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The Crowdfunding Trend – Threat or Opportunity?

Crowdfunding was previously only an approach for start-ups to get up on their feet, but the method is now showing potential for established companies to shift their strategy and encourage positive and profitable change. Lauren Razavi analyses the potential of crowdfunding as both a disruptive threat and an opportunity for established companies.

Crowdfunding has been gaining more and more ground in recent years, especially among European consumers. It might seem like a trend embraced only by start-ups desperate for cash, but in reality crowdfunding is quickly becoming a useful tool to recruit and maintain an enthusiastic client base for companies across multiple industries.

We live in a world in which failure to adapt to technological advances can spell destruction for a company. But is crowdfunding a dangerous threat that start-ups will use to disrupt industry, or an opportunity for established players to make profitable changes to their process?

Alternative Finance 101

A report by CrowdfundingHub.eu identified four major types of crowdfunding:

  • Donation Based crowdfunding relies on the charity of the customer base, with little to no anticipated reward. The biggest risk is that the company won’t raise the funds they need to deliver on their promises – in which case, they are responsible for either returning the donations or funnelling them into an acceptable project.
  • Reward Based crowdfunding provides security to the investor by giving them a sample of the finished product. This will satisfy most consumers, who aren’t looking for a share of the profits but simply to support an idea they find compelling. However, this type of crowdfunding requires the company to actually have a sample product they can ship, which means that the initial funds will have to come from another source.
  • Equity Based crowdfunding is similar to traditional investment methods in that the backer will receive a stake in the company, and possibly even some control over the final product. The primary issue with this type of crowdfunding is that in Europe the company will be subject to the regulations and policies of the European Banking Authority.
  • Peer-to-Peer Lending is also similar to traditional financing – the backer will provide funds on the understanding that those funds will be paid back with interest at some point in the future. In some countries such as Italy and Belgium, peer-to-peer lending is prohibited, and there are various other restrictions in place across Europe.Each type of crowdfunding has its own pros and cons, but a major advantage of all of them is that they are more accessible to less established companies who may not be able to guarantee a consistent return on investment.

Industry Disruption

There are some concerns that the rise of crowdfunding will cause major disruption across industries. According to the world bank, 2016 saw more money raised from crowdfunding than from venture capital.

That’s bad news for investment managers – instead of paying costly legal and management fees, big investors are now choosing to cut out the middleman and interact directly with the companies they feel best align with their interests. As more and more platforms choose to cater to specific industries, investors are better able to make decisions for themselves, instead of relying on financial experts who charge fees for their knowledge.

The unregulated nature of the crowdfunding sector is also a cause for concern. In Europe, regulators have struggled to harmonise the challenges that  crowdfunding brings with existing financial practice. In Finland, for example, there is no requirement for crowdfunders to have an MiFID licence, which means that companies who have obtained a licence are more strictly regulated than their unlicensed competitors. Other nations have been quicker to adapt – in France and the UK existing legislation has been brought smoothly up to date to be compatible with crowdfunding.

However, it can’t be denied crowdfunding is bringing in some much needed changes, especially in European markets. Traditional investors tended towards funding large, trusted companies during the financial crisis, which meant that many small to medium businesses were lagging behind in capital investment. Crowdfunding means that general consumers can now invest in local, small to medium businesses from their smartphones – and that means that those same struggling companies are able to gather the funds they need to compete in the big leagues.

Power to the People

Easy access to the internet and the simplicity of digital payment options is the driving force behind the crowdfunding boom. Europeans are demanding a more transparent financial market, and right now it seems as though crowdfunding is answering that demand. The European Crowdfunding Network hosts articles on its website guiding companies through everything from designing compelling incentives to identifying the motivations of their funders. Crowdfunding means that companies are connected to their consumer base more closely than ever. Whether that’s a curse or a blessing depends on the company’s willingness to engage with their backers.

