Blog posted by Mark Kenkre, partner and head of the investment fraud and mis-selling group at Legal Futures Associate Keller Lenkner UK
Crowdfunding can be an attractive prospect for investors looking for high returns but a recent case has highlighted the risks involved and the apparent lack of due diligence.
Investment crowdfunding is a popular method for small and growing businesses to raise capital from a large number of disparate investors via a single platform. Crowdfunding is a regulated activity and platforms and providers are required to hold specific permissions with the Financial Conduct Authority (FCA).
The Financial Services Ombudsman (FOS) recently made a decision which raises significant issues and concerns, however.
The ruling concerned an investment made through the crowdfunding platform Crowdcube through which the claimant invested £18,000 into Zing Zing – a start-up Chinese takeaway restaurant chain.
The case alleged that the business plan provided by the start-up via Crowdcube had failed to adequately explain its true intentions and that the reality was significantly different from the proposed growth strategy.
The business pitch placed on Crowdcube to attract funding stated: “Having grown from two sites to four since their last round on Crowdcube, [the company] is revolutionising the Chinese takeout industry through its takeaway only locations with rapid delivery and custom technology. Now raising funds for further expansion.”
The investor complained that the company did not use the funds raised through Crowdcube for the purported purposes and that the statement used on the crowdsourcing platform had led him to believe that the funds would be invested in multiple new restaurants.
This did not happen, and the business later went into administration.
Ombudsman Ben Waites found that Zing Zing’s investment pitch was “at best unclear and, at worst, misleading”, and upheld the complaint.
Mr Waites concluded that Crowdcube had failed to inform investors that Zing Zing’s plans to expand were “not substantiated with sufficient documentary evidence for it to conclude how plausible” they were.
This meant that Crowdcube had failed to meet regulatory obligations to act in its clients’ best interest and to make sure that Zing Zing’s pitch was “fair, clear and not misleading”.
The investment platform was ordered to repay the investor his £18,000 less any applicable tax relief the investor had enjoyed.
Time will tell whether this was an isolated case which turned on its individual facts – Crowdcube strongly denied any wrongdoing – or if it is a game-changer for the growing number of investors choosing to invest their money through crowdfunding companies.
To assess that requires an understanding of both this particular form of investing and of Crowdcube.
Crowdcube is a well-known crowdfunding platform which offers businesses a comprehensive capital raising service including overall strategy, communications and legal input into the transaction.
It invites investors to “own shares in Europe’s high-growth businesses”.
Its website tells potential investors: “Whether you’re a beginner or experienced investor, you can join our million-strong community who want to invest beyond their property or pension by building a portfolio of start-up, growth and venture backed businesses, with the potential to deliver significant returns.”
It claims impressive results. The website says over 50,000 investors have had the chance to realise more than £60m in returns from investments made with Crowdcube.
It tells prospective investors that “global brands like Nestle, Europcar, Diageo and EDF have acquired businesses that raised with Crowdcube, while others have listed on the stock market or completed a secondary share sale on Cubex”.
The FOS ruling raises significant issues and concerns. As a single regulatory decision, it does not have binding consequences for the crowdfunding industry.
However, if it is indicative of a wider precedent, the consequences will be far reaching for crowdfunding platforms.
It would essentially mean that they would be expected to foresee future strategic shifts in fundraising companies’ business plans which turn out to have a material impact on investors’ fortunes – or, at the very least, undertake reasonable diligence in respect of such shifts.
If this proves to be the case, the recent decision is truly a landmark ruling which could mark a crossroads for the UK crowdfunding marketplace.
Platforms will no doubt argue that they simply cannot predict the future of any issuer or business. It is not clear how far the FCA’s regulatory reach will extend in situations such as these.
In what circumstances will it be able to hold a crowdfunding platform liable for the veracity of a business plan that changes over time at the hands of the company’s management?
Regulatory intervention by the FCA may be required to clarify this. However, the FOS ruling does seem to imply that crowdfunding platforms owe a duty to investors to test the credibility of business plans and statements made by companies seeking to raise money.
That undoubtedly opens a door, perhaps even a floodgate, for disgruntled and disappointed investors. It could lead to multiple claims from those who have lost money and can point to misleading statements by companies which the crowdfunder has failed to scrutinise sufficiently and warn investors about.