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A new EU regulation that entered into force a few days ago is expected to boost cross-border crowdfunding services, removing obstacles that have held back start-ups, particularly in smaller Eastern European markets, from effectively raising funds from the public.
Earlier this week (November 10), a new EU regulation on crowdfunding entered into force. Regulation 2020/1503 is expected to harmonise rules governing crowdfunding across member states, making it much easier for start-ups and online platforms to reach out to the public for investment.
Crowdfunding enables businesses, including start-ups, to raise small amounts of money from a large number of people and organisations. It typically involves three parties: the business that is seeking funding for a project; investors who fund the project; and an intermediating organisation, the crowdfunding service provider, that helps the two parties connect through an online platform.
As small and medium-sized enterprises (SMEs) in many member states are struggling to gain access to money, crowdfunding has emerged as an alternative to venture capital for funding business activities.
It can validate a business idea, help entrepreneurs get insights and information from a large number of people, and can also help create buzz around an idea.
This service could be a powerful tool for fintechs to bring in much-needed investment and support for their innovations. Most recently, London-based crypto payments app Ziglu announced closing its second crowdfunding round after raising £7.19m on Seedrs. This adds to last year’s crowdfunding, which brought £6m to the fintech from 1,250 investors.
Although crowdfunding has become an established funding tool in the UK, Austria and Germany, the product has not gained traction in many Eastern European countries due to complex national legislation, Ádám Illés, vice president of the board at Visegrad+ Legal, told VIXIO.
In Hungary, to set up equity-based crowdfunding, in which supporters acquire a stake in security, companies must prepare a prospectus under the Capital Markets Act. The prospectus, which has to comply with various investor protection rules, has to be approved by the Hungarian central bank, Magyar Nemzeti Bank (MNB).
“Preparing this documentation, which in practice can run to more than a hundred pages, is a major task involving financial and legal experts, and the costs are not necessarily proportionate to the amount of resources planned,” Illés said in a post.
However, Hungary is not the only one in the region where these activities are held back by a complex national framework.
Fundraising intermediaries in the Czech Republic are required to apply for a trader licence to the Czech National Bank. The process to set up a platform, which includes meeting specific capital requirements and filing a prospectus, often proves to be an expensive exercise for new businesses, Illés noted.
Similarly, in Poland, businesses may need to submit a prospectus, depending on the type of business legal entity. Shares in a limited liability company do not constitute security under Polish law, but shares in a joint-stock company do. There is a de minimis threshold that exempts businesses from the obligation to file a prospectus in case the product has fewer than 150 fundraisers who raise less than €100,000 in a year, but these requirements are usually not met in case of a crowdfunding service, Illés added.
The differences between the existing national rules are such that the EU acknowledged they obstruct the cross-border provision of crowdfunding services and have a direct effect on the functioning of the internal market.
The fragmented national legal framework and substantial legal costs discourage investors from investing cross-border by means of crowdfunding platforms.
“As a result, crowdfunding services have remained hitherto largely national, to the detriment of a Union-wide crowdfunding market, thus depriving businesses of access to crowdfunding services, especially in cases where those businesses operate in smaller national markets,” the EU regulation notes.
The new EU regulation, which came into effect on November 10, establishes uniform requirements for platform operators and raises the applicability threshold to €5m to include more crowdfunding platforms within its scope, Illés explained.
It requires crowdfunding platforms to meet a number of conditions, such as internal rules and procedures, professional requirements, and the need to obtain a licence from the supervisory authority of the member state where they are established.
However, businesses are no longer required to prepare a prospectus; instead, they have to prepare a key investment information sheet that allows investors “to make informed investment decisions”.
“The biggest advantage of the new regulation for start-ups is that this document does not require approval by the supervising authority, unlike the issuance of securities under the [Hungarian] Capital Markets Act,” Illés stressed.
The company and its manager are nonetheless liable for the accuracy and completeness of the information contained in the document, he added.
By harmonising the crowdfunding legal framework across the EU, the regulation enables businesses to rely on the passporting regime, meaning that they can provide their services across borders once they get a licence in any one member state.
The new regulation is expected to boost the market of crowdfunding within the EU, especially in terms of cross-border services, Illés said, adding that as the legal framework of crowdfunding in Hungary will be put on a completely new legal basis, he expects that crowdfunding will get a kick in Hungary too.
The regulation allows member states to apply for a transition period lasting until November 2023. Therefore, in Hungary, the regulation will apply only to investments below €1m over the next two years.
