Opinion: Crowd funding and peer to peer lending: Will it end in tears?

Among the initial excitement spurred by the by Financial Markets Authority’s announcement it had licensed the first peer-to-peer lending platform, a DLA Phillips Fox partner has warned it could all end in tears

Among the initial excitement spurred by the by Financial Markets Authority’s announcement it had licensed the first peer-to-peer lending platform, DLA Phillips Fox Wellington partner Sue Brown warns it may all end in tears. She explains why.
 
In the past few weeks, there’s been growing excitement among innovative start-ups and SMEs, as new ways of accessing growth capital move closer through peer to peer lending and equity-based crowd funding.
 
The Financial Markets Authority this month announced it had licensed the first peer to peer lending platform and is expected to licence the first crowd funding platform soon.  This opens the way for businesses to seek up to $2million a year from investors through licensed platforms without the need to provide the formal disclosure documents (investment statement and prospectus or from 1 December 2014, a product disclosure statement) usually required.
 
The licensing represents a major step forward in opening up the internet as a source of funding for business.  Equity crowd funding and peer to peer lending became possible under the Financial Markets Conduct Act (FMCA) in April.  It has taken three months for the first platform to satisfy FMA it meets the required minimum standards.
 
The new, internet-based, ease of access to capital is great news for small businesses looking to grow - perhaps some of the businesses kick started in this way will become New Zealand’s next corporate success stories and will list on NZX's growth market or its main board in the future.
 
But the opportunities come with a word of caution. Some businesses funded in these ways will inevitably fail. In the UK and USA, some online platforms have also failed
 
Businesses looking for funding are likely to be small, untested and speculative - carrying higher than usual investment risk.  More traditional investments must be made through offer documents containing clear information about the offer.    Investors investing through the new platforms will receive only very limited information and warnings before they hand over their money.
 
Furthermore, while each business can raise only $2 million a year through the platforms, there are no limits on the amount an investor can invest.
 
FMA's guidance warns investors they may not get their money back. But when failures do happen, investors will not react rationally - they will react emotionally. Warnings will be forgotten - and investors will remember only that the platform through which they invested was licensed by the Financial Markets Authority.
 
This could erode the market confidence FMA has worked so hard to grow over the past three years.
 
Businesses considering the opportunity to raise funds through the new platforms also need to take care.
 
First, they must make sure they are dealing with a licensed platform.  They should also understand the legal structure of the investment they are seeking.   If they are seeking equity investment through crowd funding (rather than a ‘loan’ through peer to peer lending), then this may have long term and significant implications for ownership and control of their business.
 
Finally, they must be clear and honest about the deal they are offering, and how it is described in the marketing materials.  If they are less than honest, they risk breaching the FMCA fair dealing rules.
 
The regulatory risk FMA carries in this area means it will be vigilant and quick to act if it learns of misleading behaviour.  

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