The rise of crowdfunding presents a golden opportunity for established companies to reconnect with their audience and test the waters before fully committing to a project. Your funders will eventually become your customer base. They know exactly what they’re looking for in a project, and they are more than happy to talk about it. When you engage with your audience on this level you’re essentially bringing them on board as co-creators – and their advice can be more helpful than you’d think. Your funders might not be the most seasoned market analysts, but they can be valuable mentors and smart beta testers.

One of the major advantages is that it combines financing and marketing in one easy package. Your funders will be your biggest cheerleaders – they know every feature of your product, every drawback, every brilliant innovation. Some of them will be marketing professionals themselves. Some of them will be experts in their field who are desperate to share this helpful new tech with their colleagues. All of them will be guaranteed customers by the time your product hits the shelves.

Whether it is a threat or an opportunity for your company depends on your willingness to embrace change. Those who have so far failed to adapt to the crowdfunding trend are already suffering repercussions, but those who have taken the time to adjust their methods and bring them in line with the trend are finding that crowdfunding isn’t so scary after all – in fact, if you play your cards right, it can be an important tool for your business going forwards.

Source: Eureka

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An introduction to crowdfunding

Crowdfunding is an increasingly popular alternative method of raising finance. But what is crowdfunding? In this article we explain how crowdfunding works, the risks and rewards and the UK regulation.

What is crowdfunding?

Crowdfunding is the practice of raising money from a large number of individuals for the purposes of financing a project, venture, business or cause. Traditionally, crowdfunding has been carried out via subscriptions, benefit events and door-to-door fundraising. However, today the term is typically associated with raising money through website platforms, which allows crowdfunding to reach a larger pool of potential funders.

How does crowdfunding work?

Crowdfunding usually takes place on a light-touch online platform rather than through banks, charities or stock exchanges. The business or individual seeking finance will typically produce a pitch for their business, project or venture, which is then uploaded to the online platform with the aim of attracting as many loans, contributions and investments as possible. Websites such as Kickstarter, Seedrs and Crowdcube are examples of the available online platforms, which enable project initiators to reach a pool of thousands, if not millions, of potential funders.

What are the different types of crowdfunding?

Crowdfunding can broadly be split into four main categories:

  1. Loan-based: also known as peer-to-peer lending (P2P), this involves individuals lending to businesses or other individuals in return for interest payments and a repayment of capital over time.
  2. Investment-based: individuals invest directly or indirectly in new or established businesses by buying investments such as shares, debt securities or units in an investment scheme.
  3. Donation-based: people give money to individuals, organisations or enterprises they want to support, with no expectation of any return on their investment.
  4. Pre-payment or rewards-based: individuals give money to receive a reward, product or service (for example, concert tickets, artwork, a new product etc.).

In addition, less-common forms of crowdfunding exist whereby funders invest in order to receive, for example, software value tokens (see A guide to initial coin offerings) or a share of the compensation from the results of litigation.

Crowdfunding examples

Crowdfunding’s success is not just limited to industry – it has been used to successfully raise funds for a range of not-for-profit organisations and charitable causes. Children’s charity, Kids Company, successfully raised over £100,000 in under two months in 2014/15 with their campaign on the platform Crowdfunder. In 2016, crowdfunding campaigns raised £12.3 million on the platform JustGiving, a platform for online charitable donations.

That said, businesses are also benefiting from crowdfunding initiatives. Starting in 2007 as a two-man partnership, BrewDog successfully crowdfunded their way (using an equity-based platform) through year-on-year growth to become an international company valued at circa £1 billion in 2017. Perkbox, a cloud-based employee perks and engagement platform for businesses, raised circa £4.3 million with its campaign on Seedrs. Finally, in 2016 Crowdcube raised circa £6.7 million, effectively making the crowdfunding platform its own biggest success story.

How is crowdfunding regulated?

