How the World Regulates Equity Crowdfunding

Equity crowdfunding is a new innovation in early-stage company financing. It allows start-ups and growing companies to effectively conduct “mini-IPOs,” offering shares to the members of the general public, under a reduced disclosure regime and in lieu of issuing a full prospectus—a document filed with the SEC that outlines a company’s financial health for potential investors. Different regulators in different countries have taken different approaches to equity crowdfunding, with varying effects on the development of each of their respective financial ecosystems. Some countries have taken very liberal approaches to equity crowdsourcing, while others are very protectionist. The more protectionist regulators have significantly stifled the development of their equity crowdfunding markets, while the more liberal regimes have ended up being more effective, through self-policing driven by competitive pressures originating from the platforms. Mirroring its leadership in the wider financial technology or “fintech” space, the U.K. has the world’s most developed equity crowdfunding industry. The Financial Conduct Authority (the U.K. counterpart to the U.S. Commodity Futures Trading Commission) has taken a fairly relaxed approach to equity crowdfunding oversight. But despite the U.K.’s light-touch regulations, equity crowdfunding platforms still strongly screen the companies that come through their doors. The platforms see it as in their own best interest to develop a reputation for quality, so as to build the trust of their investor base. These commercial realities, rather than heavy-handed regulation, have been the secret to the U.K.’s success. The progress of the U.K.’s market has also been bolstered by the highly attractive tax incentives offered through the Seed Enterprise Investment Scheme (SEIS) for seed-stage early stage companies and through the Enterprise Investment Scheme (EIS) for somewhat more mature start-ups. These investor tax breaks allow those contributing to an eligible crowdfunded company to offset their investment against their existing tax liability. In the United States, regulations were slower to change, coming into force only in 2016, with Title III equity crowdfunding (or “regulation crowdfunding”). U.S.-based companies can use equity crowdfunding portals to raise up to $1.07 million—an amount which rises annually, along with inflation—in any 12-month period. The relatively low amount of capital allowed under Title III crowdfunding restricts the use of equity crowdfunding to very early-stage companies. Notably, investment companies and special purpose vehicles are unable to take advantage of the U.S. Title III regime—in contrast to the U.K. approach. This means that Title III crowdfunding is exclusively for direct company investments—not for managed funds, such as those that would manage several companies within a single investment vehicle. Also available are alternatives to Title III crowdfunding, such as Reg A+ and Reg D offerings, both of which resemble more “light IPO” capital raising, rather than the reduced-disclosure offer documents that equity crowdfunding is best known for. Funding portals including WeFunder, StartEngine, and Republic have demonstrated early leadership in the U.S. Rewards crowdfunding site Indiegogo has also begun its own equity crowdfunding offering, becoming one of the few sites globally to offer rewards crowdfunding alongside equity. Meanwhile, Canada’s rules are more restrictive. Each of the different Canadian provinces has its own regulator, rather than a single one at the nationwide level. Having 13 sets of rules, rather than just one, has significantly impeded the growth of Canada’s equity crowdfunding market. For example, it is difficult (if not impossible) for a platform in British Columbia to accept a company registered in Ontario. Each of the Canadian provinces allow “accredited investors,” as well as family, friends, and close business associates to invest without needing a full prospectus to be produced. Unfortunately, the “Crowdfunding Exemption,” which came into effect in January 2016, has been a disappointment for the industry. It still imposes too much cost and disclosure burden to be a realistic option for the startups that it was supposed to help. Ostensibly, these rules are meant to protect investors, but the real effect has been to kill the industry altogether. New Zealand’s early-stage funding landscape has been significantly altered by the arrival of equity crowdfunding. Relative to the market’s comparatively small size, New Zealand equity crowdfunding has seen significant interest from investors, as well as attention from the press. Affluent individuals and venture capital funds are participating in equity crowdfunding as cornerstone investors. There is no cap on what ordinary investors are allowed to invest in New Zealand. The Financial Markets Authority—New Zealand’s securities regulator—has also elected not to enforce any particular requirements for equity crowdfunding companies to disclose any particular information, in contrast to the highly prescriptive U.S. and Canadian rules. Some were concerned that this relatively laissez-faire regulatory approach could result in a “wild west” of substandard platforms. The New Zealand equity crowdfunding scene, however, has proven to be very robust to these concerns. Australia was the last country of these five to make retail equity crowdfunding legal. Although the market only really kicked off in the latter part of 2018, equity crowdfunding sites have been making up for lost time by listing offers across many different sectors. The greatest complaint that Australian funding portals’ have about the regulations is that only public and proprietary limited companies are allowed to raise capital under the crowdfunding rules. This is in contrast to the more straightforward and less administration-heavy private company structure which startups and early stage ventures usually prefer. As a result, crowdfunding companies are needing to transfer to a less-than-desirable company structure in order to use equity crowdfunding in Australia. The case for equity crowdfunding is compelling, as it allows start-ups and growing companies to fill the “funding gap.” But for it to become a substantial force, the lessons from these five countries show that regulation needs to be supportive—to allow for funding portals, companies, and investors to meet. In particular, the evolution of the marketplaces in New Zealand and the United Kingdom demonstrates that the equity crowdfunding platforms create their own market best-practices, even in the absence of restrictive regulation. Other countries should take note as they look to review their own rules.

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