This article first appeared in Connect magazine.
Crowdfunding is a way in which individuals and businesses raise money to finance or re-finance their activities through online platforms. These online platforms are often known as "crowdfunding platforms" and they typically adopt either a loan-based model or an investment-based model to attract a broader range of individual funders.
Crowdfunding grew out of the 2008 financial crisis and was initially viewed by many as a short term funding solution for businesses seeking to raise debt finance in a market place where the traditional lending institutions were holding on to their capital. It was particularly difficult for start-ups and early stage growth companies to raise finance during this period. The culture was risk averse and start-ups are, by their very nature, perceived to be risky. However, although initially seen by many as a short-term fad, crowdfunding is now a recognised funding platform that is gaining traction globally (mainly in the UK and the US). It is part of an increasingly fragmented lending market which is no longer dominated solely by the big global banks.
How does it work?
So how do these platforms work? Crowdfunding models are very simple but seek to challenge traditional lending methods. The online platforms give those seeking to raise funds access to thousands of potential lenders and investors who are looking to make a return on their money. Although the sums put on risk by each lender or investor may be modest the available funding can quickly grow and become quite significant when aggregated with the amounts contributed by others.
Loan based Crowdfunding
The loan-based crowdfunding model is more closely linked to the traditional lending model of the bigger banks and is sometimes referred to as "peer to peer lending". Individual investors lend modest sums of money for a set term with an agreed rate of interest. Provided the business is successful, the individual lender will receive interest together with the principal amount loaned at the end of the term.
Investment base Crowdfunding
The investment-based crowdfunding model invites investors to subscribe for shares in a company looking to raise funds. A return on this investment is only likely to be received when a market for trading those shares is established – such as when the company lists on a regulated exchange or is sold. Equity investors hoping that the company will return a dividend in the meantime should recognise that, if investing in a start-up, any such dividend payments are likely to be many years away.
Interestingly, despite the rise of the crowdfunding industry, there is currently no crowdfunding platform operating in Jersey. This is because most UK based crowdfunding platforms will only accept applications from UK or EU incorporated companies. Local start-ups and other businesses could therefore potentially benefit greatly from the development of a crowdfunding platform in Jersey. Once established there may also be scope to scale-up a Jersey crowdfunding platform to benefit entities off-island. This could therefore represent a real opportunity for Jersey.
As with any new financial service offering, a crowdfunding platform would of course require appropriate oversight and regulation. It is suggested that Jersey's existing legal and regulatory framework could be readily adapted to accommodate the crowdfunding model whilst continuing to safeguard Jersey's Blue Chip international reputation. The sunrise regulation of crowdfunding in the UK, which was developed by both law makers and the UK's Financial and Conduct Authority, could perhaps prove to be a useful template for Jersey in developing its own legislation.
So there you have it. Crowdfunding has been developing for the last 8 or so years and is now well established in the UK and the US. With Digital Jersey having recently identified Fintech as one of its three main areas of focus for the development of Jersey's digital economy, crowdfunding could well turn out to be one of the keys to implementing that strategy, should we choose to embrace it.
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