New regulations could make it more difficult for small businesses to raise money through crowdfunding.
This is according to the Crowdfunding Centre, whose founder Barry James recently told the Guardian that new rules will “take the crowd out of equity crowdfunding.”
As part of a new crackdown on the rapidly expanding alternative finance method, regulators have restricted the size of investments that new investors can make – but will these rules really make it more difficult for SMEs to raise funds?
What are the new rules?
Crowdfunding is now regulated by the Financial Conduct Authority (FCA). This organisation is responsible for regulating firms and financial advisors “so that markets and financial systems remain sound, stable, and resilient.”
There are two key forms of crowdfunding: equity crowdfunding, and debt crowdfunding. The FCA has decided that both need to be more strictly regulated, but that equity crowdfunding is riskier and therefore requires special measures.
The new rules mainly impact debt crowdfunding (that is, platforms that allow businesses to raise crowdfunded loans) on the platform side. The platforms will be required to maintain certain capital ratios, and some may be required to give clearer information to investors about the potential risks associated with the activity.
But the rules have a much more dramatic impact on equity crowdfunding. Under the new regulation new investors will only be allowed to make investments in crowdfunded businesses of up to 10% of their total assets, excluding homes and pensions. This applies to the first two investments, after which investors can apply to become recognised as ‘experienced’ – a process that requires them to complete a questionnaire.
What about ‘pledge’ platforms?
There is a third type of crowdfunding platform, under which backers give money in exchange for ‘perks’ such as pre-release versions of new products. These platforms do not come under the scope of the regulation, and are unaffected. This means that backers will be able to continue to use platforms such as Kickstarter in the same way.
What does this mean for me?
The new rules have not been widely publicised, but are likely to have a material impact on the prospects of businesses trying to raise money through crowdfunding platforms.
Securing loans through these platforms will remain relatively simple, but the terms of those loans are likely to become less favourable as the platforms pass on the cost of new regulation. In practice, this is likely to mean higher interest rates and higher administrative costs.
Perhaps more important, though, is the impact on equity crowdfunding. There is concern that limiting individuals’ investments will dramatically reduce the pool of potential investors from which businesses can draw. There is concern that the 10% figure is a blunt tool with which regulators are tackling a new technique that they do not yet understand. Similarly, some believe that non-professional investors will be put off by the more stringent new restrictions.
However, crowdfunding remains in the ascendant. Businesses that want to raise money without pursuing bank funding will still be able to do so, but you should be prepared for new restrictions as regulators continue their work.
You can read more about crowdfunding in our small business finance guide.