The Financial Ombudsman Service (FOS) in the UK has long intermediated disagreements within the financial services sector including investment crowdfunding. A recent decision by the FOS has caused some concern amongst industry insiders as it may challenge the entire crowdfunding model based on the liability of a business that raises capital online when things change and money may be lost.
A recent complaint filed by an investor in a company raising capital online sought compensation for an investment of £18,000 that closed in 2018. According to the document posted by the FOS, the issue is pertaining to an un-named “food takeaway company” that raised over £500,000 on Crowdcube. Today, the company is no more and in liquidation but the investor believes that Crowdcube is at fault due to a lack of diligence pertaining to the business plan presented by the company. Neither the investor nor the FOS alleges any type of fraud, as far as we are aware.
According to the complaint, the investor participated in the securities offering under the belief that funds raised would be utilized to open additional locations. By mid-2018, the business had not expanded and at a later date, the investor discovered that the company no longer had plans to open up additional sites. At this time, the investor requested the issuer to repurchase his shares. The business declined.
The investor, who is described as a sophisticated individual, approached Crowdcube with his complaint that the information provided on the offering page was misleading. The allegation is that if Crowdcube had sufficiently vetted the company’s statements the individual would not have invested.
In brief, the complaint states that a portion of the business plan, which is a restricted document on the offering page, outlined future additional store openings. It also explained that half of the £500,000 the issuer was looking to raise would be used to open a new site and referred to one other site already being in the pipeline.
Apparently, as the document was restricted, Crowdcube did not review and perform diligence on it, or that “Crowdcube hadn’t acted fairly or professionally in accordance with [the investor’s] best interests,” according to the impacted individual. The investor claims that he expected Crowdcube to have “seen evidence of leases and other necessary agreements to show that the new sites were either in place, or under negotiation, before promoting the investment.”
The FOS document states:
“The crux of Mr S’ complaint is that Company A didn’t use the funds raised in the way in which Crowdcube promoted it would. However, there is a distinct lack of information provided in the pitch about what Company A wanted to raise funds for. The only information given on this point is:
“Having grown from 2 sites to 4 since their last round on Crowdcube, [Company A] is revolutionising the…takeout industry through its takeaway only locations with rapid delivery and custom technology. Now raising funds for further expansion.”
The pitch provides no further clarification regarding what further expansion for Company A entails. Clearly, how a business intends to use funds raised through crowdfunding is essential information which should be provided to investors to enable them to make a reasoned decision to invest or not. Providing all relevant and essential information is especially important considering Crowdcube was promoting high-risk, non-readily realisable securities to Mr S.”
The document continues later:
“The pitch didn’t provide sufficient detail to give Mr S a balanced indication of the benefits and the risk involved in Company A. As far as Mr S was concerned, Crowdcube had fact-checked Company A’s plans for expansion in line with its due diligence charter and it was reasonable for him to believe these included plans for opening new sites. There was no reason for him to believe these weren’t sufficiently substantiated or that there was a risk that Company A might not open up any new sites. As I’ve said above, I think Mr S was reasonably entitled to conclude that further expansion would involve the opening of new sites. And given everything Crowdcube said it did before approving a pitch, I’m persuaded he thought Crowdcube had satisfied itself about [the] Company A’s plans for further expansion. In my view, Mr S was entitled to know that there was, in fact, no evidence of any concrete plans for further expansion.”
The Ombudsman believes the investor would not have participated in the offering if he had known no expansion would take place and the FOS has decided to “put things right” and require Crowdcube to re-pay the £18,000 (minus any possible EIS benefit).
Crowdcube has disagreed with this decision but following a review, the FOS issued a final decision that required the investor to accept or reject their decision before April 12, 2021. It is not completely clear what the investor decided but one may assume he has accepted the resolution.
As a singular regulatory enforcement action, it may have little consequence for Crowdcube beyond the monetary penalty but one must wonder about the precedent being set requiring crowdfunding platforms to foresee a strategic shift at a company that has raised capital online. Early-stage ventures and startups pivot and change direction all of the time. If you have ever worked at a startup you know that is a fact. A startup’s agility and the ability to quickly adapt can be a positive characteristic of management. Of course, in this case, the startup failed and investors lost money but then many, if not most, small businesses will eventually fail. That is how a market economy works. Investors understand that from the beginning. Just like venture capital investors, the returns of the few make up for the losses of the many that fail or simply bounce along.
One industry insider believes the FOS’s decision will cause an upheaval in the UK investment crowdfunding sector as platforms simply cannot predict the future of any issuer nor business. And chaining a company to a business plan that is deemed by management as no longer feasible, nor optimal, stretches regulatory credibility. It may take an action by the Financial Conduct Authority to provide a final determination.