EQUITY CROWDFUNDING VS OTHER TYPES OF CROWDFUNDING

EQUITY CROWDFUNDING VS OTHER TYPES OF CROWDFUNDING

A little while ago we wrote an article on the regulatory vacuum relating to equity crowdfunding. Whilst there has been little movement from a regulatory perspective as to how South Africa is going to regulate crowdfunding – meaning that it is still unregulated – there have been some positive steps taken by the Financial Services Board (“the FSB“). Crowdfunding has been at the forefront of the FSB’s recent discussions – hopefully an indication of their support.

If you are unfamiliar with the term “crowdfunding” and you have looked to “professor” Google to gain a bit of an understanding of what it is, here is a small overview on what crowdfunding is and the types that are available.

The term “crowdfunding” is essentially a description of a funding raise of multiple (typically small) sums of money from the general public to fund some form of venture, whether that be a charitable venture or a profit-making venture.

  • Donations based crowdfunding is fairly straightforward – a group of people donate money to an organisation or person that they believe in, generally for a charitable cause. Backabuddy is a good example of this in motion in South Africa.
  • Rewards based crowdfunding is widely used to incentivise people to fund the venture of a small business. This is similar to donations based crowdfunding, but with a key difference, as the person seeking funding offers a reward to the person / people donating. Thundafund is an example of a South African rewards based crowdfunding platform.
  • Loan based crowdfunding occurs where the person / company borrows money from the crowd and the crowd receives interest as their return. Entrepreneurs typically use this to get a better interest rate than they would have gotten if they went to the more established money lenders.
  • ICO’s (Initial Coin Offerings) have become the most recent of the crowdfunding fads. Unfortunately, there have been a few notorious fraudulent schemes using ICO’s. In fact, the Useless Ethereum Token famously launched a satirical ICO that clearly stated that its coins were worth nothing and it raised USD$93,949 (+/- R1 million)! ICO’s are fairly complex, so we are not going to go into them in this article, but if you would like to see a previous article written on the subject, you can read about it here.
  • Equity based crowdfunding occurs where shares in a company are offered to the public in exchange for funding. This is really significant as the crowd become business owners of the company and have certain rights attached to their investment.

Equity based crowdfunding has previously been avoided in South Africa, as people are generally wary of entering a space like this due to the regulatory concerns. Uprise.Africa (which has already had its soft launch) has, however, started an equity based crowdfunding operation in South Africa and is about to become fully operational.

What’s the difference?

Equity based crowdfunding differs significantly from its more underpowered cousins, as shareholders in a company (even minority ones) have certain rights that they can exercise to ensure that startups aren’t off buying bean bags and half-price sushi with investor funds. This means that the crowd has some oversight and can share in the rewards or growth of the business. So, the crowd is rewarded in the long term for investing into the startup (although most startups are high-risk investments and returns are not very common).

What this means for the startup is that they can market test their product to see whether the general public would be interested in the investment. It also means that the startup can probably get a more favourable investment than your average venture capital (“VC“) firm would give as the crowd isn’t normally as interested in the bottom line of the startup as your average VC firm is.

Equity crowdfunding has such huge potential to boost the South African economy, in fact the World Bank recently predicted that the market potential in Africa for crowdfunding will be up to $2.5 billion by 2025. Equity crowdfunding in South Africa will hopefully tap into that and unleash significant potential in the startups that are based here.

BITCOIN, BLOCKCHAIN, CRYPTOCURRENCIES AND ICO’S: LEGAL ENIGMAS FOR START-UP’S OPERATING ON THE FUTURE FRONTIER

BITCOIN, BLOCKCHAIN, CRYPTOCURRENCIES AND ICO’S: LEGAL ENIGMAS FOR START-UP’S OPERATING ON THE FUTURE FRONTIER

The latest buzz words shaking up the technology, business, financial and legal establishments are not to be treated lightly. These terms are uniting (hard as it might be) all the major role players in their quest to evaluate the potential far-reaching effects it might hold for the future of commerce globally. It is difficult to ignore the fast-paced development of the latest technological advances, as we find ourselves amid the fascinating transition phases nestled between the Third and Fourth Industrial Revolutions. More importantly, as the universal compatibilities envisioned for this technology have now progressed from hypothetical online discussions between “tech-developers” and futurists to functioning real-life applications, passionate debates have erupted across a variety of diverse forums. Ranging from the corridors of legislators and financial regulators to the living rooms of the Stokvel run by Joe Soap, as people are curious (and watchful) about the industries based on the Future Frontier – and rightly so.

