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What is Crowdfunding?
Crowdfunding is an innovative and alternative way of raising funds for projects, products, or ventures by gathering small contributions from a large number of persons via online platforms, instead of seeking a single large investment from a traditional source, such as, a bank or venture capitalist, project owners and entrepreneurs turn to a diverse online community to collectively finance their ideas.
Essentially, crowdfunding allows start-up companies or growing businesses to finance their projects by accessing alternative funds, whilst indirectly and simultaneously serving as a marketing tool to attract potential customers.
Crowdfunding is not a new concept. Prior to the digital era, individuals used to come together as a community to fund a communal project via subscriptions, fundraising events, and even door-to-door fundraising. Nowadays, crowdfunding takes place online via a crowdfunding platform, which is a website that enables interaction between the project owners and the crowd (i.e. the public). The crowd will be in the position to review the presented projects and if interested, fund one or more of those projects.
It is noteworthy that there are several types of crowdfunding, and the differentiating factor is the manner in which the investor is remunerated for funding a project:
This is when individuals contribute money to support a project or business with the expectation of receiving in return a non-monetary reward or incentive. An example of a non-monetary reward may be exclusive content or branded merchandise.
This form of crowdfunding is also known as charitable crowdfunding, and unlike rewards-based crowdfunding, individuals contribute money to support a project or business without expecting any financial returns or rewards.
Through investment-based crowdfunding, individuals invest money in exchange for ownership shares in a business or project.
In this scenario, individuals lend money to project owners through online platforms, typically in exchange for interest payments over a specified period. Unlike investment-based crowdfunding, where backers receive ownership shares, and donation-based crowdfunding, where backers make contributions without financial returns, lending-based crowdfunding involves providing loans that are expected to be repaid with interest.
The latter two types of crowdfunding are regulated under the European Crowdfunding Service Provider Regulation (Regulation (EU) 2020/1503 of the European Parliament and of the Council of 7 October 2020 on European Crowdfunding service providers for business, and amending Regulation (EU) 2017/1129 and Directive (EU) 2019/1937) (the “ECSPR”). Therefore, in accordance to the ECSPR, a service provider requires a licence authorised by the Malta Financial Services Authority in order to provide Investment-Based Crowdfunding and/or Lending-Based Crowdfunding services.
Crowdfunding Services in Malta
In recent years, the landscape of fundraising and investment has undergone a remarkable transformation, thanks to the rise of crowdfunding. Crowdfunding has emerged as a powerful tool for entrepreneurs, startups, and creative individuals to access much-needed capital while also engaging with a wider community of supporters. Malta has embraced this trend, harnessing the potential of crowdfunding to fuel innovation and entrepreneurial endeavours.
The financial sector has undoubtedly experienced a rise in crowdfunding services. Nonetheless, despite its popularity, this alternative method of raising capital, or venture, or cause by gathering small amounts of money from a large number of individuals remained unregulated throughout the European Union (“EU”) until 2021.
Due to the lack of harmonised regulation, the EU was triggered to implement a uniform legislative framework for the provision of investment-based and lending-based crowdfunding services related to business financing, as well as for ensuring the protection of investors, which can be summarised in the European Crowdfunding Service Provider Regulation (Regulation (EU) 2020/1503 of the European Parliament and of the Council of 7 October 2020 on European Crowdfunding service providers for business, and amending Regulation (EU) 2017/1129 and Directive (EU) 2019/1937) (hereinafter referred to as “ECSP Regulation”, “ECSPR”, and the “Regulation”). Thus, eliminating one of the biggest hurdles faced by crowdfunding platforms – offering their services across borders.
The Regulation thus allows platforms to apply for an EU Passport based on a single set of rules, which facilitates offering services across the EU with a single authorisation. On the opposite end of the spectrum, investors on crowdfunding platforms, will benefit from an aligned and enhanced investor protection framework, based on:
- clear rules on information disclosures for project owners and crowdfunding platforms;
- rules on governance and risk management for crowdfunding platforms; and
- strong and harmonised supervisory powers for national authorities overseeing the functioning of crowdfunding platforms.
On the 14th July 2023, the Crowdfunding Service Providers Act (Act no. XXV of 2023) was enacted with the purpose of implementing the relevant provisions of ECSPR. Aimed to be read in conjunction with the ECSP Regulation (including any Implementing and Regulatory Technical Standards issued therefrom), the Malta Financial Services Authority had also published Rules back in 25th January 2022, entitled Crowdfunding Rules. The Crowdfunding Rules serve to provide further detail to the requirements laid down in the Regulation.
