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Collection of crowdfunding logos

In its various forms crowdfunding is now a $34bn global industry, with portal sites like Crowdcube and Kickstarter providing an alternative means of funding for innovators and start-ups to develop their ideas.

The UK prides itself on being a global crowdfunding leader, at the forefront of the industry’s boom, and the government itself has put £85m into various forms of crowdfunding through the British Business Bank.

Tim Wright, director of crowdfunding consultancy twintangibles, believes that the reason the UK is at the forefront of equity crowdfunding in particular is because of its legal tradition: “if you can satisfy the regulations as they are set out then, you’re permitted to get on with doing what you’re doing.”

However, clarifying the regulatory and legal landscape around crowdfunding and spelling out the risk and challenges to those who invest is still a work in progress,

Risk and reward

According to the Liberum AltFi Data indices, which have been created with the intention of increasing visibility within the alternative finance sector. AltFi data believe that bringing transparent metrics to the sector will improve its profile and further enhance the sector’s appeal to investors.

AltFi data shows that out of 367 companies that have raised money between 2011 and the first half of 2015 via equity crowdfunding, only one has made a profit for investors (with Camden Town Brewery becoming the second after agreeing to sell to a rival brewer).

This rate doesn’t surprise Luke Lang, Crowdcube’s founder and CMO, who feels this is a normal part of small business expansion: “These are early stage businesses; they’re in the early stages of their growth and looking to grow rapidly. They’re not looking to turn a small profit, they’re looking to scale and invest into the business, and I think investors understand that.”

Almost all crowdfunding platforms make it clear that there is an element of risk involved with your investment, and part of the idea is that investors are funding a potential project rather than making a purchase.

In some cases, different motivations bring a different risk perspective for investors. Brewdog’s fundraising efforts provide an interesting case study here. One accountant investor explained that he’d handed his money over to Brewdog “not in the expectation of getting anything back but because I like the guys and like getting 10% off the beer”.

Ideas and enthusiasm for a particular project can also shape its future direction. As Tim Wright explains: “Crowdfunding can provide companies with deep insight into what the marketplace needs and wants. Its great strength is that the money is different money. It comes with additional benefits: The market validation, the price pointing, and the visibility. All of these things are of tremendous value, particularly for the entrepreneurial start-up.”

Due diligence

In 2014 a firm called Crumpet Cashmere pitched for funding on equity crowdfunding website Crowdcube. It raised more than £160,000 from Crowdcube investors, but just over a year later the company entered liquidation, leaving investors with little hope of recovering their outlay.

Pebble_watch_trio_group

Pebble Watches started life as a crowding poject

What has since emerged is that Crumpet Cashmere was formed from the ashes of a company who previously traded as Crumpet England. The firm had previously folded with debts of close to £800,000, and an investigation in the Times newspaper, alleged that their previous circumstances were not made clear in their Crowdcube pitch.

However, Crowdcube’s Luke Lang has issued a statement denying this and asserts that a previous restructuring of the company was disclosed in the business plan, and the business’s resurrection had been discussed in depth on the site’s forum.

Lang went on to say that the company was the victim of a competitive market and difficult trading conditions, but the risks were “always transparent and clear”.

“We’ve got a strong vetting process we put businesses through”, said Lang, “and we do make sure businesses disclosure all relevant information, but ultimately it is down the individual to make that investment decision”.

This and other cases which have made media headlines in recent months endorse the fears of crowdfunding sceptics, who feel the sector is not as safe and secure as it is made out to be, as so-called ‘unsophisticated’ investors are not able to conduct the same due diligence as experienced fund managers or companies.

In terms of due diligence offered, Crowdcube has a team of business and financial analysts, legal professionals, compliance officers, all making sure that everything presented on a pitch has been checked and validated – a process followed by the majority of crowdfunding platforms.

“We recognise that confidence is an important part of the long term future of crowdfunding”, said Lang, “and having those checks and balances in place helps this.”

Regulation

In terms of crowdfunding regulation, the environment remains a complicated legal space. According to Tim Wright: “The platforms that operate, certainly within the UK, all have slightly different models, and those different models potentially expose them to different regulatory requirements depending on a whole range of things.”

In April 2014 after a consultation the FCA brought in specific regulations that dealt with crowdfunding, equity crowdfunding in particular – really an extension of existing law. Since then the platforms themselves have become FCA authorised or are in the process of doing so.

If a company does not adhere to the regulations, the regulators can issue a notice that they must rectify this or a cease and desist order will be serve that means they will no longer be able to trade.

However, although the current rules are up for review via a consultation, the messages coming from government are broadly supportive of the alternative finance sector, and according to Tim Wright unless there is a significant scandal there would be “considerable resistance to reining it in with additional regulation”.

Future challenges

In spite of the credibility issues raised by crowdfunding sceptics, there seems little doubt that the industry will continue to grow in 2016. With its first phase almost over and the sector moving towards maturity, the next challenge for the industry and its regulators will be to recognise the issues that have emerged for both investors and companies and move with them.

So if you’re thinking of investing a few bob into an organisation that is raising finance through crowdfunding you should visit Financial Conduct Authority Website to check on whether if it is regulated by the FCA and if not, ‘Caveat Emptor’.

Image of David Jones Shrewsbury Accountant and Founder of Morgan Jones

If you would like more detailed information on some aspect of UK Tax, send me an e-mail and I’ll be pleased to advise further.

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