Settlement agreements and crowd funding

Settlement agreements are often reached over disputes between investors and owner managers. Such disputes seem likely to appear increasingly in the field of crowd funding.

Crowdfunding was something of a hot topic in 2013 and looks set to continue to spark debate in 2014. It is an attractively simple concept – a means of funding a business or project by raising capital by appealing to a large group of people for relatively small individual contributions. In recent years, bank lending to business generally has slowed; small and medium sized enterprises (SMEs) and start up ventures in particular, have struggled for support. At the same time, savers have seen poor returns on traditional investment accounts. Against this background, the exponential growth of social media has provided the lubricant for a new model; access to the internet has made it easier for entrepreneurs to reach a wider public. Economic conditions and technological advances have conspired to make crowdfunding an idea whose time has come.

The increasing popularity of the crowdfunding model, (in the UK estimated to be worth £360 million in 2013), raises issues for business, would be investors and the regulators. As more small scale investors appear keen to get involved, the trick, for regulators, will be to protect their interests without stifling the whole process.

Following a recent consultation by the Financial Conduct Authority (FCA) on its approach to crowdfunding, we look at what rules currently apply and what tighter regulations are expected during the course of 2014.

Crowdfunding – how does it work?

A business or other organisation seeking funding or sponsorship may access the public via a website (the platform), featuring a range of projects for which contributions are invited. In turn, this platform takes a fee, typically in the form of a percentage of the money collected from investors. There are four main models for crowdfunding:-


  • Donation based: individuals give money to an enterprise whose activities they want to support. This was the original blue print for crowdfunding and is usually some kind of charitable or artistic project. There is no loan or credit issue and no participation in future profits, the only “return” for the donor is the satisfaction of being involved in the project.

  • Pre payment or reward based: individuals give money to an enterprise in order to receive a reward in the form of a service or product. For example, in April 2012 Eric Migicovsky's company, Pebble Technology, launched a Kickstarter campaign seeking to raise $100,000 to fund the development of a new kind of watch, the “Pebble”, which would display messages from a smart phone. Individuals who donated $115 would receive a Pebble watch when these became available. This represented a significant discount and the target sum was raised within 2 hours of the campaign going live. When funding closed, more than $10 million dollars had been pledged.

  • Loan based: individuals lend money to individuals or businesses in the hope of a financial return in the form of interest payments and a repayment of capital over time.

  • Investment based: individuals invest directly or indirectly in start up or established businesses by buying shares or debt securities or units in an unregulated collective investment scheme.

Not all crowdfunding activity falls within the scope of the regulators; of the models described, only investment and loan based crowdfunding raise particular legal issues. In an economic environment in which funding for new businesses has been difficult, alternative ways of accessing investors are likely to be of interest. Investing in SMEs can offer tax advantages for individuals. As a result both investment crowdfunding and loan or “peer to peer” lending has seen an increase which in turn has attracted the attention of the FCA. In practice, the regulator must balance measures designed to stimulate business activity with adequate investor protection. Investment based crowdfunding is already regulated by the FCA (with new rules proposed) and from 1 April 2014 loan based crowdfunding will also be regulated.

Issues for potential investors

The issue from an investor’s view point is that risk is properly understood. There is concern that individuals who don’t fully understand the process will be attracted by invitations on the web platform offering unrealistic rates of return and not appreciate the risks which include:


  • Possible conflict of interest

  • Fraud and money laundering

  • Platform failure and poor administration

  • Loans never repaid

  • No Financial Services Compensation Scheme

  • 50%-70% start up businesses fail completely

  • Unauthorised advice

  • No dividends, possible dilution of equity, no exit

The dragon’s den scenario has many traps for the novice investor and the recent FCA consultation proposed changes in the rules for investment based crowd funding and regulation, for the first time, for peer to peer lending.

Regulatory implications for business and crowdfunding platforms

Different rules apply to loan based and investment based crowd funding. At present, the former is not regulated by the FCA but this will change on 1 April 2014 when the FCA assumes responsibility for consumer credit regulations from the Office of Fair Trading and loan based crowdfunding will be subject to similar rules as other investments. Although a “lighter touch“ regulation than that in place for investment based crowdfunding, there will be a new regulated activity “operating an electronic system in relation to lending” and specific requirements for clarity of information, minimum capital provisions, rules to protect client money, a mechanism for dispute resolution and other conduct of business rules. Any business currently operating a lending based crowdfunding platform will need to implement significant changes.

Investment based crowdfunding already falls within the scope of existing regulations but tougher rules have been proposed. At present, investment based crowdfunding is subject to existing regulations under the Financial Services and Markets Act 2000 (FSMA) which, among other things, makes it an offence to carry on a regulated activity without being authorised by the FCA and prohibits offers to the public and any kind of financial promotion. Authorisation can be expensive, onerous and time consuming and although various exemptions to the offers to the public and financial promotions rules may apply, the regulatory framework is a maze. The consequences of getting things wrong are serious; contravention of the relevant sections of the FSMA is a criminal offence and any agreement made by an unauthorised person is unenforceable, so any investor could potentially ask for his money back and compensation. The thrust of the FCA proposals are that investment based crowdfunding platforms should focus on self certified sophisticated investors, certified high net worth individuals and a restricted category of clients who have effectively acknowledged they are aware of the investment risks.


Most commentators believe crowdfunding is a positive development with real potential for businesses. There is clearly a balancing act for the regulators in ensuring adequate protection for investors but avoiding strangling the process with red tape and a policy statement is expected from the FCA in the next few months.

Hopefully this will reduce the amount of disputes but all disputes of this nature can be settled by way of some form of settlement agreement.

For further information, please contact our specialist team. digg stumbleupon buzzup BlinkList mixx myspace linkedin facebook google yahoo