CSB Group assists clients intending to provide crowdfunding services and clients (mainly start-ups and small and medium-sized enterprise) intending to raise their finances through crowdfunding. Through the use of a web platform, otherwise known as a “crowdfunding platform”, project owners are able to promote their projects to the public and collect funds from a large number of contributors. The ECPR regulates the following types of crowdfunding:
- Lending-Based Crowdfunding;
- Investment-Based Crowdfunding;
If your goal is to enter the realm of crowdfunding services or to introduce an innovative and unconventional approach to funding your projects through a crowdfunding platform, we offer a comprehensive and adept range of services:
- Expert guidance on the structure, legal, and regulatory aspects of crowdfunding platforms.
- Assistance in obtaining a Crowdfunding Service Provider Licence, encompassing the entire licensing procedure.
- Thorough assessment and preparation of necessary documentation, including business plans, policies, procedures, and application forms.
- Ongoing communication and coordination with the competent Maltese authorities.
- Full support in the process of company incorporation.
- Consultation to ensure adherence to Anti-Money Laundering and Counter-Financing of Terrorism (“AML/CFT”) requirements, alongside the establishment of robust Know-Your-Client (“KYC”) protocols for both Lending-Based Crowdfunding and Investment-Based Crowdfunding.
- Support for the seamless cross-border facilitation of crowdfunding services across the EU.
With the implementation of the European Crowdfunding Service Providers Regulation ("ECSPR"), crowdfunding is experiencing growth across the European Union ("EU"). Crowdfunding offers an alternative financing avenue for start-ups and small to medium-sized enterprises. It encompasses diverse forms, including Investment-Based Crowdfunding and Lending-Based Crowdfunding, both of which fall within the ECSPR's regulatory framework.
The ECSPR defines Lending-Based crowdfunding as:
the matching of business funding interests of investors and project owners through the use of a crowdfunding platform and which consists of the facilitation of granting of loans.
Furthermore, the ECSPR outlines a loan as:
an agreement whereby an investor makes available to a project owner an agreed amount of money for an agreed period of time and whereby the project owner assumes an unconditional obligation to repay that amount to the investor, together with the accrued interest, in accordance with the instalment payment schedule
In essence, Lending-Based Crowdfunding operates much like conventional loans. The process initiates with a project owner presenting their funding requirement on the Crowdfunding Service Provider's (the "crowdfunding platform") online portal. The general public or crowd then evaluates the presented projects, deciding whether to provide funding.
Unlike Investment-Based Crowdfunding, Lending-Based Crowdfunding investors do not acquire transferable securities. Rather, they extend loans to project owners for the specified project. Project owners, in turn, commit to repaying the borrowed amount along with interest within an agreed time-frame. This parallels the conventional lending process, similar to bank loans. However, crowdfunding distributes the lending process among multiple investors, as opposed to a single source. The Crowdfunding Service Provider's role lies in facilitating the connection between investors and project owners, enabling the loan transaction to take place.
The advent of the European Crowdfunding Service Providers Regulation ("ECSPR") has ignited a surge in crowdfunding activity across the European Union ("EU"). Crowdfunding is emerging as an alternative avenue for financing start-ups and small to medium-sized enterprises, encompassing various models such as Investment-Based Crowdfunding and Lending-Based Crowdfunding, all governed by the ECSPR framework.
The ECSPR, defines Investment-Based Crowdfunding as:
the matching of business funding interests of investors and project owners through the use of a crowdfunding platform and which consists of the placing without a firm commitment basis of transferable securities and admitted instruments for crowdfunding purposes issued by project owners or a special purpose vehicle, and the reception and transmission of client orders in relation to those transferable securities and admitted instruments for crowdfunding purposes
Crowdfunding predominantly transpires on a Crowdfunding Service Provider's online platform (the "crowdfunding platform"), where project owners present their funding needs. Subsequently, the public or crowd evaluates the projects and determines their interest in investing or contributing.
Investment-Based Crowdfunding serves as a mechanism for project owners to secure funding by enabling investors to invest in the project, typically the company. In return, investors receive transferable securities and recognized instruments (such as company shares or bonds). This reciprocal arrangement boosts the incentive for investors to engage in project funding. Notably, this differs from other crowdfunding models where the funding party does not receive reciprocal benefits, as seen in Donation-Based Crowdfunding (which remains unregulated at present).
In the realm of Investment-Based Crowdfunding, investors, as stakeholders of the project or company, establish a deeper connection to their investment. As stakeholders, their partial ownership translates to potential profits in the event of project success or potential losses in case of failure. Nevertheless, the ECSPR imposes comprehensive disclosure regulations on both project owners and Crowdfunding Service Providers, ensuring that investors are well-informed before making investment decisions.
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