In the UK only certain crowdfunding activities are regulated. Donation-based and rewards-based crowdfunding are not regulated, whereas firms carrying on activities associated with loan-based or investment-based crowdfunding may require FCA authorisation under the Financial Services and Markets Act 2000 (FSMA). Accordingly, what follows is a high-level summary of the regulation of both loan-based and investment-based crowdfunding in the UK.

Loan-based crowdfunding

The platforms

In 2013, with loan-based crowdfunding becoming an increasingly popular means of raising money and recognising that it was difficult to regulate the practice under existing regulatory provisions, the FCA took the step of adding a new activity, at article 36H, to the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (SI 2001/544) (RAO).

Under article 36H of the RAO, loan-based crowdfunding became regulated as the “activity of operating an electronic system in relation to lending“. Under this provision, online platforms facilitating loan-based crowdfunding between two individuals or between individuals and businesses will be carrying on a regulated activity and will, therefore, require FCA authorisation (unless certain exemptions, such as for charities or appointed representatives apply).

Regulated platforms will be required under the FCA rules to comply with certain consumer protections around the clear disclosure of information and the protection of customer funds.

The participants

Generally speaking, where the borrower is an individual (or a partnership or unincorporated body of individuals), and the investor is lending in the course of a business, the terms upon which the loan is made may constitute a regulated credit agreement and consequently be subject to the full requirements of the Consumer Credit Act 1974 (CCA). The investor will then need appropriate FCA authorisations for the provision of consumer credit and will be required to comply with the relevant rules in the FCA Handbook (CONC in particular). To help with this, the FCA has published a webpage, which provides a useful summary of the key provisions of the FCA Handbook that apply to loan-based crowdfunding firms.

Where the investor is not acting in the course of business, so that the agreement is a non-commercial agreement under the CCA the investor will not require FCA authorisation. There are, however, additional obligations on the operators of the platforms in CONC to help protect consumers from some of the risks associated with these non-commercial agreements.

Participants acting by way of business should also take care not to inadvertently carry out other regulated activities when crowdfunding. In this context, the FCA has warned that businesses which borrow through a crowdfunding platform with a view to lending this to other individuals may be carrying out the regulated activity of accepting deposits – which will require additional authorisation.

Investment-based crowdfunding

The FCA regards investment-based crowdfunding as a high-risk investment activity, with the potential for capital losses. This is likely due to the fact that the instruments traded on such investment-based crowdfunding platforms are non-readily realisable securities that are not listed on regulated stock markets and are instead traded over the internet and via other means.

The platforms

Unlike the bespoke regulatory rules for loan-based crowdfunding, activities associated with investment-based crowdfunding platforms typically fall under the existing rules, including article 25 of the RAO which covers both arranging deals in investments and making arrangements with a view to participating in deals in investments. Accordingly, online platforms facilitating investment-based crowdfunding are likely to be carrying on a regulated activity and therefore require FCA authorisation.

While the FCA has not published a webpage summarising the FCA Handbook provisions applicable to investment-based crowdfunding, it is thought that many of the provisions applicable to loan-based crowdfunding will be relevant to investment-based crowdfunding.

The FCA introduced further rules around financial promotions applicable to firms operating investment-based crowdfunding platforms in 2014. As a result, such firms may only make direct offer financial promotions to retail clients if such clients either:

  • have taken regulated advice
  • are high net worth or sophisticated investors (as defined in the COBS provisions of the FCA Handbook)
  • have confirmed that they will invest less than 10% of their net assets in the relevant investment.

Regulated platform operators must also be able to assess whether retail clients understand the risks involved with investing if they do not take regulated advice – the FCA expects this to be done as part of the online registration process for the platform.

The participants

Businesses buying and selling investments through crowdfunding platforms should take care not to accidentally fall within the UK’s regulated activities and financial promotions regime. In particular, businesses contemplating raising equity finance via investment-based crowdfunding platforms should be careful not to fall foul of the restriction on offers to the public under section 755 of the Companies Act 2006. For more information on the implications of this legislation on investment-based crowdfunding, see our previous article Crowdfunding: restriction on ‘offers to the public’.