As the terminology is complex, we will not aim to explain what the Blockchain, Cryptocurrencies (which include BitCoin) or Initial Coin Offerings (“ICO”) are. We will also not attempt to define or address the application possibilities of these initiatives in this post, as the possibilities are vast and beyond the scope of this post. (For more information on the technical aspects relating to these terms, please see the links below explaining this in more detail.[1]) We will only briefly aim to highlight some aspects start-ups and potential investors should bear in mind when investigating the opportunities created by the technology found on this Future Frontier.

For Start-Up’s

Start-ups looking to venture into the industries of the Future Frontier are advised to note that there is still a lot of uncertainty as to the regulations governing and enforcing the practical application thereof. As such, carefully considering the current legislative frameworks in existence (and more importantly, the purpose behind it) might provide a helpful understanding of the things entrepreneurs should consider when developing their business models for the market. In a South African context, start-ups should consider the following legislative and regulatory concerns which might be applicable to them:

  • FICA, Money-Laundering and Know-Your-Client (KYC) legislation: due to cryptocurrencies trading far more anonymously over various encrypted platforms entrepreneurs are encouraged to familiarise themselves with the relevant FICA, Money laundering and KYC processes. Especially in industries where payments are being made by potential payment or payment systems operators;
  • Business of a Bank and Collective Investment Schemes: Business models based around the collecting and pooling of fees and/or accepting deposits for investments into cryptocurrencies and ICO’s might be considered to be Collective Schemes or structures conducting the business of a bank, both of which are strictly regulated by the SARB and FSB, respectively;
  • Financial Advisory and Intermediary Services Act (Twin Peaks Financial Sector Regulation Bill): any current or potential services aimed at the financial advisory or intermediary industries are strictly regulated by the Financial Services Board (and will soon fall under the Twin Peak Provisions);
  • Exchange Control Regulations: Strict requirements regarding the outflow of capital and funds exist in South Africa. As a result, certain apps or services designed to facilitate transfers of this kind without prior SARB approval, tax clearance from SARS or adherence to existing policies may pose some concern to regulators;
  • Companies Act: A very popular means to raise funds for start-ups focusing on Future Frontier industries is by way of an ICO. During an ICO the start-ups issue their own crypto- tokens to participants at a discount and often raise vast amounts of capital. However, an ICO might, depending on the rights attached to these crypto-tokens, in some cases be regarded as a thinly veiled offer of securities to the public. If that is the case, the Companies Act and accordingly, the strict laws relating to the issue of securities by way of an offerings to the public will be applicable. Since the Securities Exchange Commission of the USA recently declared this position (not without criticism), other jurisdictions may follow suit; and
  • Consumer Protection Laws: The loss of virtual cryptocurrencies value, tokens issued to paying participants without any underlying value and other types of blockchain transaction issues such as erroneous payments and systems breaches, hacks or Ponzi schemes are things to consider. If not adequately managed, this may create serious liabilities, not to mention reputational damage, to any start-up involved in these types of commercial venture.

These are merely some of the myriad questions start-ups are urged to consider as a starting point into the regulatory and compliance frameworks regulating the industries on the Future Frontier.

Investors

Warren Buffet once said the following: “What counts for most people in investing is not how much they know, but rather how realistically they define what they don’t know”.

In keeping with this thought, we would therefore urge any investors considering investing into start-ups which focus on the Future Frontier industries to not stray too far from established investment principals. Especially in determining what the Investor does not know, conducting an adequate due diligence investigation (or “DD“) into the envisioned Start-up’s proof of concept, management of regulatory and compliance issues and the viability of their intended financial and business models should be considered a minimum requirement. Further to this, investors would do well to consider special escrow arrangements for any transfer of investment funds irrespective of whether these funds are done by way of crypto-funds/tokens and/or fiat currency. Also using respected and knowledgeable service providers may mitigate against any risks involved in these investments.

Conclusion

There are various levels of uncertainty regarding the practical and legal implications of these Future Frontier industries. This accordingly provides ample grey area for entrepreneurs and investors alike to either flower or flounder through. As such, we would recommend that any Start-Ups or investors contemplating to venture into these Future Frontier Industries to make sure that they have a clear view of the legal nature of the transaction at hand. If the legal nature of the transaction is clear, it enables the parties to take a measured approach to control the relative risk associated and build in the protective mechanisms that the law requires.

We hope to see legislators work with other industry experts to create a legislative framework that promotes certainty, without smothering the revolutionary initiatives and staggering opportunities presented by Future Frontier technology.

[1] For further detailed information regarding how Cryptocurrencies and the Blockchain function and operate please make use of the following recommend sources: