Will crowdfunding regulations disadvantage entrepreneurial businesses?

What will the FCA crowdfunding regulations mean for growth businesses? Menzies' Paul Davies writes.

 Will crowdfunding regulations disadvantage entrepreneurial businesses?

The Financial Conduct Authority (FCA) is set to publish a review of crowdfunding rules, in a move which could affect the way platforms operate and increase the cost of borrowing for entrepreneurs. While regulation could increase transparency and provide more protection for investors, entrepreneurs could end up paying the price.

Over the past decade, the crowdfunding marketplace has grown rapidly; becoming an efficient way for entrepreneurs to secure that all-important funding to kick-start their business idea or take it to the next stage. Innovators pitch their business ideas to the marketplace through a crowdfunding platform and interested parties can choose to fund it. Those choosing to participate can invest as little as a few hundred pounds. Investments can be made in the form of loans, repaid with interest over a fixed period, or an equity share in the business itself. According to an investment tracking platform, in the first quarter of 2017, £45 million was invested through crowdfunding platforms in the UK.

Crowdfunding practices are largely unregulated. While some platforms highlight their screening processes for potential campaigns, it is often uncertain to investors exactly what these entail. Some of the appeal for investors is that crowdfunders tend to be more flexible and willing to look at riskier business proposals that attract higher rates of return.

However, issues can and do arise. There have been a number of high-profile cases of crowdfunded businesses falling into administration and losing their investors’ money. Claims management company, Rebus, folded in 2016, with allegations subsequently arising that they withheld key information from investors. Rebus had reportedly failed to disclose that they had been experiencing cash-flow difficulties and had hired restructuring specialists. Investors went on to pledge over £800,000.

So, what are the new regulations, expected to come from the FCA in early autumn, going to look like?

It is expected that the main goal of any regulations will be transparency. While investors should be allowed to determine what they do with their money, it is important that they have access to vital information, which could influence their course of action.

Greater transparency would bring benefits for the crowdfunding marketplace as a whole. From an investor point of view, they would be more informed to help protect against making poor investment decisions. For entrepreneurs, they would be able to compare platforms to see which would be best suited to their requirements.

However, there is a worrying possibility that new crowdfunding regulations could diminish opportunities for some small and medium-sized enterprises (SMEs) to obtain critical funding that might be difficult to access elsewhere.

Borrowing from crowdfunding platforms can be expensive by comparison with a bank loan. They tend to be used by entrepreneurs who lack a track record of business performance or have failed to gain funding from a traditional lender. They provide a useful alternative source of finance to unproven businesses with potential for growth.

While crowdfunding platforms are likely to continue, with or without regulatory controls, the added administrative burden could drive up costs for borrowers. In the case of smaller businesses with low funding requirements, the cost of providing a facility could become disproportionate to the amount of the funds being sought. Some platforms could even introduce minimum facilities in order to ensure the loan becomes viable to the platform and its investors, cutting some smaller businesses out of the lending loop.

It is important that crowdfunding platforms are afforded the flexibility needed to continue to grow in a regulated and responsible manner. There are many crowdfunded success stories – from Seedrs’ award-winning “M” restaurant group, to Crowdcube’s Camden Town Brewery, which was bought by the world’s largest brewer, Anheuser-Busch InBev, in 2015.

Even banks, the stalwarts of traditional investments, have begun to involve themselves in the practice. In the future, we could potentially see the introduction of international crowdfunding opportunities.

For now, it is important for those seeking to either invest in, or raise funds from, crowdfunding to be aware of potential changes to regulations and look out for the FCA’s review.

Any new regulations that follow must be beneficial for all parties – investors need clarity and innovators need funding. If the crowdfunding marketplace shrinks, or becomes viable only for larger businesses, UK growth and development in the SME market could slow dramatically. If it remains accessible, this contemporary practice could become an important ingredient in post-Brexit entrepreneurial Britain.

Paul Davies is director of business turnaround at accountancy firm, Menzies LLP.

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