Two's company, three's a crowd?

18th January 2013

The FSA has issued guidance in relation to "crowdfunding" amidst concerns that such schemes offer insufficient protection to amateur investors.

"Crowdfunding" refers to financing provided by individuals who co-ordinate their efforts and pool their resources to invest in projects. Typically, the arrangements are organised via online platforms where investees can pitch their particular project and potential investors can opt to invest, often from as little as £10. The funding is generally provided on an "all or nothing" basis with the investee setting out its required funding target and money from investors only being passed over once that target has been achieved.

Historically, crowdfunding has been particularly successful in the charities sector as well as for funding projects such as films. However, as traditional sources of equity for entrepreneurs and SMEs have dried up over recent years, there has been an increase in services looking to raise funds for investments in businesses. This has led to concerns by the FSA that those who choose to invest via such sites may not appreciate the inherent risks in the investments they make. The FSA points out that although higher than average returns may be possible in some cases, this is very much the exception rather than the rule and investors risk losing all their money, being diluted by later share issues and being unable to sell any shares issued to them in the absence of a secondary market for those shares.

Whilst acknowledging that crowdfunding could make up part of a diversified portfolio of investments, the FSA believes that most crowdfunding should only be targeted at sophisticated investors who understand the inherent risks of funding start-up businesses and can accommodate the potential loss of all their invested funds. The FSA has not announced any plans to introduce further regulation at this stage, although it points out that websites which allow investees to pitch their projects to potential investors may be making financial promotions which will be illegal unless the website is authorised by the FSA or one of the limited exceptions apply.

Comment: it remains to be seen whether the FSA will look to regulate this sector further in the future. If it does, it is hoped that any such regulation will take a "light-touch" approach so as not to stifle what is becoming an increasingly important source of funding for entrepreneurs and SMEs.