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					              Crowd Funding-
   The Wisdom of Crowds - are you a part of it?




IoD 'Crowd Funding' Breakfast Seminar
29 January 2013
        Crowd Funding : What is it?

•       Crowd Funding is an internet-inspired means of raising money from the mass
        market, for a project or business.




•       It is a relatively recent concept that originally had its origins in community and
        arts-based ventures, which members of the public were inclined to support for
        mainly benevolent reasons.




    © Lupton Fawcett Lee & Priestley 2013
     Crowd Funding : What is it?

• Initially, businesses/ new ventures/ individuals approached the public
  at large for cash/ loans/ donations/ investment into their film/ music/
  arts projects and in return the individuals would typically receive a gift
  such as tickets to a film premier/ opening night or a mention in the
  credits etc.

• Crowd Funding was initially seen by many as a concept unsuitable for
  use in the business world.

• Despite this scepticism, the tightening of banks’ lending criteria and
  unavailability of commercial finance has meant that Crowd Funding is
  gaining attraction on both sides of the Atlantic.

• Crowd Funding creates investors and lenders out of a company’s
  customers, therefore creating loyalty within the company’s customer
  base.

 © Lupton Fawcett Lee & Priestley 2013
    Crowd Funding : Some definitions


    “The practice of funding a project or venture by raising many small
    amounts of money from a large number of people, typically by the
    internet”


    “The democratisation of borrowing, lending and investing”


    “A continuous and growing series of virtual on-line auction houses,
    matching borrowers and lenders; investors and investees; and
    donors and donees”



© Lupton Fawcett Lee & Priestley 2013
    Crowd Funding : Types of models


    Debt:                         Investors are repaid for their investment over a period
                                  of time at a specified rate of interest.

    Equity:                       Investors receive a stake/ shares in the company.

    Donations: Contributions go towards a benevolent cause with the
               ‘investor’ receiving nothing in return.

    Rewards:                      Investors receive a tangible item or service in return
                                  for their funds. (Invest in film, and get tickets to the
                                  premier.)



© Lupton Fawcett Lee & Priestley 2013
    Crowd Funding : Examples
    1997               - British rock group Marillion’s USA
                         tour was underwritten by donations
                         from fans. $60,000 raised.

    2009               - “The Age of Stupid” was the first full length feature film
                         to be financed entirely by Crowd Funding. £1.5 m raised.

    2012               - Revolution Software Ltd, a video game developer based
                         in York, raised $771,560 to develop the fifth entry in their
                         Broken Sword adventure series, The Serpent’s Curse.


    Other non-corporate examples: disaster relief campaigns; political
    donations; scientific research etc


© Lupton Fawcett Lee & Priestley 2013
    Crowd Funding : Where did it start?
    • Banks became risk averse and suffered solvency issues.




    • The cost of raising finance has always been expensive, particularly for
      small projects.

    • There is an altruism gene in everyone.

    • The internet changed everything!


© Lupton Fawcett Lee & Priestley 2013
    Crowd Funding : Recent developments
    in the USA
    • 5 April 2012, President Obama
      signed the JOBS (Jumpstart Our
      Business Startups) Act. Prior to
      this, US legislation prohibited public
      solicitation for private companies
      raising funds.
    • The JOBS Act was due to come into effect
       on 1 January 2013 and whilst the main provisions of the Act took
       effect promptly, the Securities Exchange Commission in the US (the
       “SEC”) has missed the deadline to repeal the ban on general
       solicitation and advertising of private placements as required by the
       JOBS Act, and has not yet proposed a substantive set of rules to
       enable Crowd Funding to function effectively.
    • The SEC will regulate Crowd Funding in the USA.
© Lupton Fawcett Lee & Priestley 2013
    Crowd Funding : The size of the market


    USA: c. $900 million (2012)



    The World: c. $2 billion (2012)



    Forecast: $6.8 billion forecast for 2013   CFP= Crowd Funding Platform


    (Difficult to validate)




© Lupton Fawcett Lee & Priestley 2013
Crowd Funding : Increase in market size


    Equity based Crowd Funding
    has seen the greatest compound
    aggregate growth rate (CAGR)
    since 2007, however Rewards
    Based Crowd Funding still holds
    the lion’s share of the Crowd
    Funding market.



