By Perle Krüger and Assia Belaïd, University of Montpellier, Centre du Droit de l'Entreprise
OVERVIEW
The current accessibility to vast networks of family, friends and colleagues is currently used to raise money from a large audience. Among these persons, there are potential future investors interested in funding selected projects. This financing method, known as "crowd-funding", is spreading from the musical arena to a large range of humanitarian, political, cultural and economic activities.
We can distinguish three main categories of crowd-funding.
With "Reward crowd-funding", the funder gives money to a project due to personal motivation but without expecting anything in return, other than the satisfaction of supporting a cause or something he believes in.
With "Loan crowd-funding", the funder expects a return : primarily the money they initially invested, with interest.
With "Equity crowd-funding", the funder exchanges his money. The counterpart consists of shares, the value of which may go up or down.
With 1,400 million € raised worldwide in 2011 and 2,800 million € forecasted in 2012, crowd-funding is emerging. It can be seen as a solution to the difficulties met by the project-backers to be financed. It can also be considered as a cheap and simple alternative to the classic bank loan. Indeed, most crowd-funding platforms award to the lenders a return on the investment made. Furthermore, the return can be much more favorable than the return offered by the bank.
This Quick Overview (formerly known as QuickCounsel) reviews regulations applicable to crowd-funding in France, the United Kingdom, and Italy, with some discussion of the practical application of the rules.
THE FRENCH REGULATION
Dozens of platforms dedicated to crowd-funding exist in France (among them My Major Company, KissKissBankBank, Ulule, and Babeldoor). Currently, this activity is regulated by official and unofficial rules. The lack of specific rules had led authorities to enact new ones.
The current official rules
Firstly, crowd-funding may be seen as payment of services such as acquisition of paying orders (Article L 314-1 II) 5°) of the French Financial and Monetary Code or "FMC") and execution of wire transfer operation associated to the payment account management (Article L. 314-1.II.3° of the FMC).
Secondly, crowd-funding can be treated as a credit service, a bank operation under article L313-1 of FMC related to the Bank monopoly in case of financial loan (article 511-5 CMF) . It would then be subject to a special authorization. The violation of this monopoly is sanctioned by a 375.000€ fine and 3 years imprisonment (article L571-3 FMC).
This monopoly does not apply to interest-free loans and to the reception of public funds if the latter has been affected to a use precisely determined (article L312-2 FMC).
If the crowd-funding platform does not cash funds on behalf of a third party, and that we are in presence of a free-interest loan, the platform would not legally be subject to these rules.
Thirdly, regarding equity crowd-funding, there is a risk that the crowd-funding operations will be considered as a public offering, regulated by article L411-1 FMC. This kind of operation is specifically regulated, notably by the need of a prospectus publication (article 212-1 of the " Autorités des Marchés Financiers " (AMF) Regulation). They can benefit from a prospectus exemption, if, for example, the total amount of the offer does not exceed 100.000€ within 12 months (article L411-2 I 1 of FMC and article 211-2 2°) of the AMF Regulation).
These limitations are not strictly enforced. In addition, the practice of unofficial rules related to the crowd-funding activity has been noted.
The current unofficial rules
The unofficial rules may derive from the unwritten practice general terms of usage of four of most well known crowd-funding platforms i.e. My Major Company, Babeldoor, Ulule, and Kisskissbankbank. These usages have also been noticed in the "FAQ" (Frequently Asked Questions) of these platforms, the Autorité de Contrôle Prudentiel et de Résolution (ACPR), AMF guides, and the White book of the Fin-Part association.
These unofficial rules can be likened to the notion of "usages". The usages can be understood as continued practices that have been adopted by commercial persons within a specific field of activity.
A first usage is to publish a Project online for free. Once the project is accepted and put up online by the crowd-funding platform, the platform has accepted as a usage to publish it on its website for free.
A second usage relates to the gauge (understood as a "threshold"). It is not possible, once the project has been put up online, to modify, the collection period term, the gauge amount (the financial objective that needs to be reached in order to consider the project as financed), or the compensation proposed to lenders in exchange for their contribution.
As can be seen in the crowd-funding platforms FAQ, platforms generally propose a collection period running from 1 to 180 days (max). Once the collection period is over, or the project backer will have his project entirely funded and the funds will then be put at his disposal. If the sum has not been reached, the collection period cannot be extended.
When the minimum aggregated amount for the project financing is not reached during the collection period, the lenders receive a repayment and their contribution is canceled. In this case, the project backer will not receive any funds and the platform will not make any commission.
This "all or nothing" rule forces the project backer to have a better consideration of the necessary amount of money needed for the project achievement.
In the case where the financial expectations have been overreached, crowd-funding platforms have agreed to leave the project online until the collection period reaches its term. Thus, the lenders could still contribute to this project.
A third usage relates to the remuneration. The crowd-funding platform directors will not charge any fees for any online project publication. The usage is then to collect a fee based on the total amount of money collected by the project backer. According to the usage, this commission rate will not exceed 10% (all charges included) of the total amount of money for the project achievement. This commission will be withdrawn during a period that will not exceed 8 workdays following the end of the collection period determined by the project backer.
