Crowdfunding is a relatively new concept and, while many are excited about it, there are also a number of concerns.

Earlier this month the Financial Services Authority (FSA) stated that: "Many crowdfunding opportunities are high risk and complex" and added that they should only be aimed at "sophisticated investors". The FSA also expressed a concern that "some firms involved in crowdfunding may be handling client money without our permission or authorisation, and therefore may not have adequate protection in place for investors".

This has left crowdfunding companies, businesses that seek investment via crowdfunding and investors who use crowdfunding companies wondering how they should proceed."  

In each case, the first point to consider is the firm's relationship to the FSA. If the firm is (or should be) regulated by the FSA, then the FSA's views are crucial to how that firm runs its business. If, by contrast, the firm's business model is such that it does not come within the FSA's remit (either by its nature or because of a valid exclusion), then it may have the option to be more relaxed.

Crowdfunding companies

The issue is whether the firm is carrying out a regulated activity.  

Crowdfunding platforms operate in different ways and these different ways may mean that different regulated activities are potentially engaged. Some firms may be arranging deals in investments while others may be dealing in investments as principal.

Equally, if it seems that a regulated activity does apply, some firms may still escape the need to be authorised because their business model falls within an exclusion; others may not. If the firm is carrying out a regulated activity and no exclusion applies then the firm should be authorised by the FSA (and abide by its regulation and guidance).  

Any crowdfunding platform businesses that believe they do not need to be authorised by the FSA should review the basis of that belief and ensure that is solid.  

If the firm is, or should be, regulated by the FSA, then it should consider restricting its pool of potential investors to sophisticated investors, ensuring that:

  • risks to investors are made clear;
  • the firm's client money procedures are robust; and
  • the firm complies with applicable FSA regulation more generally.

There may also be financial promotion issues (discussed more fully below) to consider.

Businesses seeking investment

Businesses wishing to raise finance via crowdfunding should consider whether they will be breaching the financial promotion rules.  

There are specific exemptions that may operate to exclude companies seeking investment from the financial promotion rules. However, where no such exclusion applies, and unless the business is FSA-authorised (or unless the relevant promotion has been approved by a firm that is FSA-authorised), then the business must not "in the course of business, communicate an invitation or inducement to engage in investment activity".

Again, given the diversity of approaches taken by crowdfunding platforms, it would be wrong to make sweeping generalisations about the likelihood of this prohibition being breached in a crowdfunding context.

However, any business that seeks investment via crowdfunding platforms should review the process operated by the given crowdfunding platform and see whether its role in that process would see it breaching the financial promotion rules.  

In the context of the financial promotion rules, businesses seeking investment via crowdfunding should also consider whether they should produce a prospectus.  

More broadly, from a reputational point of view, businesses seeking investment via crowdfunding should consider whether the crowdfunding platform that they propose to use is properly established, complies with its regulatory requirements and treats investors properly.

Investors

The obvious takeaway point for investors is the FSA's view that crowdfunding opportunities are high risk and complex.  

While the FSA acknowledges that crowdfunding opportunities may have their place in the portfolios of sophisticated investors, anyone who proposes to invest via a crowdfunding platform should satisfy themselves that they are happy with the level of risk involved.  

Investors should also satisfy themselves that the platform is soundly established.  

Take a look at some related crowdfunding action points from our financial services specialists.