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The facts about crowdfunding for your business
Crowdfunding through online portals (crowdfunding platforms) is an increasingly popular method of raising money for new businesses and organisations to finance their activities. Crowdfunding can take different forms but generally falls into four categories: rewards-based; donation-based; loan-based (also known as peer to peer lending “P2P”) and investment-based. Those thinking about using a crowdfunding platform to raise funds or to make an investment have a number of things to consider from risk to regulations to tax issues.
In the UK, the activities of loan-based and investment-based crowdfunding are regulated by the Financial Conduct Authority (FCA) under the Financial Services and Markets Act 2000 (FSMA) and the Financial Services and Markets Act 2000 (Regulated Activities) Order (SI 2001/544). Rewards based (in return for goods, services or “perks”) and donation based (no expectation of return) are usually exempt from the regulatory regime.
Regulation of loan-based and investment-based crowdfunding includes requirements relating to knowing your client checks; restrictions on investors; disclosure; investment limits and professional requirements. It has to be supervised by an “authorised person” who is authorised by the FCA.
Issuing share through crowdfunding
Companies need to consider various things when seeking to issue shares through an investment-based crowdfunding platform. These include Companies Act restrictions; class of shares to be issued and Prospectus Directive (2003/71/EU) restrictions. A company wanting to raise funds will need to prepare a prospectus, which will likely constitute a direct offer financial promotion under section 21 of FSMA and will need to be approved by an authorised person before it can be released. The prospectus must be very carefully prepared so it is completely accurate and not misleading as both the company and its directors are responsible for it under financial services regulations.
Companies and investors must also be aware of the tax issues when looking to issue or acquire shares through an investment-based crowdfunding platform or dealing with P2P loans. Income and capital gains arising on shares acquired will be taxed in the same way as those arising on other shares. Dividends received by individuals are taxed as income.
There are various tax reliefs available to companies and investors including the Enterprise Investment Scheme; which is designed to help smaller higher-risk companies raise finance by offering tax relief on new shares in those companies that qualify. For the investor, it’s a tax efficient way to invest in small companies. The Seed Enterprise Investment Scheme (“SEIS”) is a generous derivative of the Enterprise Investment Scheme (EIS) and was introduced in April 2012. Its aim is to encourage seed investment in early stage companies. Investors, including directors, can receive initial tax relief of 50% on investments up to £100,000 and Capital Gains Tax (CGT) exemption for any gains on the SEIS shares.
The risks of business crowdfunding
There are risks involved in crowdfunding including risks associated with the platforms themselves. These can include security of investor data, cyber attacks, fraud and even mal-practice.
For investors the risks are obvious: the businesses tend to be early stage with that obvious risk; there is the risk of dilution by subsequent funding rounds and there is generally no market for their shares until the business is sold, although some crowdfunding platforms have a bulletin board of the investments promoted by the platform to allow investors to offer securities for secondary sale.
Companies raising money through a crowdfunding platform can find it a useful marketing tool: it can help raise awareness of a product or business through a network of investors and others accessing the platform. It can also act as an introduction to other sources of finance including angel networks or other private funds.
Those investing through crowdfunding tend to invest less and in the full knowledge that they may lose their investment. This can make it easier for businesses with a high risk profile to raise capital.
For more information about how using crowdfunding for your business, contact the Commercial team on 02380 717717. Alternatively you can visit their section of the website here.
This is for information purposes only and is no substitute for, and should not be interpreted as, legal advice.