HM Insights

From free beer to The Fonz - why lawyers might need to follow the Crowd

Brewdog. East Fife FC. Happy Days the Musical. Barack Obama. That's not only the most unlikely list you're ever likely to read in a legal publication, it's also a small selection of the media-grabbing campaigns which show just how pervasive the influence of crowdfunding has become in recent years.

These examples of successful and potential crowdfunds are all exciting or quirky in their own way. But why should providers of professional services and business advisers, including corporate lawyers, pay any attention?

Well, when you add to that list high-tech companies, professional service providers and a whole host of other early-stage and high-growth companies satisfying their need for investment via crowdfunding, the burgeoning sector becomes more than just a headline.

The UK crowdfunding sector was estimated to be £200 million in 2012 with projected growth of £300 million for 2013. There are more than 40 UK crowdfunding platforms with the likes of CrowdCube reporting growth in the amount of money raised between 2012 and 2013 at 434%. In total they've raised more than £16 million for more than 83 businesses, including a record £1.9m for one alone.

A face in the crowd

I first became interested in crowdfunding a number of years ago, and have become more involved as it moved from being viewed as the latest fad of the digital age to becoming a viable alternative to traditional forms of fundraising.

Advising many early stage and high-growth businesses, it's fair to say that there is a huge frustration at the lack of funding, the cost of funding and the speed of funding. So crowdfunding could yet become one of the most important developments in finance in a generation.

In the second half of 2013 I addressed almost 1000 people on crowdfunding at events across the country. From this it is clear that there is phenomenal interest as well a broad spectrum of knowledge about it - from those of understand and embrace crowdfunding to those who are either unaware or think it is of little significance.

Whether you can derive fees from crowdfunding at this stage is one thing, but anything which successfully enables more businesses to exist has to be good in the long term, including for professionals such as ourselves.

What is it?

Put simply, crowdfunding is a way for businesses or organisations to secure vital investment by appealing to a large group of people for small contributions that, when added together, provide the money for a project or business venture.

The principles behind it aren't new, however the spread of internet access and social technologies have led to explosive growth in recent years - particularly for new businesses that may not require huge sums to get up and running.

There are four main types of crowdfunding: donation - where the 'crowd' contributes funds for nothing in return; reward – in return for a contribution, a funder redeems a 'reward'; equity – in return for an investment, the investor is offered shares in the company; peer to peer – a loan that is brokered between a borrower and a 'crowd' of lenders.

Equity crowdfunding and P2P are the most serious forms from a business perspective, though some crowdfunding campaigns offer a hybrid, for example adding a reward element to an equity crowdfund in the way Brewdog offer lifetime discounts as well as shares to investors.

Where do lawyers come in?

Any business considering crowdfunding really needs to do its homework. There are a plethora of crowdfunding platforms operating different models and it is vital that a company chooses the form of crowdfunding and platform which suits their business needs.

Equity crowdfunding in particular should be treated as any other form of investment so a business has to be investor ready, and its future plans must be considered at the earliest stage. It is essential that nothing is done which prohibits a business moving forward, such as hampering its ability to raise a further round of equity or giving away too much in terms of rewards at an early stage.

Within this context, there is a wide range of assistance that a lawyer or business adviser with a particular expertise in crowdfunding can offer.

From a legal perspective, one of the main issues to consider at an early stage is as regards whether the "crowd" have the right to vote and how this could impact on a business going forward. In addition, another concern is the protection of intellectual property (IP). Revealing an idea to the world before the IP has been protected means you can no longer gain a patent for your invention, an error which has already cost several crowdfunders dear.

There are many other potential risks that a business might not consider, such as having restrictive covenants in place for employees. Carrying out some basic diligence could be priceless in the long run.

Regulation, regulation, regulation

Currently, in the UK, equity crowdfunding platforms are subject to many complex regulations on areas such as financial promotion rules and regulated activities

Many UK platforms, and particularly the peer to peer platforms, were keen to see some more regulations and in October 2013 the Financial Conduct Authority (FCA) published a consultation paper on the industry.

In some ways the FCA has effectively blessed the utilisation of crowdfunding for retail customers in the UK in a controlled environment.

The objective of the FCA was to protect investors who lack the knowledge, experience and resources to cope with potentially significant losses when investing through crowdfunding platform. As such, it distinguishes between loan-based crowdfunding and investment-based crowdfunding with the former being seen as lower risk thus meaning a slightly lighter touch approach was adopted.

Many established UK crowdfunding platforms already follow a lot of the practices set out by the FCA however there are some areas, such as more clarity on risk, where the majority will need to improve the way they operate.

The consultation closed on 19 December 2013 so the exact shape of the new rules remains to be seen. In this regard, 2014 will be an important year for the future shape of crowdfunding in the UK.

Conclusion

As a sucker for an interesting investment, I've been part of the crowd on opportunities ranging from chocolate to high-tech companies. If you lack the spare capital to be a business angel you can still build up an exciting portfolio of investments for not too much money.

Whether you invest in them or not, the ideal early-stage client is one that you can grow with and share in its success, right through to a successful exit. Crowdfunding is set to play a greater part in this journey in the coming years.

Throw in free beer, and what's not to get excited about?