Have you come across the term “crowdfunding” but aren’t quite sure what it means? Or are you familiar with crowdfunding but interested in the new legislation being proposed at the European level? If so, this article is just for you.
Crowdfunding as an Alternative Form of Financing
Crowdfunding is an alternative way to finance your business. In practice, this method is used primarily by aspiring entrepreneurs who, while having a potential “business plan,” lack sufficient capital to finance it. As the name of this financing suggests, its target group is the crowd, meaning it is aimed at a relatively broad audience—the masses. The principle of crowdfunding involves collecting typically smaller financial contributions; however, on the other hand, these contributions are expected from a significantly larger number of investors, and the amount of the contribution is in no way limited. A contribution can range from a few euros to several tens of thousands. It cannot be said that crowdfunding is focused exclusively on certain types of projects; on the contrary, it can finance any project—from scientific research, through charitable campaigns, to private business activities.
Currently, crowdfunding enjoys considerable popularity, which we attribute mainly to the massive growth of the internet itself, as well as social media platforms, which are an ideal tool for promoting your projects and, at the same time, a great way to bring ideas to the attention of the general public. This is also evidenced by the ever-growing number of online platforms where potential investors can choose the project that appeals to them most and subsequently contribute to its activities.
The question remains, however, what leads a potential investor to put their money into such a startup. Generally, everything will depend on the nature of the project. In the case of charitable projects, the human side of the individual—the philanthropist who wants to contribute to a good cause without expecting anything in return—comes to the fore. In the case of financing private business activities, however, it will mostly involve some form of consideration, such as a share of the profits, a reward in the form of a specific product or service, participation in a presale, and various other options. It can be said that both the project’s goal itself and the way its creator chooses to reward investors will depend directly on the creator.
Like any form of business and investment, crowdfunding also carries a certain risk, and therefore one must always bear in mind that the success of a project is never guaranteed, and thus it may happen that, despite funding from a large number of investors, the project ends in failure.
Proposed Regulation of the European Parliament and of the Council
The proposed legislation in question is the Proposal for a Regulation of the European Parliament and of the Council on European Crowdfunding Service Providers (ECSP) for Business dated March 8, 2018.
Crowdfunding as such has been a subject of interest for the European Union for several years. One of the reasons is precisely the lack of, or insufficient, legal regulation at either the national or European level. This is also evidenced by the fact that the term “crowdfunding” is not defined anywhere in our legal system.
The explanatory memorandum to the aforementioned regulation indicates that crowdfunding may become an important source of non-bank financing in the future, precisely because of the increasingly frequent use of this method of financing start-up projects. This was also one of the reasons why the European Union began to take a closer interest in this issue and developed the proposed regulation in question. In the following paragraphs, we will attempt to clarify the objectives of this regulation and outline its content, with a focus on the new provisions introduced by this legislation.
The regulation is intended to establish a European designation for crowdfunding platforms that enables cross-border operations and appropriately addresses the associated risks. This regulation should facilitate the expansion of crowdfunding across the entire internal market, that is, the entire European Union market. It should be noted, however, that donation-based crowdfunding—such as the aforementioned charitable projects—is excluded from the scope of this regulation. Another objective of the regulation is to provide investors with the necessary information, including a warning about the risks associated with such investments. To support investors, the regulation will introduce various necessary safeguards to minimize risk, and compliance with these safeguards will be a requirement for all creators of crowdfunding projects. In practice, these safeguards should therefore strengthen the position of investors should they decide to use their funds to support a project.
The European Union also aims to establish specific rules regarding crowdfunding at the EU level. However, it should be noted that this regulation will not replace national rules in areas that are already covered by legislation. Under the proposal, a crowdfunding service provider may choose whether to provide or continue to provide services on a domestic basis in accordance with applicable national legislation, or to apply for authorization to provide crowdfunding services under the proposed regulation. In the case of authorization under EU rules, the authorization applies to the provision of services in a single Member State as well as on a cross-border basis.
As for the creators of crowdfunding projects, they must, under the regulation, meet organizational requirements at all times, and natural persons with the authority to manage such crowdfunding should possess appropriate skills and professional experience. However, the Regulation does not further specify what exactly is meant by these terms; therefore, we believe that this issue will be assessed on a case-by-case basis and will always depend on the specific project, its size, complexity, and other factors. It is certainly worth noting, however, that anyone interested in such a financing method will have to meet several requirements and simultaneously apply to the European Securities and Markets Authority (ESMA) for authorization to operate as a crowdfunding service provider. The application for authorization must include, for example, information on the registered office, legal status, articles of association, business plan, a description of systems and procedures, as well as the identities of the persons responsible for management. ESMA may play a key role in this area in the future, as in addition to granting authorizations, it will also establish a register of crowdfunding service providers, supervise such financing, and have the authority to revoke an authorization already granted. ESMA will also be authorized to impose sanctions in the event that a crowdfunding service provider fails to fulfill its obligations, neglects to fulfill them, or violates any of them.
The key requirements that this regulation establishes for all projects are transparency, clarity, easy access to information, and compliance with rules at both the national and international levels. This fact is also reflected in the objectives and new provisions described above that this legislation will contain.
In this article, we have sought to briefly outline the issue of crowdfunding, including in light of the planned legislation at the European level. Our goal was not to provide a comprehensive analysis of the entire legislation, but to offer readers a brief overview of the planned changes. If this topic has piqued your interest and you would like to learn more, our team of experts is always available and happy to answer any questions you may have—not only regarding crowdfunding.