© Lupton Fawcett Lee & Priestley 2013
    Crowd Funding in the UK?
   •      Protection of widows and orphans/
          investor protection is generally seen
          as a major issue.
   •      The Financial Services and Markets Act
          and the Financial Services Authority were
          both designed prior to the Crowd Funding
          concept.
   •      Current UK legislation is not fit for purpose and Crowd Funding
          businesses face a number of obstacles.
   •      Typically in the UK, lending is governed by the Consumer Credit Act
          and/ or the issue of a banking licence.
   •      The raising of share/ equity capital requires the issue of a prospectus
          or an investment memorandum. The targeting by private limited
          companies of potential investors is generally limited to high net worth
          individuals/ sophisticated investors.
   •      FSA approval can take 6 to 18 months.

© Lupton Fawcett Lee & Priestley 2013
    Crowd Funding : Comments by the FSA
    and Government
     FSA                          :     “Websites which allow businesses to raise finance from
                                        consumers should not be promoted to amateur
                                        investors.”

    FSA                           :     “Crowd Funding website(s) … should be targeted at
                                        sophisticated investors who know how to value a start up
                                        business.”

    BIS                           :     “The government is working with industry to support a
                                        range of new ways of lending and other innovative
                                        financial models.” (Code for “we are working on it!”)

    Vince Cable :                       “I want to see as much competition in the market as
                                        possible and for businesses to have access to a wide
                                        range of finance sources”


© Lupton Fawcett Lee & Priestley 2013
    The Regulations : Debt Crowd Funding
    WHO?

    • There are numerous peer to peer (P-2-P)/business
    lending websites currently in the UK market place.
    Funding Circle, RateSetter and Rebuilding Society to
    name just a few.




© Lupton Fawcett Lee & Priestley 2013
    The Regulations : Debt Crowd Funding
    HOW?
    • These sites are not deposit-taking institutions and are therefore not covered by the Financial
    Services and Markets Act 2000 or the Financial Services Compensation Scheme. Instead, these
    companies are currently regulated by the Office of Fair Trading under the Consumer Credit Act
    1974/2006.

    • The platforms must have a Consumer Credit License that will generally allow them to deal with
    the following:
    • Credit brokerage
    • Debt administration
    • Debt collecting
    • Provision of credit information services, excluding credit repair
    • Provision of debt-adjusting on a commercial basis

    • The application fee for a Consumer Credit Licence is £1250 and can
      take 25-50 working days.

    • Government has, however, now made a move to regulate P-2-P lending and has amended the
    Financial Services Bill, currently passing through parliament. The Treasury will soon be
    launching a consultation exercise to decide exactly what form the regulation will take.

    • Responsibility will be given to the new regulatory body, the Financial
    Conduct Authority (FCA), that will be taking over from the FSA on
    1 April 2013.

© Lupton Fawcett Lee & Priestley 2013
     Debt Crowd Funding : Funding Circle
1.       Funding Circle

•        Funding Circle is an online marketplace designed to help businesses find low cost loans
         quickly and investors get better returns.
•        Businesses ask to borrow a specific amount of money over a term of either 12, 36 or 60
         months.
•        Individual lenders offer to lend the businesses their money at the individual’s chosen
         rate of interest.
•        Businesses can then accept the offers with the most favourable interest rates.
•        The businesses that have taken loans, repay Funding Circle part of the loan each
         month, and interest equal to the average interest rate attaching to each of the
         individuals’ loans.
•        Funding circle then pay the individual lenders using an automated system that uses the
         individual rates of interest offered to work out how much each person is owed.
•        Since Funding Circle launched in August 2010, more than 4,000 businesses and savers
         have signed up, with over £73,158,920m offered to businesses to date.
•        Vince Cable recently announced that government is to bypass traditional banks and
         lend money directly to small businesses and traders in a £110m scheme, using 'peer to
         peer' internet-based lenders. Funding Circle, will receive £20m to lend to businesses.




