Crowdfunding – the pros and the cons for business funding
SMEs and changes to crowdfunding regulations
We’ve included the key points from this initial review below, all of which relate predominantly to investors and investor-funding platform relations. For the most part, the findings prioritise protecting consumer or investor interests. There are, however, some points worth watching if you are a business owner looking to crowdfunding for alternative finance.
Firstly, relating transparency of information
There are calls for the information supplied to investors to be much clearer and more detailed. This is in terms of the quality of information supplied, and the time scales in which it is supplied. The FCAs concern is that investors have a clearer idea of what products they are being offered, and a better idea of the risks involved in this form of lending. The FCA suggests that approximately one in five crowdfunded businesses fail and investors need to be able to better assess the financial risks they are taking.
Much of this relates directly to the platforms’ practices, however, it is also potentially likely to impact upon the case that you as businesses have to make to participate. On the one hand, to the platforms to qualify for lending and on the other, the quality of the information, or the level of detail that you will need to provide to investors once you have been accepted onto the site. This is actually a key concern amongst investors who choose which businesses they lend to (some use automated processes to invest their money). Generally speaking, investors will avoid lending to businesses that don’t provide enough or compelling information.
Crowdfunding and the Consumer Credit Act
Secondly, in its report, the FCA identified some concerns about borrowers’ positions specifically relating to the Consumer Credit Act (CCA). There is a lack of clarity whether some borrower agreements fall under protection offered by the CCA. The FCA is under an obligation to review the retained CCA provisions and to report to Government by April 2019, however, so it is unlikely that this will be addressed in 2017. There will however be a call for input in February, so that interested parties can voice their opinions.
Crowdfunding property and mortgages
Thirdly, the review has raised flags on mortgage type lending, which constitutes a large proportion of investments and loans. Specifically, it’s possible that the FCA may ensure that mortgage based restrictions that currently apply to banks and building societies may apply to loan-based crowdfunding platforms. Many peer-to-peer platforms offer short-term mortgages and some longer-term buy-to-let mortgages for property developers and landlords, which provide returns to investors. Currently, this type of lending is not subject to the same rules as banks and building societies.
Under new rules coming in next year, traditional buy-to-let lenders will impose tougher restrictions on which borrowers qualify for these types of mortgages. In order to avoid a situation in which borrowers are able to access lower cost and less regulated loans from one type of lender (i.e. crowdfunding platforms), the FCA is likely to try and ensure that the same, or similar rules that are applied to banks and building societies for this type of lending are applied to crowdfunding sites. It is unlikely to allow a situation in which a large discrepancy exists between different types of lenders.
Research from the University of Cambridge and NESTA in partnership with KPMG estimates that in 2015, the market value of the UKs alternative finance sector increased from £1.7 bn in 2014 to £3.2 bn. This an 84% year-on-year increase, which is significantly down on the previous year’s year-on-year growth, but nevertheless still shows rapid growth. Real estate, it finds, is the single most popular sector in this market. In 2015, £609 million of nearly £1.49 billion total lending to SMEs in the UK came from the real estate sector. It provided capital for mostly small to mid-sized property development companies, financing residential and commercial developments.
Interestingly, the report finds that the crowdfunding sector is satisfied with its existing regulation – more than 90% of platforms stated they thought current regulation was adequate and appropriate. It will therefore be interesting to see what conclusions the FCA comes to and implements in 2017. According to the same University of Cambridge report, industry professionals believe that the greatest risk to continued growth and development of the industry is not increased regulation or changes to tax, but potentially ‘events related to their own conduct: malpractice or a cyber-security breach’.
As it grows in size, sophistication and complexity, the crowdfunding industry is undergoing rapid change. Now that it has received recognition from regulators, greater institutional backing from traditional financial institutions (45% of all platforms reported some institutional backing by either governmental, NGO, funds or family offices) and legitimisation by the government through tax and ISA reforms, just how the industry will ‘grow up’ in these conditions, remains to be seen. What we do know is that it is evolving rapidly, and has innovative business practices. How practices develop in response to market and regulatory conditions will be something to watch as we progress into 2017.
Key points released by the FCA from its initial findings:
Relating to loan-based and investment-based crowdfunding:
- it is difficult for investors to compare platforms with each other or to compare crowdfunding with other asset classes due to complex and often unclear product offerings
- it is difficult for investors to assess the risks and returns of investing on a platform
- financial promotions do not always meet our requirement to be ‘clear, fair and not misleading’ and
- the complex structures of some firms introduce operational risks and/or conflicts of interest that are not being managed sufficiently
Relating only to loan-based crowdfunding
In the loan-based crowdfunding market in particular we are concerned that, for example:
- certain features, such as some of the provision funds used by platforms, introduce risks to investors that are not adequately disclosed and may not be sufficiently understood by investors
- the plans some firms have for wind-down in the event of their failure are inadequate to successfully run-off loan books to maturity
- we have challenged some firms to improve their client money handling standards
We plan to consult on additional rules in a number of areas. These include more prescriptive requirements on the content and timing of disclosures by both loan-based and investment-based crowdfunding platforms.
For loan-based crowdfunding we also intend to consult on:
- strengthening rules on wind-down plans
- additional requirements or restrictions on cross-platform investment
- extending mortgage-lending standards to loan-based platforms
If you are thinking about peer-to-peer lending and wondering whether it may be suitable for your business, don’t hesitate to contact one of our business rescue experts.