Crowdfunding has become an increasingly popular method of financing in recent years. While this method of raising funds from the wider public creates a lot of new investment opportunities, there are also risks associated with it. EU financial market regulators are responding to the growth of crowdfunding and related risks in order to protect investors.

Crowdfunding: definition & models

The term crowdfunding first appeared in the 1990s to describe an internet platform designed to collect funds to finance various artistic or social projects. Nowadays, there are thousands of crowdfunding platforms all around the world. The most successful platforms include GoFundMe, Kickstarter, Indiegogo, RocketHub and FundRazr.

Basically, crowdfunding is a form of funding a project or venture by raising monetary contributions (usually small amounts) from a large number of people (investors), typically via the internet. Crowdfunding usually involves three participants: (i) the operators of the crowdfunding platform, who set the conditions for the functioning of the platform, and determine the requirements for accepting a project; (ii) investors, who provide their resources to finance individual projects offered through the platform; and (iii) applicants, who request funds needed to implement their projects.

The types of financed projects can vary: development of new technologies, works of art and cultural events, but also private real estate purchases or loans to buy a car or other consumer goods.

The traditional crowdfunding model is donation-based crowdfunding, which is used to raise funds, mostly for charitable or other public purposes. The legal relationship under which the investor provides resources to the applicant is usually based on a donation contract, and therefore investors do not expect an immediate economic consideration or service from the applicant.

Today, however, the most popular crowdfunding model is reward-based crowdfunding, which is a model based on economic compensation. This compensation may be either material or financial. Reward-based crowdfunding with material consideration is often used to fund arts projects (films or music albums, books or theatre performances) to support certain communities or organisations, but also to finance various technical and technological innovations. The legal relationship between the investor and applicant usually has the nature of a donation agreement, purchase agreement or agreement on the provision of services, and often it is a combination of these.

On the other hand, there are different models of reward-based crowdfunding with financial consideration. One of these is debt/lending based crowdfunding, where each investor decides how much to lend the respective applicant or specific project (peer-to-peer lending, “P2P”), and possibly lending companies to other companies (business-to-business lending, “B2B”). The legal relationship between the contributor and the applicant is usually regulated by credit agreements or loan agreements.

The last crowdfunding model with financial consideration – equity based crowdfunding – is a platform mediating investment interests in business corporations or to a particular asset when the contributor becomes the owner of that asset, or of an interest in a company. This model is most commonly used by start-up companies and entrepreneurs in the IT sector.

Regulation of crowdfunding in the Czech Republic

Czech law does not explicitly regulate crowdfunding, but it does lay down certain rules and limitations for the collection of funds from the public and their use, rules on consumer protection and the prevention of money laundering.

In addition to the general rules establishing consumer protection conditions, including the negotiation of contracts through the internet, regulated by the Civil Code and the Consumer Protection Act, the following Czech laws may be applicable: (i) the Act on Banks, which prohibits the acceptance of deposits from the public without a banking licence; (ii) the Act on Payment Systems, determining rules for the provision of payment services, including transfers of funds; (iii) the Act on Capital Markets, regulating the mediation of investments in shares and bonds and public offerings; (iv) the Act on Public Collections, regulating the collection of voluntary cash contributions from contributors for a predetermined public benefit; and hypothetically also (v) the Lottery Act, where winning or losing is decided by chance.

Whereas those rules are fragmented into many Acts, and it is not always clear which set of rules will apply to each platform, there are many platforms that work outside the statutory regime. Therefore, it would be desirable to adopt a comprehensive regulation laying down rules that are in accordance with the individual sector regulation.

The Czech Ministry of Finance is currently preparing a new Act on Consumer Credits, which will tighten the conditions for the provision and procurement of credits to consumers, probably also including some form of regulation of dedicated crowdfunding platforms for the funding of consumer loans.

Moreover, the EU has long been considering the establishment of harmonised crowdfunding legislation. The European Banking Authority (“EBA“) as well as the European Securities and Markets Authority (“ESMA“) proposed a series of measures to reduce risks connected with crowdfunding, including the possibility of introducing specific registration and regulation of operators of crowdfunding platforms.

It is expected that future EU legislation, which should be presented by the European Commission later this year, will resemble the system in the UK, where crowdfunding platforms need to be licensed by the British Financial Conduct Authority.

Czech law does not explicitly regulate crowdfunding, but it does lay down certain rules and limitations for the collection of funds from the public and their use, rules on consumer protection, and the prevention of money laundering.