So, 5 years into the new world of equity crowdfunding, and from somewhere within a new FCA review of its regulation, how is the industry doing? Here’s one investor’s personal vision …

Truth is, not as well as we’d hoped.

We’ve had three exits - not one of them making a multiple ROI that justifies the type of risk taken by investors and certainly none that will alleviate the mounting industry failures.

On the whole, the platforms continue to increase in number and many continue to offer what can best be described as questionable deals. For the moment, the investors seem transfixed by the promise of the next Facebook or Oculus Rift, or both together.

So, if we could turn back the clock and start it all over again, how could equity crowdfunding be set up so that it works both as a source of much needed investment for SMEs and as a relatively high-risk, but well-regulated, part of ordinary people’s investment portfolios?

From SMEs’ Perspective

To grow, companies need capital and, for early stage companies, this is normally not obtained via profits. Equity crowdfunding provides access. However, with that access we need to see a much higher degree of engagement. A more open and honest approach to what is possible. If we can’t achieve that without regulation, then we have to do so with regulation, because achieve it we must or we will continue to see the sort of investor mistreatment that increasingly seems to be the norm.

From my experience in this area, it is often not the investee companies that are inflating expectations but the platforms themselves. The current equity crowdfunding model – which has essentially evolved from the Kickstarter rewards-based model - is that these platforms only get paid if the pitch reaches its target. So, human nature dictates that the platforms will do everything in their power to make the offer as enticing as possible. Massive profit forecasts and 10X predicted returns are obvious options.

Companies need to vote with their feet. Continuing to support platforms that are at the wilder end of the spectrum will only make things worse. Raising the capital is just one step. Being able to deliver the plan and make a profit is far more important but this so often appears to have been forgotten. Overtrading, the flaw that so many companies that have failed to date have fallen foul of, is a foreseeable problem - a problem currently being inflated by the platforms.

So, businesses that were running along quite nicely and could have continued to do so, suddenly grow massive, raise the money and go bust. Start ups with no real plan for making a profit are instantly born and go the same way. Meanwhile, there are some unscrupulous individuals who have openly abused the system, raising money, taking salaries and then going bust.

From the Public’s Perspective

Equity crowdfunding was launched in the UK with extravagant claims about Dragon’s Den and becoming an armchair investor in the next big thing.

It’s a simple and, on the face of it, a great idea  - lots of small bits going into making up a substantial degree of help for SMEs. However, there was generally little to no expertise within these initial platforms to judge how the funded companies might be sustainable. Exits and ROI were predicted after 3 years as a norm. All of this was thinly veiled by caveat emptor warnings and gave platforms free license to promise the earth.

The public loved it. The then-coalition government loved it. It was a hands off, unregulated lifeline for British SMEs at a time when the Banks had shut up shop.

The problem with the current system is that the public are not being given a fair chance. Information manipulation is seemingly commonplace and the UK’s accounting rules for SMEs were never set up to cope with equity crowdfunding. Caveat emptor only works if there is information symmetry.

The public need some protection from less scrupulous platforms and founders.

What it Might Look Like

Platforms would be obliged to take more responsibility for their pitches.  The bar set by regulatory bodies for them to be set up would be raised to a level where platforms would need to demonstrate business acumen and relevant investment-industry experience in their team. A special equity crowdfunding licence would be issued and reviewed annually. They would have to commit to a time period, post investment, where they were actively engaged with the funded companies – this might be linked to the size of the raise, for example.

Companies using equity crowdfunding would be charged an upfront fee either by the platform or the FCA/HMRC, or both, some of which would go into a compensation fund. This fund would be used to cover creditors debts on a business failing. Some of it could be handed back to the company against the percentage they pay the platform if successful. Either way, this would mean that ECF would not be a free-for-all for anyone out there who thinks they have a business idea.

Platforms would have to produce lists of funded companies, active and closed, and keep this up to date. Misinformation would result in their licence being rescinded.

Accounts for companies launching equity crowdfunding campaigns would have to be filed at CH for the period O/S, no matter what the filing date, and HMRC would take a more active role in checking these. Company directors would be legally liable for this information. HMRC could charge a fee for this service.

Funded companies would be obliged, under law, to complete bi-annual shareholder reports, copies of which would be filed at CH but not open to non-shareholders. Fixed penalties for misfiling or non-compliance would be levied, both on the companies and platforms which facilitated their funding, for 5 years.

It would be made easier for ordinary shareholders to club together to take action against a company that raised equity funding and then abused its position.

The outcome of this set would be to create a more equitable offer. Companies would have to pay something up front, which would deter the more unscrupulous. Innocent creditors - who I’d argue are currently being hung out to dry by some of the platforms within the very system that is supposed to be helping them - would have some form of compensation. Platforms would have some skin in the game and could not just concentrate on commission. The more flippant platforms would have their licences removed or would have to seriously up their game. We would all end up with a funding channel that is genuinely sustainable and which helps our all-important SMEs grow.