© Lupton Fawcett Lee & Priestley 2013
The Regulations : Equity Crowd Funding

Types
 There are two main models in the UK for equity Crowd Funding:

1) FSA Authorised (Unregulated collective investment scheme) (Seedrs
   Limited)



2) Approved by an individual authorised by the FSA (Non-FSA authorised)
   (Crowdcube Limited)




© Lupton Fawcett Lee & Priestley 2013
The Regulations : Equity Crowd Funding

 •         Under Section 21 of the Financial Services and Markets Act 2000
           ("FSMA"), an unauthorised person is prohibited from
           communicating a financial promotion unless the content of the
           promotion is approved by an authorised person or is exempt. The
           exemptions are set out in the FSMA (Financial Promotion Order)
           2005. These include promotions made publicly to "Investment
           Professionals”, "Certified High Net Worth Individuals" and
           "Sophisticated Investors.”

 •         Crowd Funding aims to hurdle/ get around these restrictions by
           utilising the current regulation in a way that was not originally
           intended or envisaged.


© Lupton Fawcett Lee & Priestley 2013
Equity Crowd Funding : FSA Authorised
(Unregulated Collective Investment Scheme) -
Seedrs
   1.       Seedrs

   •        Seedrs have FSA authorisation to arrange deals in units as an Unregulated Collective Investment
            Scheme (pooled investment).
   •         Seedrs rely on an exemption from the prohibition on promoting unregulated collective
            investment schemes by restricting access to its services to those investors which it has assessed as
            adequately knowledgeable to understand the risks of investing in a collective investment.
   •        Under the Code of Business Conduct (COBS) and in particular COBS4 (“Communicating with
            clients, including financial promotions”) and COBS 4.12 that governs Unregulated Collective
            Investment Schemes, Seedrs are allowed to communicate to the public at large by:
   (1)      undertaking an adequate assessment of each individual's expertise, experience and knowledge so
            that the assessment can give reasonable assurance, in light of the nature of the transactions or
            services envisaged, that the person is capable of making his own investment decisions and
            understands the risks involved;
   (2)      giving a clear written warning that enables the firm to promote unregulated collective investment
            schemes to the client; and
   (3)      the client stating in writing, in a document separate from the contract, that he is aware of the fact
            the firm can promote certain unregulated collective investment schemes to him.
   •        This exemption is due to be repealed by the FSA and Seedrs are currently looking at ways which
            will allow them to continue approaching the public at large.




© Lupton Fawcett Lee & Priestley 2013
       Equity Crowd Funding : Non FSA
       authorised – Crowdcube
   2.       Crowdcube
   •        Crowdcube is a company ltd by shares. However, when investors sign up to the website they become a member of
            Crowdcube Ventures Ltd, a company limited by guarantee.
   •        Investee companies agree to become subsidiaries of Crowdcube Ventures Ltd for the duration of the time that they are
            listed on the Crowdcube platform. Thus, both Investor and Investee are part of the same body corporate and exempt
            from financial promotions regulations.

   •        The disclaimer on the Crowdcube website confirms that they are able to approach investors in this way under Article 43
            of the Financial Services and Markets Act 2000 (FPO) 2005. This states:
   •        "Members and creditors of certain bodies corporate
            s. 43 (1) The financial promotion restriction does not apply to any non-real time communication or solicited real time
            communication which is communicated—