How is regulation likely to change/develop in the future?

In December 2016, the FCA published a feedback statement (FS16/13) in response to their previous call for input to the post-implementation of their crowdfunding rules. Following the publication of the feedback statement, the FCA has indicated that it intends to consult on, among other things, additional requirements relating to wind-down plans, cross-investment of loans on different loan-based crowdfunding platforms and mortgage lending standards where the investor is not lending by way of business.

In addition, the FCA has raised concerns regarding the quality of communications with potential investors on loan-based and investment-based crowdfunding platforms. Accordingly, it intends to consult on more prescriptive rules in respect of financial promotions and the content and timing of disclosures.

What is the UKFCA code of conduct?

The UK Crowdfunding Association (UKCFA) is a self-regulatory body that was set up in 2013 with the purpose of promoting the interests of crowdfunding platforms, their investors, and clients. Members of the UKCFA are required to agree to the code of conduct which, among other things, promotes and implements transparency, security, appropriate safeguards and compliance with applicable laws and regulations.

What are the benefits of crowdfunding?

Investors

  • Involvement – investors may find it rewarding to be involved in the development of a specific business, project, venture or cause. Crowdfunding enables potential funders to choose how they invest their money more freely.
  • Returns – crowdfunding may offer investors higher returns than those available from other, more traditional, financial products.
  • Costs – by obviating the need for various intermediaries such as brokers, investors may receive benefits via reduced search and transaction costs.

Borrowers

  • Accessibility – crowdfunding enables borrowers to access finance where it may not necessarily have been available to them from banks or other institutional lenders.
  • Numbers – crowdfunding enables individuals and businesses to receive finance from a potentially unlimited pool of investors and with relatively low associated access costs.
  • Exposure – raising finance via crowdfunding provides borrowers with significant exposure may help to raise the borrower’s profile and provides them with free access to market feedback.

What are the risks of crowdfunding?

Investors

  • Information asymmetry – potential funders may face the problem of information asymmetry and find that they lack the ability to conduct proper due diligence on the borrower.
  • FSCS – investment via crowdfunding platforms does not provide the investor with any access to the government’s Financial Services Compensation Scheme, which may leave the investor with no access to compensation in the event that the borrower becomes insolvent.
  • Liquidity – due to the lack of any established secondary market for crowdfunded investments, investors may find it difficult, if not impossible, to cash-out their investment.
  • Start-ups – many borrowers on crowdfunding platforms are start-ups or businesses in the early stages of their development. There is a significant risk that the borrower business will fail, resulting in a capital loss to the investor.
  • Shares – it is unlikely that shares issued on crowdfunding platforms will carry any associated voting rights or rights to dividends for the investor. In addition, the value of any investment many be significantly diluted if more shares are issued.

Borrowers

  • Reputation – whether through lack of experience or time-pressures, borrowers may fail to achieve their proposed goals set out in their initial pitch. This may result in irreversible reputational damage to their business and the borrower’s public support.
  • Intellectual Property – in order to receive public backing, borrowers may find that they have to make a trade-off between producing a detailed and thorough initial pitch and exposing designs or products that have not yet been properly protected.
  • Management – successful crowdfunding campaigns may result in a borrower having to manage a large number of investor’s expectations, demands and investments. Without the appropriate resources, borrowers may struggle to successfully carry out this task.

Source: Lexology

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How P2P could be a financial lifeline for UK landowners

Landowners and farmers are set to be among the hardest hit workers as Britain negotiates its way out of the EU. However, access to funding through a peer-to-peer (P2P) platform could provide a valuable form of finance so that farmers can grow, diversify or refinance amid the uncertainty of Brexit.

