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Is the regulation of crowdfunding fit for purpose?

by Harry Curtis

Crowdfunding has surged in popularity over the last five years. Fuelled by the rise of Kickstarter, a website that lets you share the cost of ideas online, the emergence of sites like Crowdcube, Seedrs and Indiegogo has helped start-ups and SMEs obtain finance from the masses. The innovation charity Nesta estimates that British companies raised £245 million through crowdfunding in 2015, opening new doors for the country’s budding entrepreneurs.

This rapid growth has predictably left a trail of failures in its wake. While the media has reported numerous stories of leaky companies giving budding investors the run around, there has yet to turn into a flood. Calls to increase regulation of these promising platforms should focus on how we enforce current regulation – not whether we introduce more.

The Times reported recently on Rebus Group, a claims management company which went into administration soon after it raised more than £800,000 via Crowdcube. The company reportedly failed to warn that it had brought in restructuring experts to plug a cashflow crisis, setting off alarm bells over the lack of protection granted to investors. Regardless of what occurred here, the simple fact is that regulators are still largely powerless to stop companies that give misleading pitches on inflated valuations. The company responded that nothing was hidden in the financial documents - which bidders may have failed to properly read.

It follows the case of Hokkei, a Cardiff takeaway which raised more than £300,000 on Seedrs in the summer of 2015, and went bust less than six months later. Upper Street, a shoe brand, raised close to £250,000 also through Seedrs and has since gone into liquidation. LumeJet, a high tech photo printing company which raised £1.54m through CrowdBnk, is another high profile collapse of recent months.

There’s no clear proof that any of these companies’ pitches were fraudulent. However, it is true that crowdfunding platforms can often be the place of last resort for a company seeking finance. Those who invest are largely amateur investors. This clearly means they may not necessarily grasp the risk of what’s on offer, even if presented with a stack of financial documents.

The Financial Conduct Authority (FCA) brought in new regulations covering loan and investment-based crowdfunding in 2014. The new rules mean firms can only seek professional investors, and any ordinary investors can only stump up 10 per cent of their investable cash at any one time. This is on top of the standard protections offered to consumers against fraudulent pitches and business plans. But something can be misleading without being actively fraudulent.

Crucially, these investments are not covered by the Financial Services Compensation Scheme. Investors still run the risk of losing everything. In fairness the FCA does warn on its website – in bold letters no less – that investors should only chip in money they can afford to lose. There’s no such thing as a safe investment, after all.

Wannabe investors need to keep in mind the cold, hard truth that most start-ups fail, as do a high number of crowdfunding campaigns. A study last year by AltFi Data found that one in five companies that had sought equity funding through crowdfunding between 2011 and 2013 had since gone bankrupt. The same survey found that £5 million was invested in companies which had either ceased trading or were showing signs of distress.

While this figure may not seem high, it’s made up of the companies which have passed the platforms’ vetting procedures and still didn’t make it.

If you invest in a start-up through these platforms, with the intention of making a profit, there’s a significant chance you could lose your money. So, is the protection for consumers adequate?

Certainly there should be added safeguards for investors who have been misled and compensation when fraud has taken place. But we should not rush to point the finger or join the push for more regulation. The issue here is not lack of regulation, but a failure on the part of the crowdfunding platforms to properly vet those seeking funds - as seemed to happen with Rebus - on top of amateur investors not reading the fine print.

In the same way that public hysteria and calls for further press regulation peaked in the aftermath of the phone hacking scandal, a few more cases like Rebus Group could light a fire under the regulators of crowdfunding.

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