            (a) by, or on behalf of, a body corporate (“A”) that is not an open-ended investment company; and
            (b) to persons whom the person making or directing the communication believes on reasonable grounds to be persons to whom
            paragraph (2) applies, and which relates only to a relevant investment which is issued to an undertaking (“U”) in the same group as A.
            (2) This paragraph applies to—
            a creditor or member of A or of U;”
   •        The Crowdcube platform allows potential investors to invest in companies that pitch the merits of their business using
            the site as an intermediary. These investors receive an equity stake in the companies in which they choose to
            invest. Once the investment threshold is met, a Direct Debit facility called Go Cardless then takes the funds from the
            investor’s bank account (eliminating the need to hold client funds/ seek FSA authorisation).
   •        Following the recent FSA guidance published regarding Crowd Funding, however, Crowdcube have had to put a further
            hurdle in place that potential investors must meet in order to invest on the site. Potential investors must now self
            certify that they are either a high net worth individual or a sophisticated investor. This ‘should’ drastically reduce the
            amount of potential investors that are able to meet the required criteria.
   •        In practice it looks extremely unlikely that this will stop the average member
            of the public investing.

© Lupton Fawcett Lee & Priestley 2013
    Crowd Funding in our Region (1)

Crowd Funding is having a large impact:
1) Revolution Software
•    A video game developer based in York, raised $771,560
     by pitching its proposal to develop the fifth entry in their
     Broken Sword adventure series, The Serpent’s Curse, on
     Kickstarter, a rewards based Crowd Funding platform.
    Crowd Funding in our Region (2)

2) SkinKind (UK) Ltd
•    SkinKind (UK) Ltd is a family owned firm that for the
     last 23 years has successfully developed and marketed an
     industrial range of natural hand cleaning products to
     companies . It is now looking to raise £49,000 through
     Rebuilding Society to increase their prescribing doctors
     practices and increase the number of individual Doctors
     prescribing SK products.
    Crowd Funding in our Region (3)

3) Brew Dog
•    In 2009, as a 2 year old company
     Brewdog became a public company
     and the first company in Europe to sell
     shares online in a scheme which was
     fully authorised by the Financial Services Authority,
     through the company's own website.
            • Over 6,500 people invested, giving the company
              capital for growth and investors an equity stake.
    Crowd Funding : does the market place provide an
    opportunity for “Crowd Frauding?”

• Crowd Funding is currently in its infancy. Use of the current regulatory regime in
a manner that was neither envisaged nor intended has led many sceptics to
question what protections the average member of the public can fall back on if
things were to go awry.

• Barbara Roper, director of investor protection at the Consumer Federation of
America, warns against expecting too much from Crowd Funding sites. Crowd
Funding “has precisely the same place in the average person’s investment portfolio
that lottery tickets do,” she says. “If you have a little spare cash that you think it
would be fun to gamble with, that’s fine, but don’t consider it part of a well-
thought-out investment strategy.”

• Investing in start-ups, be it through a portfolio or individual investments, is not
for the risk averse.



© Lupton Fawcett Lee & Priestley 2013
    Crowd Funding : does the market place provide an
    opportunity for “Crowd Frauding?”

• Until Crowd Funding regulation is enacted in the UK, akin to the regulation that
is soon to be put in place in the USA, should Crowd Funding carry a health
warning?

• The FSA has produced guidance on the area, stating that “investors in a crowd
fund have little or no protection if the business or project fails, and…they will
probably lose all their investment if it does.” They are also concerned that “some
firms involved in Crowd Funding may be handling client money without [their]
permission or authorisation, and…may not have adequate protection in place for
investors.”
• The hope is that regulation is put in place sooner rather than later that reduces
an individual’s exposure in this type of investment and provides certain investor
protections.
• If a ‘legitimate’/ transparent marketplace is created then Crowd Funding
 has enormous potential.

© Lupton Fawcett Lee & Priestley 2013
    Crowd Funding : The future
Is this a market place with untapped potential?

- There will be casualties
- There will be consolidation
- The market will grow
- Technology will be the great enabler
- Regulation may take some time to develop


- Regulation giving lucidity to the current regime cannot come soon
enough.

If you would like to discuss this further then please don’t hesitate to get in contact:

Andrew Lindsay                             Adam Gray
Tel:   0113 280 2025                       Tel:   0113 280 2240
Email: andrew.lindsay@lf-lp.com            Email: adam.gray@lf-lp.com
© Lupton Fawcett Lee & Priestley 2013

				
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