A recent study of 172 farms by the Prince’s Farm Resilience Programme found that just 16% made a profit from their farming activities over the period assessed. The analysis found that instead many farms are now reliant on alternative income streams to turn a profit, such as tourism, renewable energy and selling their products directly to consumers.

But moving into alternative areas of business requires capital. And – with the average farm in the study making a loss of more than £20,000 from its farming activities – it may be capital that landowners require to invest in their business to prevent a loss.

P2P lending could be a lifeline to the UK farming industry. It allows landowners to raise much-needed funds to help diversify their business. Meanwhile, local lenders can enjoy the produce and services their money has contributed towards creating.

The farming industry has already had to tackle a number of significant challenges in recent years. Supermarket giants have squeezed profit margins and demanded ever-increasing output levels.

It’s estimated that the number of dairy farmers has more than halved over the past decade, unable to keep up with cost cuts. A survey by the National Farmers’ Union last year found confidence among farmers on the outlook over the next three years had plunged. A recent report by the Agriculture and Horticulture Development Board (AHDB) estimated that the average farm could see its income more than halved after Brexit.

EU subsidies have provided a much-needed boon to many farms. Leaving the EU will likely leave a major gap in many farms’ balance sheets and local lending could provide the plug many farmers may require.

Many small businesses are turning away from the high street lenders when they are looking for funding or finding banks unwilling to lend to them. At the same time, many investors are looking for a more social and sustainable way to earn interest on their cash. It is estimated that in 2015 some 12% of lending to small- and medium-sized businesses came through P2P platforms and the proportion is only growing.

The appeal is easy to see: investing money in local businesses means not only do lenders have the chance to earn an inflation-beating rate of interest, but they can also see exactly how their cash is being used within their local communities.

Folk2Folk champions local lending because we believe in creating financially and socially sustainable communities by matching local businesses with local lenders. With headquarters in Cornwall and hubs across the UK in rural communities, we’re well aware of the importance and impact landowners and farmers have on their local communities, and all the challenges and opportunities they face during the Brexit transition.

Source: Bridging and Commercial

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The UK is leading the way in crowdfunding and P2P lending as the rest of Europe plays catch-up, says University of Cambridge data

The UK has helped to prompt a boom in European crowdfunding and peer-to-peer (P2P) lending, according to new research from the University of Cambridge’s Judge Business School.

While the UK remained the largest alternative finance market in Europe by far, at €5.6bn (£4.9bn), the rest of Europe began to play catch-up as it grew its own market by 101 per cent, the data from the university’s Centre for Alternative Finance showed.

Though this meant the UK lost market share, senior research manager Tania Ziegler said it was a positive story for the country which was showing signs of consolidation in a maturing market.

“Europe is growing from a much lower base so you are going to see much more rapid growth,” Ziegler said.

“It’s slower growth in the UK but that’s because we have seen consolidation, and the platforms that are active are very strong incumbents. It isn’t much of a worry because it’s a case of Europe catching up.”

Ziegler added that the UK “has been ahead because of innovation and a regulatory regime that has allowed innovation to grow”, which other countries are beginning to learn from.

France came second after the EU in the size of its online alternative finance market at €444m, followed by Germany and the Netherlands. Some of the more surprising rankings included Finland at number four and Georgia at number seven.

Excluding the UK, Estonia ranked first for alternative finance volume per capita for the second year in a row, at €63, followed by Monaco and Georgia.

P2P consumer lending accounted for the largest portion of alternative finance in Europe at 34 per cent, followed by P2P business lending, invoice trading, equity-based crowdfunding and reward-based crowdfunding.

Source: City A.M.

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The UK has the highest number of new business developments in a developed country despite Brexit

  • There were 218,000 new businesses in the UK last year, a 6% rise year-on-year. 
  • Other developed countries saw an average of just a 2% rise. 
  • Crowdfunding and peer-to-peer lending has been credited with this sharp rise in start-ups.

The UK outranked all other major developed economies in terms of the number of businesses established last year, according to figures from accounting group UHY Hacker Young.

