Crowdfunding poses benefits, risks

Financial return crowdfunding does not pose systemic risks to the world economy yet, according to a report issued Wednesday by staff researchers working for the International Organization of Securities Commissions (IOSCO). But in the marketplace, crowdfunding – which is growing in popularity – poses both benefits and risks, according to the report.

Crowdfunding involves the use of small amounts of money from large numbers of individuals or organisations to fund projects or businesses through an online platform.

Researchers focused on what’s known as “financial return crowdfunding,” which consists of peer-to-peer lending and equity crowdfunding. Despite the lack of a systemic risk, these markets pose problems for investor protection that need to be addressed, and regulators worldwide are working to provide oversight for financial return crowdfunding, according to the report.

In the US, the Securities and Exchange Commission (SEC) and the states regulate peer-to-peer lenders, and equity crowdfunding is regulated under equity regulation, with some exceptions created as a result of the Jumpstart Our Business Startups Act of 2012. The SEC has issued a crowdfunding regulatory proposal – whose comment period ended Monday – for non-accredited investors who wish to invest in start-ups.

In the UK, peer-to-peer lending will be regulated by the Financial Conduct Authority beginning April 1st, and equity crowdfunding is regulated under equity rules, the report says.

The benefits of financial return crowdfunding, according to the report, include:

• Providing entrepreneurs with a way to raise capital without giving up large parcels of equity interest.
• Spreading risk, as the majority of investors are individuals and funding requests are filled in small amounts.
• Lower cost of capital and higher returns to investors.
• Helping economic recovery by financing small and medium-size businesses.

But financial return crowdfunding also comes with risks, the report says. These include:

• A high risk of default and investment failure, estimated to be around 50% for equity crowdfunding. For peer-to-peer lending, the estimated high was 30% in 2009.
• Risk of platform closure/failure. According to the report, one peer-to-peer lending platform has already closed, leaving no data on contracts behind and a 100% investment loss.
• Fraud risk. The anonymity created by the online aspect of these industries increases the risk, the report says.
• Risk of illiquidity. The lack of a secondary market prevents investors from selling their participations.
• Risk of cyber-attack. The online nature of crowdfunding makes this a risk.
• Lack of transparency and disclosure of risks. Risks may not be disclosed until a lender or investor becomes a member of the platform, the report says.

—Ken Tysiac (ktysiac@aicpa.org) is a CGMA Magazine senior editor.