.K. is being developed sensibly with industry and consumer groups each having a fair say in the consultation, so that the regime looks well balanced to enable the industry to thrive.”
There has been no fraud to date within the crowdfunding sector even alongside of the “hands off regulatory approach”. Steinhoff is of the opinion that portal operators in the UK are policing themselves. “All British-based platforms performed some level of gatekeeping through applicant screening for fraud, and many portals used their broad discretion to vet proposals for potential appeal to investors…portal operators in the United Kingdom have developed several measures to police themselves for the sake of legal protection and to protect their brand images.”
Many crowdfunding industry participants are under the opinion that proposed rules for Title III retail crowdfunding are so completely flawed and limited that final rules are dead on arrival either entering as a “flop” or bilking the masses for sketchy investments. Steinhoff is more optimistic in this regard, seeing the model evolving to become “relatively fraud resistent” and seeing issuers producing conniving business models to be reviewed by the crowd. Once again using the UK experience to foreshadow the US future;
“The British application of the all-or-nothing funding requirement has proven to be a powerful anti-fraud measure in the crowdfunding market because it requires companies to commit to broad disclosure in order to attract sufficient financing. This approach enables potential investors to use social media as a conduit for conducting due diligence and spreading the word of possible fraudsters.”
The lesson learned by Steinhoff’s research is perhaps one where the regulators at the SEC, and policy makers on Capitol Hill, should take note. Investment crowdfunding is working in the UK and the regulators there have strategically taken the path of allowing it to experiment and evolve – acting when necessary but not half-cocked from fear of the unknown. “Securities crowdfunding in the United Kingdom demonstrates the potential for a vibrant alternative source of entrepreneurial finance that, given the appropriate opportunity, should similarly succeed in the United States”, states Steinhoff.
“This funding model exhibits inherent fraud-preventative measures. It is scalable and designed to work within today’s social-media-addicted economy. Finally, securities crowdfunding has successfully adapted to a changing regulatory landscape, as evidenced by British stakeholders’ general acceptance of rules similar to those legislated in the United States. For these reasons, this Comment concludes that securities crowdfunding (and particularly debt crowdfunding) will likely develop into a robust market for entrepreneurial finance despite the American government’s best efforts to marginalize it.”
The comment is embedded below.
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