It became home to 218,000 more businesses in 2016, a rise of 6% over year-on-year. Meanwhile, other major developed economies including France, Germany, Italy, Japan and the US saw an average 2% rise in number of businesses over the year.

The UK ranked sixth of the 21 countries studied by UHY, behind China, Pakistan, Vietnam, Malta and India. Across all the 21 countries, there was a 7.7% rise in established businesses.

“Enterprise and entrepreneurship in the UK have been gathering pace at impressive speed,” said UHY’s Daniel Hutson.

“As a range of new sources of funding gain traction in the market and the corporation tax burden lightens, the start-up climate is improving, financial pressures are easing and investment for growth is on the cards.”

UHY credited alternative funding sources, such as crowdfunding and peer-to-peer (P2P) lending, with helping to boost the entrepreneurial environment. The Conservative plan to lower corporation tax to 17 per cent by 2020 may also be helping to attract firms to the UK.

“The figures suggest confidence in the economic outlook, despite Brexit. Whether this is sustainable, given the uncertainties that still surround the ongoing negotiations with the EU, will be something the government will want to watch,” said Hutson.

While the UK had a total of 3.9 million businesses within its borders as of the end of 2016, China — which saw a massive increase of 19% — had 26.1 million.

The US fell in 13th place, with the number of businesses increasing by 2.1% over the year to 11m.

Source: Business Insider

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Pension funds, small businesses boost growth in UK alternative finance

LONDON (Reuters) – Britain’s alternative finance market grew by 43 percent in 2016, research showed on Friday, with interest from start-ups, small businesses and institutional investors helping to boost demand for services such as crowdfunding and peer-to-peer lending.

Last year, 4.6 billion pounds ($6.2 billion) was raised through alternative channels, up from 3.2 billion pounds in 2015, according to a survey of 8,300 investors and 77 crowdfunding or peer-to-peer platforms.

“Alternative finance has entered the mainstream and is likely here to stay,” said Byran Zhang, executive director of the Cambridge Centre for Alternative Finance (CCAF) at the university’s Judge Business School, which conducted the survey.

Approximately 72 percent of the year’s market volume, or 3.3 billion pounds, was driven by demand from start-ups and small businesses. That was up from 50 percent the year before.

 Peer-to-peer business lending was the largest market segment in 2016, growing by 36 percent to 1.23 billion pounds, providing an equivalent of 15 percent of all new loans lent to small businesses by UK banks.

Major banks reined in their lending in the wake of the financial crisis, and many small businesses complain of poor treatment and difficulty accessing funds.

Several alternative finance providers have sprung up to try to fill the gap, such as peer-to-peer lender Funding Circle, which announced this week it had lent more than 3 billion pounds to almost 40,000 businesses since its launch in 2010.

Another, MarketInvoice, offers peer-to-peer loans secured against businesses’ invoices and has lent 1.7 billion pounds since 2011.

ATTRACTING ATTENTION

After peer-to-peer business lending, the biggest categories were peer-to-peer consumer lending, peer-to-peer property lending, invoice trading, equity-based crowdfunding, real-estate crowdfunding and reward-based crowdfunding.

Institutional investors including pension funds, asset managers and banks were also increasingly backing the platforms, the survey showed. Funding from these sources accounted for 34 percent of peer-to-peer property lending, 28 percent of peer-to-peer business lending and 32 percent of peer-to-peer consumer lending.

 Peer-to-peer lending can offer relatively high returns. Funding Circle, for example, currently boasts an all-time average annual return of 6.6 percent.

But the sector’s fast growth has also caught the attention of the Financial Conduct Authority, which is looking at introducing new regulation for the sector, highlighting concerns about past loan losses and due diligence.

This week, peer-to-peer lender RateSetter, the UK’s third-largest, reported a pretax loss of 23.7 million pounds after it took a hit from a bad loan.

Source: UK Reuters