Revolution in crowdfunding

Crowdfunding, i.e., funding by community, is a form of alternative funding that is most frequently used by start-ups and small and medium-sized enterprises. Given an increasing interest in this institution among entrepreneurs and investors, it was necessary to regulate that issue in the large market of the European Union. As a response, at the beginning of October 2020, the European Parliament adopted regulations on crowdfunding. They include the Regulation of the European Parliament and of the Council (EU) of 7 October 2020 on European crowdfunding service providers for business, and amending Regulation (EU) 2017/1129 and Directive (EU) 2019/1937 (Regulation). In addition, the European Parliament amended the MiFID II Directive, which excludes the application of the regulations of the Directive to crowdfunding service providers.

1. What is crowdfunding?

Crowdfunding is defined as a type of collecting and allocating capital for the development of the defined project in return for the defined benefits that involve a wide group of investors by use of telecommunications and IT technologies and subject to a smaller entrance barrier and better transaction conditions than those generally available in the market.^[1]

Crowdfunding usually involves 3 entities:

• A project owner that wants to acquire capital to carry out its project;
• Investors that finance the project;
• A crowdfunding service provider that acts as an intermediary between project owners and investors through a relevant Internet infrastructure.

Crowdfunding may have various forms; however, the Regulation only applies to crowdfunding based on loans and an investment crowdfunding model.

2. New limit of collections

The Regulation introduces a new limit of the total value of an offer which the Regulation will apply to. It is EUR 5,000,000 during 12 months. This is a significant change in comparison with the previous limit of EUR 1,000,000. Undoubtedly, this will let extend the catalogue of projects funded in such a way significantly and open new opportunities for investments where a large development contribution is necessary.

3. Business activity control

Crowdfunding services can only be provided by legal persons that have their registered office in the European Union and obtained a crowdfunding service provider authorisation. Such authorisations can be granted by competent authorities of a member state. Based on the new regulation, the activity can be carried out all over the European Union with an authorisation obtained in one member state. Further authorisations will not be necessary and member states will not be able to reduce the activity of entities that have already obtained the authorisation in another member state. In such a way, borders will be open for crowdfunding service providers, which will be able to expand their activity all over the European Union. Therefore, the market will be unified and is likely to form the largest crowdfunding market in the world.

4. Protection of investors

To ensure a relevant protection of investors, the EU legislator enforces the breakdown of investors into sophisticated and non-sophisticated based on the definition of a professional customer set out in Annex II to the Directive 2014/65/EU. As there are various categories of investors, various levels of investor protection measures applied by crowdfunding service providers were established. They focus on the special protection of non-sophisticated investors. Protective mechanisms set forth in the Regulation include, among others:

• Obligation of providing fair and clear information to customers;
• Entry knowledge test and simulation of the ability to bear loss for non-sophisticated investors;
• Pre-contractual reflection period of 4 calendar days from the submission of an offer to invest or an expression of interest by a prospective non-sophisticated investor;
• Key investment information sheet.

5. Key investment information sheet

Crowdfunding service providers must provide prospective investors will a key investment information sheet in the case of each crowdfunding offer. The Regulation provides for a detailed list of information that must be specified in the key investment information sheet, as well as requirements for the form of the sheet. Please, note that this is the project owner that is responsible for information specified in the key investment information sheet and the service provider must verify whether the information in the sheet is complete, accurate and clear before and after the submission of the information sheet to prospective investors. Such requirements are to improve the investors’ awareness of investments and protect them against the loss of funds they invest.

6. Bulletin board

A so-called bulletin board, as set out in the Regulation, is a precursor of a secondary market on which clients are allowed to advertise interest in buying and selling loans, transferable securities or admitted instruments for crowdfunding purposes that were originally offered on crowdfunding platforms, provided that the bulletin board is not used to bring together buying and selling interests by third parties in a way that results in a contract.

7. Summary

The long-awaited and necessary Regulation providing for the EU crowdfunding market must be assessed positively. This is not, however, the final “shape” of the Regulation because regulations must be elaborated in accordance with regulatory technical standards adopted by the European Commission in cooperation with the ESMA and EUNB.

The projected 12-month transitional period will enable member states to calmly implement the new regulations in their national legal orders. Entities that operated crowdfunding platforms on the basis of the existing regulations must adjust their activity to the new requirements within 24 months. In the meantime, they can provide their services without change.

The new broad regulations will let popularise crowdfunding as a manner for capital acquisition by start-ups and small and medium-sized enterprises. Facilitation procedures applicable to the acquisition of authorisations by crowdfunding service providers will let them provide their services in international markets. This can result in an increasing interest among the society, including in particular non-sophisticated investors, in investing savings not only within one’s own state. The EU legislator is prepared for that and therefore it has ensured relevant protection and verification of knowledge and awareness of decisions and investments made. Thus, the whole process will be performed as safely as possible.

Maciej Marzec