CROWDFUNDING and PLATFORMS: Legal Analysis & Considerations

I get very enthusiastic seeing that Crowdfunding started receiving popularity in Cyprus as well (as in other countries) and that this method of raising capital and/or money and/or funds and/or finance has become available for Entrepreneurs in my country. I strongly support all relevant initiatives in Cyprus (this mainly referring to 'Crowdfunding Cyprus' but to other initiatives as well) towards raising awareness around Crowdfunding as an alternative method of raising capital/finance (money in other words) especially by startups and/or newly formed ventures but also matured businesses.

This briefing's purpose is to deal in abstract with the legal challenges and/or the legal issues which arise in and/or the legal risks associated with the setting up and operation of a Crowdfunding platform. This will be seen from the perspectives of the national Law and the European Law mostly while, however, considerations will be given to the fact that, crowdfunding activities and actions/transactions on a platform needs to be seen as an international phenomenon which involves the need to be aware and/or use the laws and regulations and/or legal frameworks of most of the jurisdictions around the world.

The briefing is designed to be delivered in two parts; part one will serve as an introduction to the concept and phenomenon of Crowdfunding and the most usual forms by which it made and/or it makes its appearance in the market and the second part will deal with the Crowdfunding platform and the legal business models that they employ, as well as with the main players on such platform/s, each one’s role and targets and how these players can be better protected. The language used in this briefing is simple in order to be understood by entrepreneurs and/or individuals who do not have any law background. In other words, the purpose of this briefing is to make the 'parties' involved or wishing to be involved in a Crowdfunding transaction or those interested/contemplating to set up a Crowdfunding platform of any nature to understand to the maximum degree possible the legal risks associated with this practice and be advised from expert professionals accordingly and before they proceed. The author further hopes, that, this briefing will provide the reader with insights into the functioning of Crowdfunding Platforms (CFPs) from a legal point of view. References and bibliography for this briefing will be given at the end of the second part of the briefing.

So, let us proceed by posing the following questions which I have cited below on purpose and in a specific order and attempt to answer them one by one. In this way I believe it will be easier for you to follow.

1. What is Crowdfunding?

2. Which are the most usual forms by which Crowdfunding makes its appearance?

3. What is a Crowdfunding platform and which fundamental business models of         

   Crowdfunding platforms' exist out there?

4. Who are the 'main players' on a Crowdfunding platform and what is each one’s target?

5. What kind of legal protection they need; To which extent does such protection minimizes associate risks?

Obviously the word 'Crowdfunding' is composed by the words 'crowd' and 'funding'. The first component, the word 'crowd' obviously denotes the public at large, every single one of us, the people and it is used to refer to 'subject'. Therefore, the subject is the crowd. The word 'funding' is a 'verb' and denotes the action that the 'subject' engages to, i.e. the funding. So, the whole word means that the public at large, any one of us, the people, (either in groups -with legal personality or not- or individually engage in the action of funding. Crowdfunding, therefore, is a method, a way, a procedure, a legal mechanism by which the 'crowd' 'funds' and/or provides financial support for a variety of reasons. Crowdfunding could be defined as the practice and/or the method and/or the legal mechanism by which a project, a product, an idea, a service, a purpose, a charity, a venture (startup or even matured business/company) raise capital and/or finance (i.e. monetary contributions) through the collective effort of a larger group of people, from members of the public at large, from the crowd as we have said, who may act individually or in groups (with legal personality or not) and provide their funding typically via the internet by using or utilizing, suitable for their needs, Crowdfunding platforms (CFPs).

Therefore, it is very true to say, that Crowdfunding represents an alternative way of finance (alternative to the traditional channels existing so far, i.e. banks, other institutions and Venture Capitalists) as it can provide opportunities to raise capital/finance outside of the traditional channels. It could be argued that Crowdfunding may well substitute for traditional sources of financing.

Crowdfunding appears in a variety of forms and/or fundraising activities which, when looked at from a practical and legal point of view, in other words if seen from their legal side, these fundraising activities differ considerably among them.

Broadly speaking today there exist three (3) fundamental categories (more are in rise) of Crowdfunding activities and/or forms by which Crowdfunding makes its appearance:

-Investment based Crowdfunding activities

-Reward based Crowdfunding activities

-Donation based Crowdfunding activities

(The above categorization is very much depended on what is offered in return for the funds in each of the categories.)

Let us see each category separately:

1. Investment based Crowdfunding activities present the characteristic of 'investing' and/or that of providing funding with the purpose of investing and/or of making an investment. In other words, an investment activity is an activity which involves the use of a mechanism for the purpose of generating or producing future income and/or profit.

Investment based Crowdfunding activities can be further subdivided to:

1.1. Equity based Crowdfunding activities. (A crowd member and/or an Investor and/or a Funder engaging in equity based activities, provides a certain amount of funding and or finance and/or capital (money in other words) for a specific purpose and/or to a specific venture and receives in return an equity in that venture i.e. a number of shares and/or other forms of securities available by that particular venture, in that particular venture and usually becomes a minor shareholder (usually holding a small equity stake) of that venture. Its status (that of an equity holder and/or securities' holder and/or of a shareholder) gives her/him the legal right to expect returns and/or income and/or profit at some future time.) 

1.2. Royalty based Crowdfunding activities. This is the newest type of model, where funders invest in campaigns, to receive a share of possible, future revenue streams (Massolution 2013). Massolution (2013) describes it as: “Crowdfunders invest in campaign owners and receive a share of revenue earned in return for their investment”.

1.3. Lending based Crowdfunding activities. Credit-based crowdfunding, peer-to-peer lending or crowd-lending makes it possible for people to lend each other money, often at rated better than banks offer (De Buysere 2012). Credit-based crowdfunding is much like microloans, where funders offer the founders loans in exchange for a return on their investments (Mollick 2014). This is the crowdfunding model with the highest probability of successful funding (Massolution 2013). FundedByMe (2014c) defines it as; “Funding a company by offering yearly interest in exchange for a loan to many lenders. Loan crowdfunding lenders are entitled to a yearly interest and, depending on the company and the terms they offer, may also be entitled share of the company’s profit”.

Funding in any of the abovementioned investment based Crowdfunding activities makes the Funder an Investor in the selected campaing ( by 'campaign' ....) and affords her/him the status of Investor together with the legal right to expect (the legal right to expect not to be confused with the possibility and or risk of investing wrongly and/or based on a wrong decision) a return and/or a profit and/or an income out of this investment.

2. Reward based Crowdfunding activities.

This category of Crowdfunding activities involve a different kind of 'transaction' between the fundraisor and the funder. In this case the funders fund a campaign because they obtain a product. hey actually cannot expect to receive any other return because of their funding. They cannot expect any monetary compensation.

3. Donation based Crowdfunding activities

The basic characteristic of this category of Crowdfunding activities is that the funders fund a campaign because they support the particular cause of the campaign.

Very often we see Crowdfunding activities combining both the Reward and the Donation characteristics.

To be continued...

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