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Chris Dobson
Chris Dobson,
SENIOR ASSOCIATE - SOLICITOR
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What is ‘crowdfunding’?
26 July 2018

Co-authored by Chris Dobson and Grace Hudson

​​​​​​Crowdfunding is a way of raising finance by approaching a large group of people to invest money into a company or a particular project through an investment campaign typically hosted on-line. 

It differs from more traditional routes of raising finance where companies approach institutional lenders, private equity house, venture capitalists or angel investors for larger sums and instead, companies seek smaller levels of investment from members of the public forming part of much larger groups of potential investors.

There are four main types of crowdfunding:

  1. Donation based crowdfunding
    This is where the contributor won’t receive anything in return for their investment. Typically donations are from people who have a social or personal motivation for putting their money into the company so this type of crowdfunding works best for social or community causes and charities.
     
  2. Rewards based crowdfunding
    This is popular with start-up companies and with entrepreneurs who are seeking investment to fund the development of a new product and to engage their potential customers in advance of development.  Contributors can expect to receive different ‘rewards’ depending on how much money they contribute to the company.

    Rewards-based crowdfunding has been brought into the spotlight by crowdfunding sites such as Kickstarter.com, with recent reports stating that its crowdfunding platform has a total of 14,955,251 backers, has funded 147,355 projects and has raised a total of $3,794,290,600 in investments to date.
     
  3. Debt crowdfunding
    Also called p2p lending, this is where companies circumvent more mainstream bank lenders and utilise crowdfunding platforms to borrow sums from the general public. These types of crowdfunding campaigns are popular with entrepreneurs who may not have access to traditional types of loan facilities and who don’t want to sign over equity to private equity or venture capitalist funds immediately. In addition, companies will benefit from paying lower rates of interest than they would to a bank whilst the crowd lenders will expect to receive a higher return on the loan than if they kept their money in a savings account.
     
  4. Equity crowdfunding
    Under this model, individuals invest in return for a share in the ownership of the company seeking to raise funds (for example shares or membership in the business venture or project). Like all forms of investment, there is no certainty in the eventual outcome of the company or project being supported, but if things do go well, investors can expect to receive a return on their investment in the form of dividends or a higher share price upon exit. What rights investors receive will depend on the individual company and what provisions are in place in their governing documents.

    The craft beer brewer, Brewdog, has been a prominent player in the world of equity crowdfunding since its incorporation in 2006 and has shown that individual investments from the general public can amount to serious levels of cash injection for businesses. To date, the company have raised millions of pounds through its ‘Equity for Punks’ crowdfunding campaigns. Brewdog is currently aiming to raise £50 million through its fifth crowdfunding campaign to fund its expansion into Asia and Australia.

Legal issues to be considered prior to an equity crowdfunding campaign

A company seeking to utilise an equity-based crowdfunding campaign will first need to consider and deal with a raft of legal issues before going to the market with its investment proposition.

Consents

At a very basic level, the company will need to establish that it has the necessary consents in place to seek investment from third parties and issue new equity.  This may involve speaking to its bank or other existing lenders and also seeking consents from its existing shareholders.

Due Diligence of the Crowdfunding Platform

The crowdfunding industry is heavily regulated and companies should ensure that any crowdfunding platform they propose to use is authorised by the UK’s Financial Services and Markets Authority.

Articles of Association and Shareholders’ Agreements

It is likely that any participating companies will be required to adopt house style articles of association provided by the crowdfunding site or else agree to adopt heavily amended versions of their existing constitutional documents tailored to suit the requirements of large scale crowdfunding investment. In addition, any shareholders’ agreements between existing investors could in effect, be rendered largely redundant as crowdfunding investors will not be signing up to their terms.

Such new articles won’t need to actually be put in place until the completion of the funding round, however, given that their adoption will need to be approved by the existing shareholders of the company it would clearly be wise to ensure that the new articles have been approved before the crowdfunding process commences.

It will be important for the company to carefully manage relations with existing shareholders on the basis that many fundamental rights and protections connected with their shareholdings in the company could well be materially diluted or even lost as a result of the crowdfunder’s requirements. Areas being affected here could include existing rights of pre-emption, compulsory and permitted transfer provisions as well as the introduction of new classes of shares and their associated voting and dividend rights.  

Protection of Intellectual Property

The company should also ensure that it has sufficiently registered and protected all relevant intellectual property before uploading details of the project or company information onto a public crowdfunding site. For many start-up companies the value of their company will be rooted in the company retaining ownership of the intellectual property it utilises. The value of the company’s proposition to potential crowdfunding investors may very well depend on the company being able to demonstrate that it has secured the ownership of its intellectual property. 

 

Consistent with our policy when giving comment and advice on a non-specific basis, we cannot assume legal responsibility for the accuracy of any particular statement. In the case of specific problems we recommend that professional advice be sought.

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