Legal Challenges Related To Crowdfunding: Volume 2

Editor's Note: This is a guest post by Antti Hemmilä, a Specialist Partner at Attorneys at law Borenius Ltd.

While crowdfunding is not a new concept, it is getting a lot of media attention nowadays. Crowdfunding is evolving and new crowdfunding platforms provide an excellent tool for financing different projects, whether these are art projects, game or hardware/device development or even equity financing. Yet the use of these new platforms and practices needs to comply with the existing regulations, which sometimes causes conflict. The first guest blog published on 23 October 2012 featured legal issues related to using donation/rewards-based crowdfunding platforms, and this second blog addresses equity funding and the use of equity crowdfunding platforms.

Friends, Family … the Crowd?

Instead of VC or angel money, many startups are considering crowdfunding as a source of equity financing. We are also seeing an increasing number of equity crowdfunding platforms that help companies administer the process. It surely comes as no surprise to anyone, but the offer of shares is heavily regulated in just about every developed country in the world. Before organising a financing round, with or without using the crowdfunding platforms available, here is the least you need to know about the legal issues involved. Luckily, because of EU and EEA (European Economic Area) level regulation, the rules are surprisingly similar in all of Europe.

Navigating the Prospectus Rules

As a main rule, any offer of securities (meaning, among other things, shares in your company) requires that the issuer company publishes a prospectus, unless an applicable exemption exists. Prospectus is an information document that provides details about the shares and the issuer of the shares. In Europe, prospectuses are either EU prospectuses (regulated under the EU Prospects Directive and related rules) or national prospectuses (regulated under national rules).

Under EU rules, no EU/EEA country can require a prospectus to be prepared for rounds of less than 100,000 euros, and for rounds of 5 million euros or more, an EU prospectus is required (the euro amounts described herein are however calculated taking rounds for the previous 12 months into account). This means that in general rounds of less than 100,000 euros are good to go without a prospectus in all EU/EEA countries. As for rounds between 100,000 and 5 million euros, national prospectus rules need to be investigated. In Finland a prospectus under the national prospectus rules needs to be prepared when the size of the round is 1.5 million or more. In Sweden the limit is EUR 2.5 million, in both Norway and Denmark 1 million and in Estonia, Latvia and Lithuania 100,000 euros. It is important to remember that the company offering its shares must comply not only with the regulations of its home country, but also with the country or countries where the shares are being offered to the public.

In addition to the euro limits described above, there are other exemptions from the prospectus requirements. Most commonly used are the “private placement” exemptions, which allow offering of shares to qualified (or professional) investors or to less than 150 non-qualified investors per EU/EEA member country without a prospectus. However, for example in the UK financial promotions rules may lead to offering the shares to professional investors only.

Information Requirements Often Overlooked

Even though a prospectus exemption applies, a company launching a financing round must comply with the applicable information requirements. Under the Finnish Securities Markets Act, a company must make available sufficient information on matters that are relevant for evaluating the value of the shares, and there is general prohibition on misleading marketing of issue. Similar provisions are also included in other national securities laws. While there are no exceptions to the information requirements, the scope of the information requirements is usually dependent on the target group of the round. For example in crowdfunding rounds the amount of information required to be disclosed is higher than in closed investors only rounds.

While information requirements are often overlooked, they are occasionally enforced. For example in October 2012 the Finnish regulator (FIN-FSA) ordered a Finnish wind power startup to cease marketing of its share issue due to lack of sufficient information. Taking a quick look at the active companies in the various crowdfunding European platforms, it is fair to say that information available on these companies varies greatly and it is mostly marketing-oriented.

Role of Crowdfunding Platforms and Further Considerations

From the legal perspective, equity crowdfunding is nothing new but it needs to fit into the existing legal framework. So far, crowdfunding has not caught much attention from the authorities. But when crowdfunding and crowdfunding platforms gain more attention, regulator attention is inevitable.

For example, the current interpretation is that the crowdfunding platforms do not perform investment services as defined in MiFid (Markets in Financial Instruments Directive) and they are thus free from being licensed and supervised by the local authorities. However, applicability of MiFid is eventually dependent on the role and scope of the services being offered by the crowdfunding platform, and amended MiFid rules (MIFID2/MIFIR, proposal available next year) seem to extend the applicability of MiFid to entities “operating an organised trading facility”. Should the new MiFid rules regulate the crowdfunding platforms, it would most likely kill most of the current players, or drive their operations to EU safe havens (where interpretation of the local regulator allows operations without a licence) or outside Europe. To avoid the grey area, at least one European crowdfunding platform, Seedrs from the UK, has taken a different approach and already applied for an investment company status, and it is thus regulated by UK-FSA.

In any financing round, the company should investigate the applicability of the relevant securities markets (and other) rules applicable to the transactions. When considering a crowdfunding campaign and accepting potentially dozens or even hundreds of new shareholders, the company should also carefully consider other practical matters. How do you manage shareholders’ meetings and voting with a very large amount of shareholders? How do you keep track of shareholdings and transfer of shares? Most importantly, in the case of a new financing round or trade sale of the company, how do you get all shareholders to execute the necessary documents required for the transactions? Many companies want to maintain investment or trade sale readiness, and a shareholders’ agreement or another agreement can solve many of the governance issues involved. Crowdfunding platforms can also provide tools for communicating with the shareholders. It goes without saying that a large shareholder base is also an asset, as shareholders gladly promote the products and services of the company they partially own.

Well executed, equity crowdfunding has the potential to be the missing link between early seed and VC money, making European startups more competitive with the US counterparts. For individual investors it provides an interesting new asset class in a market where the everlasting financial crisis may make stock market investing less attractive. As for the regulatory framework, the regulator guidance and new legislation should nurture, not kill, the crowdfunding revolution.

Antti Hemmilä

Disclaimer. There is massive amount of securities markets legislation and it is changing constantly. Thus the article discusses equity funding at very general level and cannot be deemed as legal advice in any particular case.

About the Author

Antti advises on venture capital, M&A, capital markets and general corporate law related questions. He has wide-ranging experience in advising small and medium-sized companies on numerous M&A and financing arrangements, representing both companies and finance providers. Antti has also worked on numerous capital markets transactions.

Antti Hemmilä on LinkedIn.

About Borenius

Attorneys at law Borenius Ltd is one of the leading law firms in Finland offering a full spectrum of commercial law services. Attorneys at law Borenius’ mission is to be the most hands-on, client-centred business solution provider. The firm’s approach to business challenges is team-oriented, combining its strong and diverse expertise with a thorough business understanding.

Attorneys at law Borenius Ltd is part of the Borenius Group network which consists of approximately 200 lawyers in four jurisdictions in Fenno-Baltic area as well as in New York. The member firms of Borenius Group are independent and separate legal entities practicing advocacy for their own account and following their respective local Bar rules.

Top image cc licensed by James Cridland on Flickr.

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