Crowding in: European Commission gets behind crowdfunding

10 October 2013

The consultation document describes crowdfunding as "an emerging alternative form of financing that connects directly those who can give, lend or invest money with those who need financing for a specific project". Crowdfunding campaigns, according to the consultation document, "typically collect small individual contributions coming from a large number of individuals".

What is crowdfunding and how does it work?

The consultation document describes crowdfunding as "an emerging alternative form of financing that connects directly those who can give, lend or invest money with those who need financing for a specific project". Crowdfunding campaigns, according to the consultation document, "typically collect small individual contributions coming from a large number of individuals".

Crowdfunding uses the internet to connect those seeking funds with those wishing to support various projects. It appeals to a wide range of activities, including artistic projects, charitable work and businesses.

In a typical model, the organisation that is looking for funding creates a campaign page on a crowdfunding website, then, people wishing to provide funds review the various campaigns and select those that they wish to support.

What (if anything) will the providers of the funds receive?

The consultation document sets out the main options

  1. Nothing - Some crowdfunding campaigns simply seek donations and offer nothing at all in exchange. Many charitable crowdfunding campaigns fall into this category.
  2. Rewards - Autographs and CDs are examples of the sort of rewards offered by some (often artistic) campaigns.
  3. Pre-selling - Sometimes the campaign will be looking for money to fund product development and the monies provided by supporters will be purchase monies paid in advance for the product.
  4. Profit-sharing - Some campaigns offer a share in future profits earned by the business, future royalties earned by the artist etc.
  5. Rights as a lender - With peer-to-peer lending, the campaign is seeking to borrow money from a collection of lenders. The campaign will promise to repay (perhaps with interest).
  6. Securities (shares and bonds) - Under this model, supporters become shareholders or bondholders in the business to which they are providing funds.

What are the possible benefits of crowdfunding?

The consultation document lists three benefits:

  1. Economic advantages - Crowdfunding can be useful for start-ups. Some promising start-ups and small businesses cannot get access to bank lending or venture capital. Crowdfunding may allow these businesses to get off the ground. Ultimately, this could lead to economic growth and job creation.
  2. Advantages for project owners - Access to funding (often on a flexible and speedy basis) is an important advantage. In addition, crowdfunding allows entrepreneurs to test the market and refine their products. A well-supported crowdfunding campaign is a good (though not conclusive) sign that there will be a market for their product or service. It is also likely that the people supporting the campaign will be interested in the product and able to provide useful feedback.
  3. Advantages for contributors - Those who support crowdfunding campaigns may receive a financial return or a sense of well-being. They may also enjoy greater interaction and engagement with the project that they are financing.

What are the risks for investors?

  1. Fraud - The monies may not be used for the purposes stated; advertising may be misleading etc.
  2. Project failure - The project may fail and a return/repayment may not be possible or the object of the campaign may not be achieved.
  3. Lack of liquidity (in the case of debt and equity) - There may not be a secondary market or there may be difficulties in selling due to a complex ownership model.
  4. Compromised intellectual property - In order to attract crowdfunding, projects may have to reveal details about their business models and this may enable competitors to benefit from these ideas.
  5. Money laundering - People may use the proceeds of crime to provide funds to a campaign and they may then claim that they have changed their minds and request the return of the funds.

What options is the Commission considering?

  1. Raising awareness - The Commission could do more to ensure that EU citizens are aware of crowdfunding.
  2. Public financing - Some public funds might be allocated alongside crowdfunding (ie if a particular campaign were proving popular this might be a factor that might suggest that the idea had public support and should receive some public funds).
  3. Granting EU-wide access to crowdfunding platforms - More choice, more competition, and access to a larger pool of capital would be available if crowdfunding platforms could operate on an EU-wide basis.
  4. Reform to the regulatory regimes for those types of platform that allow campaigns to offer financial instruments (ie debt and equity) - The Commission wishes to determine the optimal legal framework for crowdfunding. As such, it is considering the extent to which the Prospectus Directive, the Markets in Financial Instruments Directive, the Payments Services Directive and the Consumer Credit Directive should apply to crowdfunding.

What questions is the Commission asking?

  • Given that crowdfunding is expanding, is there a problem that justifies specific EU intervention?
  • Could a large-scale scandal undermine the confidence of contributors in this early stage of the industry's developments?
  • Is there a value-added in EU-wide market access and is there a real demand for EU-wide crowdfunding campaigns?
  • Are there legal barriers that impede cross-border access or render it overly burdensome for certain forms of crowdfunding, such as financial forms?
  • Is there a need to treat crowdfunding with a social impact differently than other forms of for-profit campaigns?

What next?

It is very encouraging that the Commission is taking such interest in this important area. The actions taken by the Commission following the consultation will help determine the future of crowdfunding in the EU and anyone with an interest in this area should follow the progress of the consultation closely.

The consultation will be more effective if it receives useful responses from informed individuals and we would therefore encourage anyone with an interest in the future of crowdfunding to consider responding to the questionnaire.

Wragge & Co's Funds and Financial Services team is a specialist team comprising tax, corporate, finance, regulatory and dispute resolution experts advising financial services firms from retail product providers and distributors, banks, investment platforms, pension funds, fund managers and exchanges. The team was a finalist in the category of Funds Team of the Year in The Lawyer Awards 2013.


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