Investment Based Crowdfunding

In recent years, investment-based crowdfunding has emerged as a transformative force in the realm of finance, offering a novel solution for small and medium-sized enterprises (SMEs) seeking capital and retail investors seeking investment opportunities. This chapter provides an overview of investment-based crowdfunding, emphasizing its defining features as an internet platform-based debt and equity finance solution connecting SME issuers to a "crowd" of retail investors. Additionally, it underscores the typical risks and reflective regulatory adjustments and interventions required for this crowdfunding model to provide a new type of finance opportunity for SMEs and an investment opportunity for investors in a balanced and safe environment.

The progression of crowdfunding within a particular country appears to hinge on several factors, including conducive market conditions, an enabling and risk-proportionate regulatory environment, and a business culture that embraces technology and the internet. Moreover, the presence of an investment culture among individual investors, coupled with a consistent flow of investment prospects (particularly startups supported by accelerators and incubators entering the market), is paramount.

It also appears that regions characterized by low returns on traditional investments demonstrate greater promise for crowdfunding development, as it presents an alternative avenue with potentially higher returns. Nevertheless, this also introduces risks, as discussed in the ensuing chapter, especially for retail investors making decisions between crowdfunding ventures and more familiar or lower-risk investment options. These risks require adequate regulatory responses as discussed in chapter IV. More+

Investment-based crowdfunding has democratized access to investment opportunities, allowing entities that were previously unlikely to offer investments to the public to do so, and enabling them to reach a crowd of investors who may not have engaged in these types of investments before. However, along with its democratizing potential, investment-based crowdfunding also brings forth a range of risks, some of which are unique to this form of financing.

The evolving regulatory framework surrounding investment-based crowdfunding reflects efforts by regulatory authorities to strike a delicate balance between promoting innovation and safeguarding investor interests. By implementing targeted measures to address specific risks across multiple dimensions, regulators endeavor to foster a resilient and sustainable crowdfunding ecosystem that facilitates capital formation while upholding market integrity and investor protection.

This has commonly been accomplished either by incorporating a dedicated crowdfunding exemption coupled with crowdfunding risks specific rules into the existing regulatory framework of capital markets (as seen in the approaches of the US and Australia) or by establishing bespoke standalone crowdfunding regulations (as witnessed in the European Union)¹.

Numerous countries have implemented or are in the process of implementing regulations specifically tailored to crowdfunding. For instance, the Brazilian Securities and Exchange Commission enacted Instruction 588² in 2017 to govern crowdfunding activities in Brazil. Other instances include Mexico's Financial Technology Institutions Law along with its accompanying regulations, Malaysia's Guidelines on Recognized Markets (pertaining to equity crowdfunding)³, the Dubai Financial Services Authority's (DFSA) Rulebook, Conduct of Business Module, Chapter 11⁴, Capital Markets Board of Turkey (CMB) Crowdfunding Communiqué⁵ and Indonesia Financial Services Authority’s (OJK) Regulation⁶ While investment-based crowdfunding is still nascent in Africa, several countries including Nigeria⁷ and Mozambique have been working on introducing or already introduced regulations.

In conclusion, investment-based crowdfunding represents a potentially promising avenue for SMEs to access much-needed financing especially in cases where retail investors’ investments are paired with investments from more sophisticated “anchor” investors. The potential of this market has led many regulators around the world to introduce rules supporting development of investment-based crowdfunding. However, alongside its potential benefits, investment-based crowdfunding also presents inherent risks for both investors and issuers. Investors face risks such as information asymmetry, lack of liquidity, and exposure to potentially high-risk ventures. On the other hand, issuers may encounter challenges related to regulatory compliance, investor protection, and reputational risk.

Regulatory responses to these risks vary globally but generally aim to strike a balance between facilitating crowdfunding and safeguarding investor interests. Measures such as disclosure requirements, regulation of crowdfunding platforms, and investor protection mechanisms have been implemented in many jurisdictions to mitigate these risks. More+