Finally, a fourth usage relates to the repayment possibility. Any lender has the possibility to receive the repayment of his contribution for a specific project. However, this "opting-out right" granted to the lenders cannot be invoked once the collection period has reached its term. Lenders willing to receive the repayment of their contributions will be given the choice between having the financial repayment returned to their bank account and requesting the reconversion of their contribution into a credit. This credit could be spent on the crowd-funding platform in order to finance other projects.
If the target has not been reached, crowd-funding platforms have accepted as a usage the full reimbursement of any funds invested in the project within 10 days of the collection period term.
The future French regulation
The discrepancy between the official and unofficial rules reveal the inadequacy of the existing legal rules. For example, to be recognized as a credit institution, a lending crowd-funding platform has to present quite a high capital. Similarly, equity crowd-funding platforms have to fulfill very specific rules in order to prevent crimes like money laundering. That is the reason why the French Government is in the process of enacting a new legal framework that is arguably better adapted to reality. The idea consists of creating a regulation designed to ensure the security of the investors and to support the securities crowd-funding sector and its development. The first step toward a crowd-funding regulation was taken on May 2013 when the "Autorité des Marchés Financiers", and the "Autorité de Contrôle Prudentiel et de Résolution" (ACPR) published the "guidelines for project managers" in order to inform project managers about the upcoming rules.
Further progress was made on the 4th September 2013, when the French Minister of Economy and Finance announced the creation of a " crowd-funding investment service provider " for crowd-funding platforms. It would aim at ensuring the security of investors and, more particularly, that money is effectively invested in the project they support. Moreover, the future proposal is supposed to mention some upper limits. The first one concerns the loan amount limited to 250 € per individual per project. Furthermore, the total loan amount is limited to 300 000 € per project. However, we have to be aware, that for the moment, these are just proposals.
The crowd-funding scene is definitely evolving in France. But France is not the only country touched by the fervor born from this activity. It spreads all over Europe.
THE UNITED KINGDOM REGULATION
In the United Kingdom, the crowd-funding platforms have been multiplying. Among the most famous : "We fund", "Seedrs", "Crowdcube" and also "Blom VCI". The crowd-funding, currently monitored by the Office of Fair Trading, does not appear to be strictly regulated either. However from the 1st April 2014 crowd-funding will be managed by the Financial Conduct Authority. This regulatory body has published a consultation paper related to the changes that will be made to crowd-funding regulation. It is aimed at regulating two types of models : investment based crowd-funding platforms and loan based crowd-funding platforms. In the near future, they will be subject to a certain number of new rules which will provide a more rigorous control transparency of the information and the communications presented on the platform. It may introduce a minimum prudential requirement (by a percentage of loaned funds or a fixed minimum of £50,000). Finally, it may ensure rights and guaranties for the investors. For instance, it would create an obligation to establish a resolution plan in order to fulfill the obligation of loan repayments in the event of the platform collapsing.
THE ITALIAN REGULATION
Italy is one of the only countries who has adopted specific regulation regarding crowd-funding.
In July 2013, the Italian Security and Exchange Commission (CONSOB) enacted one of the first texts that regulates equity crowd-funding. It introduces a legal framework, legalizing this practice and encouraging the creation and expansion of start-ups that the law was designed to tackle. Indeed, it is limited to European innovative start-ups, regardless of the nationality of its shareholders, listed in a special registry with the benefit of many advantages under the respect of specific conditions. For example, turn-over shall be lower than €5 million per year. It grants the investors a wider protection and a set of rights enabling them to leave the investments in some cases. Contrary to the USA Jobs Act, the Italian law does not set an investment gap. However, a special simplified process has been established for small investments. Every investment has to be finalized through a broker-dealer in order to prevent crime, specifically money laundering.
THE ATTEMPT AT HARMONIZATION UNDER THE AIFM DIRECTIVE
This quick evolution of these national rules shows the lack of European harmonization. This fragmentation has led the European Commission to adopt the Alternative Investment Fund Manager (AIFM) Directive 2011/61/EU. The Directive entered into force on 22th July 2013 and could apply to crowd-funding platforms.
According to Article 4 (1) (a) an AIFM is a collective investment undertakings, which would raise "capital from a number of investors, with a view to investing it in accordance with a defined policy for the benefit of those investors". According to article 4 (1) (b) an AIFM is also defined as a legal person whose regular business is managing one or more alternative investment fund.
The crowd-funding provision of services appears to be in accordance with the definition given above. Therefore, it can be considered that it constitutes an AIF management.
AIMFs established in European Union will need authorization by 22 July 2013 (or 22 July 2014 in European Union Member States that use the transitional period). They will be subjected to detailed rules concerning transparency (detailed reporting to regulating authorities, annual report disclosure), remuneration (remuneration policy discouraging risks-taking inconsistent with AIF risk profile), conduct of business (conflict of interest policy), and leverage limitations.
CONCLUSION
Despite its impact, crowd-funding is not yet adequately regulated. The multiplication of national specific rules dedicated to this field demonstrates the increasing interest of the Member States. With the enactment of the AIFM Directive, which became enforceable on the 22th July 2013, many more domestic legal reforms are expected from the Member States. However, the implementation of such a directive could restrict the competitiveness of the European crowd-funding platforms.
The inadequacy of legal rules applying to crowd-funding could be solved by officially recognizing usages and their legal authority. Indeed, usages alone suffer from a certain lack of legal authority and visibility. It could be interesting to use article L612-29-1 al.2 FMC which gives the ability to the ACPR to officially recognize some usages.