In the last two decades, the Internet has radically changed the way in which we gather and share information and communicate with one another. Last year, the sometimes unexpected transformational power of the Internet was on full display, when activists from Cairo to New York, with the help of social media tools, were able to come together and demand change, in some cases even leading to the downfall of dictatorial regimes which held power for generations.
Now, through "crowdfunding," the Internet once again, stands to affect our lives, by significantly expanding and democratizing investment and funding opportunities, for ordinary investors and businesses alike.
"Crowdfunding" is the process by which, through the Internet, a group of people pool their resources together to provide financial support to a given cause, individual or organization.
Several companies such as Kickstarter (a platform which provides funding to a vast array of projects ranging from software applications to one's cultural journey across Mexico), Sellaband (a music website which enables artists to raise funds from their fans to record a professional album, in some cases reaching up to 50 000 euro's), IndieGoGo ( raises funds for a multitude of creative art projects, from inventions to gaming to performing arts) and Profounder (which enables entrepreneurs to raise capital from those close to them in order to accomplish their goals) use some form of "crowdfunding" as their business model, and in so doing are having a positive impact on the ability of a growing number of people to accomplish their dreams and aspirations.
However, for "crowdfunding" to accomplish the full measure of its potential, financial regulations in developed countries which currently restrict equity investments in private companies in various different ways, will have to be changed. Indeed, equity-based "crowdfunding" would allow investors, who usually only get a simple return on their investment, to actually own a piece of equity in the company they have supported, therefore providing them with an incentive to invest even more substantial amounts of capital.
Unfortunately, the current regulatory framework isn't there yet, although legislators most notably in the US, are currently examining different ways of easing legal restrictions which make it costly for companies in need of funding, to raise early stage capital. Last November, the Obama Administration expressed its support for a Bill that would allow companies to accept and pool donations of up to $ 1 million or $ 2 million in some cases, without having to register with the Securities and Exchange Commission.
In Europe, the legal obstacles are equally daunting. In order to attract investors lawfully, one first has to prepare what is called “a financial promotion”, which basically is an invitation or ‘inducement’ to subscribe for or to buy shares or debt securities. Financial promotions either can only be approved or issued by those institutions legally allowed to do so, or they must entirely fall under the statutory exceptions.
The general rule of the Prospectus Directive is that any offer of “transferable securities” to the public must be made in a prospectus, which is a heavily regulated and prohibitively expensive document that requires regulatory approval. The Directive does not apply when, among other things, the offer does not exceed €2.5 million, and is directed at a maximum number of 100 people in each State in the European Economic Area.
It is therefore safe to conclude, after examining the legal landscape in both Europe and the US, that the current regulatory environment significantly impedes the development of crowdfunding on a large scale. While most of the regulations mainly aim to protect ordinary investors from making risky investments, which of course is necessary and entirely justified, these rules should not, I believe, prevent this new method of investment from fully coming to fruition, and in so doing, opening up new funding avenues for all kinds of businesses in need of capital. Especially in these challenging economic times, that would be a most welcome development.
By Max Bentinck.