In April 2015 the Isle of Man began to explore a potential regulatory regime for crowdfunding with the objective of diversifying the Island's economy and bringing further inward investment to the Island by attracting crowdfunding businesses to establish operations here. After a period of consultation with industry and the general public, on 1 May 2016 a new legislative regime to regulate crowdfunding activities came into force.
What is crowdfunding?
Crowdfunding is the process by which individuals or businesses seek to raise money from a variety of sources other than traditional funding sources such as high street banks and building societies. Most often, those who are seeking investment through the medium of crowdfunding will want to reach a very wide audience including the general public and institutional investors, who are the "crowd" from whom investment is sought. In general, the person seeking funds for a particular project is referred to as the "investee" and the person putting their money into the project is referred to as the "investor".
The most common method which investees use to attract crowdfunding is to register on a website or online portal called a crowdfunding platform. Once registered, the investee's business model or project is available for all the users of the website or portal to view and to decide whether or not they wish to invest any of their funds.
A good example of a successful crowdfunding operation is Lovespace, a storage company which collects customers' items and stores them in warehouses for a set fee per box. In 2014 the company set itself a crowdfunding target of £600,000 but eventually raised over £1.6m on a crowdfunding platform called Crowdcube.
There are four principal types of crowdfunding: (1) donations; (2) rewards; (3) loans; and (4) equity. Donations and rewards fall outside the scope of this article as they are generally not subject to regulation and are not regulated in the Isle of Man.
In the case of loan-based crowdfunding (also known as 'peer-to-peer lending'), investors lend money to investees with the expectation of receiving interest payments on the loan and eventually obtaining full redemption of the capital amount. In the case of equity-based crowdfunding, investors generally subscribe for shares in a company established by the investee, or they subscribe for debt securities such as loan notes, in the hope that the company's share price will increase and thus give them a return either by way of dividend, or capital gain on subsequent sale of the shares or loan note, or both.
In the Isle of Man, there is some degree of overlap between loan-based crowdfunding and the Moneylenders Act 1991. In summary, companies which lend money to individuals are required to register with the Office of Fair Trading ("OFT"). Lending money without prior registration with the OFT is an offence. The registration requirement does not apply to companies which lend to other companies rather than individuals. Both loan-based crowdfunding and equity-based crowdfunding will be regulated on the Isle of Man under the new regime.
What is the Isle of Man's position on crowdfunding?
In its early consultation on crowdfunding, the Isle of Man Financial Services Authority (the "FSA") recognised that due to the difficult economic conditions experienced in recent years and a general downturn in the appetite of institutional lenders to make funds available to fledgling businesses, people have increasingly been turning to alternative sources of finance, of which crowdfunding is one of the most popular. Part of the FSA's rationale for its consultation programme and the subsequent introduction of the new legislation on 1 May 2016 was to support the development of the Island's economy whilst at the same time securing an appropriate degree of protection for customers of persons who carry out regulated activities.
The new legislation regulates the activities of:
- operating an electronic crowdfunding platform for loan-based crowdfunding;
- administering crowdfunded lending, including the transfer of repayment funds from borrower to lender and debt collection in relation thereto; and
- operating an electronic crowdfunding platform for equity-based crowdfunding.
These activities are contained in a new classification of regulated activity in the Regulated Activities Order 2001 (as amended), known as 'Class 6'. By comparison, the UK has regulated equity-based crowdfunding since 2001, but only introduced a regulatory regime for loan-based crowdfunding during 2014.
One of the key drivers for the regulation of crowdfunding is the fact that there is usually a high likelihood of investors losing a large part of their investment (or sometimes even all of it), given the fact that most crowdfunded businesses are small enterprises which are not yet well-established in their industry and therefore have a high risk of failure.
It is important to note that any crowdfunding platforms looking to offer advice to consumers as to the merits of a particular crowdfunding opportunity will need to obtain a separate 'Class 2' Financial Services Licence from the FSA.
In order to obtain a Class 6 licence, and in order to protect investors, crowdfunding platforms must have a paid-up share capital of at least £25,000 and must be able to demonstrate that they have tangible net resources of at least £50,000. In addition, the FSA will impose strict conditions upon Class 6 licenceholders, including a prohibition on providing recommendations or advice without a Class 2 licence; a requirement to display a prominent warning on the crowdfunding platform about the risks of crowdfunding, and a requirement to conduct due diligence checks upon borrowers and lenders and to have written terms of business with them.
The Isle of Man offers an attractive package for crowdfunding platforms to establish operations here. The Island has a world-class professional services industry which is regulated to an extremely high standard, and the Isle of Man Government has a pro-active and "can-do" attitude towards encouraging business to flourish, including assisting non-Isle of Man businesses to move to the Island. The Isle of Man has frequent air and ferry links to the UK and Ireland and benefits from attractive rates of personal and corporate taxation.
DQ's experienced regulatory team is happy to assist with all aspects of crowdfunding regulation including preparing and advising on licence applications, liaising with the FSA and providing general legal advice where required. For further information, please contact Adam Killip or Sinead O'Connor