In the years following the 2008 financial crisis, a number of alternative means of financing have been sought after contrary to the traditional modes of financing as would be Bank Lending. One of these alternative means of financing is investment-based crowdfunding, which was promoted as one of a number of solutions to mitigate the SME financing problem, especially at the start-up stage of a business. The MFSA looked to access this niche of financing through regulation of the sector, hence offering another option on the market for businesses looking to obtain the financing necessary to be able to proceed with their intended enterprises.
On 3rd November 2016, the MFSA released a Discussion Paper on investment-based crowdfunding and has today released a feedback statement on the submissions received by the 15th March 2017 deadline. Investment-based crowdfunding, is more popularly known abroad as equity crowdfunding whereby businesses raise the finance they require by placing a project idea on an internet-based platform, and individuals have the option of investing in that idea, with the return on investment being the acquisition of equity in that business proportionate to the amount invested initially. The investor, which many times would not be classified as a professional investor, would then partake in the profits of the business venture should it be successful.
Type of Investment Service
Investment-based crowdfunding platforms most commonly operate on a reception and transmission of orders basis, this being carried out on behalf of investors. However, these are not the only activities such platform might carry out. In circumstances where the activity involves controlling clients’ money, the industry is desirous of obtaining the Authority’s feedback as to whether a regulatory burden (such as reaching the capital requirements under MiFID) would be imposed.
Holding or Controlling Clients Funds
The MFSA’s reaction to the proposals made by the industry regarding the holding or controlling client’s funds showed a cautious approach with regards to imposing a lot of obligations on the platform but suggested that the platform should act as an intermediary between the investors and the issuer directly. The license suggested for a platform operator would at a minimum be a Category 2 Investment Services Licence, whereby there would be a significant capital requirement to mitigate the risk undertaken by the platform when holding and controlling client money, from when the investor makes a pledge and when the money is either transferred to the issuer or returned to the investor depending on whether the targeted amount was reached.
Investment-based crowdfunding should be available to both public and private companies, and whilst the latter are limited to fifty shareholders, the former are not. The fifty shareholder limit resonated negatively throughout the industry as several suggestions to increase this number were made. It was suggested that a new type of limited liability company should be set up, or alternatively that one can make use of a nominee.
The Authority took a holistic approach in this respect and claimed that investment-based crowdfunding can provide private companies with a springboard to other sources of funding than the traditional means. Therefore once the Issuer has progressed in its business owing to crowdfunding, it is likely that the issuer will be in a position to attract and access other sources of finance, which in turn will provide for more than fifty shareholders.
Caps on Investable Amounts per Investor + per Project
The initial safeguards applicable to investment service providers include a cap on both the maximum investable amount per individual investor and the maximum project size. The Authority looked positively to the industry’s suggestions of capping a number of projects an individual may invest in during one calendar year as well as a cap on the percentage investment per individual dependent on the investor’s income. Thus following such considerations as well as projects of the same nature in Europe, the Authority is looking to consider the following measures:
a) an investor cannot invest more than €5,000 over a period of 12 months in one issuer listed on an investment-based crowdfunding platform;
b) of an offer of securities made on an investment-based crowdfunding platform cannot exceed the value of € 5,000,000 over a period of 12 months;
c) an investor cannot invest more than 20% of his net annual income through an investment-based crowdfunding platform over a period of 12 months;
d) Measures a) and c) above shall not apply to professional clients under MiFID.
Location of the Issuer
The MFSA has considered that the current legal landscape in Europe is of the view: “issuers on investment-based crowdfunding platforms should not be restricted to Maltese Companies. Listing on Maltese investment-based crowdfunding platforms will initially be open to Maltese and EU registered”.
However, the Authority may consider whether third country registered issuers could also be allowed to list provided they are not incorporated in countries blacklisted by the Financial Action Task Force. Additionally the platform will need to apply certain reasonable due diligence measures on the project proposal and the project owners’ ability to deliver on the proposal.
The prospectus requirement and applicable exemptions under the Companies Act were set out in the Discussion Paper and it was duly noted that investment based crowdfunding platforms should be subject to specific disclosure requirements tailored to crowdfunding business. The industry was of the opinion that a summary information document was sufficient to enable the investor to understand the service to be provided by the platform, the identity of the issuer and the nature of the instrument being offered thereby ensuring the investor takes decisions on an informed basis. The objective is to provide investors with key information upon which to base their investment decisions. On the one hand there is the need to avoid replicating the onerous disclosure requirements applicable to non-exempt prospectuses under the Prospectus Directive by keeping disclosures down to a minimum whilst on the other hand, the information disclosed must be meaningful and sufficient enough to enable such decisions.
Full adherence to Prevention of Money Laundering and Funding of Terrorism Regulations must be ensured as Investment Services Licence Holders carry out “relevant financial business”. MFSA has also taken it upon itself to initiate discussions with the FIAU to streamline AML obligations for platform operators and third party payment services providers, whilst also considering issuing a Guidance Note on Fitness and Properness Standards applicable to Issuers listing on its platforms.
Investment-based crowdfunding targets investment on a small scale and hence the type of potential investors could be varied, ranging from professional investors to inexperienced investors and hence the Appropriateness Test issue was raised. MFSA did not object to license holders performing the appropriateness test online but refuted the suggestion that platforms will be able to rely on self-declarations by investors with regards to their knowledge and experience.
For further information, please do not hesitate to contact Beverly Tonna, legal associate at Nexia BT and the co-author of this article on 00356 7963 4084, or send her an email: email@example.com.