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Investment crowdfunding: 10 FAQs

Tuesday, November 4, 2014

How do equity crowdfunding and P2P lending differ?

Equity crowdfunding is a model of crowdfunding that enables an investor to take a share in the ownership structure of a business. It differs from the other main investment model, lending or P2P crowdfunding as that model entitles the investor to an interest rate on the loan and the right to call for repayment of the loan at the end of term. Equity crowdfunding does not involve an interest rate and the main liquidity event is typically a sale of the business by way of share sale. An equity investor technically could get dividend rights but for early stage companies this is unlikely in the short term and most investors will be holding out for a sale, joint venture or merger.

Why is it topical at the moment?

Many believe that equity investment opportunities should be more readily available to the average man or woman on the street and not merely high net worth investors or sophisticated investors. Recent legislative action in the US and the UK has caught the attention of the public and regulators here in Ireland and abroad.

Why choose equity crowdfunding?

From an investor perspective, the upside can potentially be a lot more than say a modest loan plus interest rate – as by holding equity in the company, the investor can participate in the sale of Company and realise a return on his / her investment. From the company perspective, it allows it scale its business with greater capital resources and without the burden of a repayment schedule to a lender.

What’s happening with investment crowdfunding in Ireland?

In Ireland, equity crowdfunding has yet to take off. While there are some legal complications that a platform and a fundraising company need to be aware of, with the right structuring it is technically possible. The lending model is working for businesses around the country with platforms such as Linked Finance, Grid Finance and Moneybush providing an alternative source to bank finance for businesses in the community. Investors are receiving regular repayments and businesses are sourcing capital to allow their business to grow.

What’s happening abroad?

London has been recently dubbed the crowdfunding capital of the World by Forbes magazine where major platforms such Crowdcube are facilitating equity crowdfunding investment of over £40 million to date and Funding Circle helping businesses raise over £400 million in crowdfunded loans. US based P2P platform, Lending Club recently filed for an IPO in the US where estimates on its valuation are expected to be $4 billion – $5 billion. It has helped fund $5 billion in loans to date. The passing of the JOBS Act in 2012 in the US was to herald the way for equity crowdfunding in the US. However the regulations to make equity crowdfunding possible for non-accredited investors have yet to be passed. Equity crowdfunding is taking place at an intra- State level currently as platforms and businesses await the passing of those regulations.

What does equity dilution mean?

It means a reduction in your percentage shareholding of the company. When additional shares are issued in a company, a shareholder who does not participate in that fundraising and does not receive shares in that investment round will see his / her shareholding percentage reduce.

Can an investor guard against dilution?

Yes. Typically an investor will look for a “pre-emption right”. This is the right to be offered the opportunity to participate in a share fundraising round based on your percentage shareholding. Not all equity crowdfunding models will afford an investor with this right. It will depend on the class of share an investor holds and the rights / restrictions attaching to those shares.

Does it matter what class of share is issued?

Absolutely. In addition to the pre-emption right mentioned above, the class of share an investor holds will determine how much is payable on those shares on a liquidity event and where his/ her share ranks in the order of priority for payments on a liquidly event.

Will an equity investor have any say over how the company is run or for example, when the company can be sold?

It depends on the rights afforded to the crowdfunding investor via his/ her shares, the Articles of Association and the Investment Agreement. Typically, equity crowdfunding investors accept the investment to be a passive investment where they will have no say and would have to abide by the decisions of the directors or the holders of a majority of the voting or preferred shares.

How do equity and P2P lending compare in terms of risk?

Every investment will involve a level of risk. Each investor must assess the potential return with the level of risk of financing a particular project through crowdfunding. The key difference between equity and debt crowdfunding is that with the equity model shareholders will be the last to be paid (if at all) if the company gets into financial difficulty. A lender is relying on regular interest payments and may even get security for the loan which it can enforce if the project company defaults on repayment. An equity investor is effectively holding out for a windfall on a sale of the business and/or dividend payments. There are also certain tax reliefs associated with equity investment (such as the EIIS in Ireland) that along with the potential to make a profit on a sale of the business make an equity investment an attractive for an investor.

For more information, please contact Eoghan Doyle