The Present and the Future of Crowdfunding Regulation

News and Analysis

News on yet another promising project raising funds or breaking another crowdfunding record strike the cryptocommunity more and more often. Still, the question remains whether the fundraising itself can guarantee a project’s success, and whether the team behind the project is liable to repay the investors if the whole affair fails?

The question would seem idle, if not for rather sad statistics. Thus, in 2012 alone, of all projects that had succeeded in fundraising at Kickstarter, only 19% have reached their goals, while in 2014 there have been only 21% successful projects. Nonetheless, the crowdfunding industry is developing. According to the World Bank’s predictions, the market cap of the industry will reach $96 billion by 2025.


Therefore it comes as no surprise that some governments have already passed laws to regulate the crowdfunding industry. These laws set requirements for projects and stipulate their responsibility for failure to fulfill their obligations.

JOBS Act: a Long Road to the Investor

The U.S. JOBS Act is one of those laws. It allows companies to raise funds at early phases of development under a simplified scheme. The bill was passed back in 2012 under Barack Obama’s administration; however, due to prolonged development of related bylaws, it took legal effect only in 2015.

Before that, only qualified investors were entitled to invest in startups not incorporated as public companies. Qualified investors are people or companies that have at least one million dollars of assets (or at least $200,000 of annual revenue.) Certainly, it made things difficult for most startups.

Now, any U.S. citizen has a right to participate in a crowdfunding campaign. Still, the maximum amount of investment depends on their annual revenue, and cannot exceed five per cent thereof.

JOBS Act has significantly changed the rules for the companies seeking funds. Thus, overall investment amount can’t exceed $1 million, while the company is has to reveal information about its founders and their financial situation, the financial situation of the project, and a detailed business plan.

Once the campaign is complete, the project team is now obliged to report on the funds spending on a regular basis to its investors and the SEC. In case it fails to comply with above requirements, the company will be held administratively and criminally liable under the existing laws.

Bitcoin wallet AirBitz was the first cryptocurrency-related project to launch a crowdfunding campaign in compliance with JOBS Act. Still, it’s not the only the federal laws that regulate crowdfunding. Last year, Illinois and Montana have passed similar bills in an attempt to attract investment in local economies.

The Old World

France is the only EU country that regulates crowdfunding. The respective law was passed in October 2014 thanks to the country’s minister Fleur Pellerine. She believes the industry of crowdfunding could become one of the ways out of the economic crisis that struck Europe.

In the post-Soviet space, Russia is the only country attempting to regulate the industry. This March, Nikolai Nikiforov, the minister for communications, stated that the country’s legislation requires amendments to regulate crowdfunding.

“We see small companies and startups garnering serious support with crowdfunding in some countries. I believe, we could develop the necessary amendments with our colleagues from the Ministry of Economic Development and the Ministry of Finance to ensure further guarantees,” he said.

The minister also stated that there are many Russian startups requiring investment, yet the government had to provide for guarantees of investment safety.

The Central Bank of Russia responded to the initiative only this autumn. In November, it held the first meeting of the working group on monitoring and assessment of consumer risks, and development of proposals as to regulation of crowdfunding. The group includes representatives for various Russia-based crowdfunding platforms.

“Supervision over crowdfunding platforms has to consider the risks existing on the market without hindering the development of efficient business models of crowdfunding,” the representatives for the Central Bank stated at the meeting.

The working group has developed a concept implying that regulation of crowdfunding in Russia would include the following:

  • regulation of crowdfunding platforms, including requirements for their owners and management;
  • requirements for issuers of securities (offered using the platforms) and loaners;
  • requirements for creditors and investors using the crowdfunding platform.

The concept’s authors also seek to define the very term of crowdfunding. Presently it goes as follows:

“a mechanism of raising loan funds or collective funding of companies or projects using internet platforms, e.g. p2p-loans, special-purpose voluntary donations, as well as investment of funds, including that via purchase of shares or bonds of a company, funding a project with the purpose of using ‘the project’s product’ (tickets for a show, discs, creating movies, etc.)”

The working group intends to complete its concept of regulatory principles in the near future. After that the Central Bank intends to develop a roadmap that would underlie the industry’s regulation.

While the lawmakers develop rules for the industry, companies successfully work and raise funds from investors. In order to find out what rules they actually use, ForkLog contacted Deloitte CIS senior consultants Ksenia Osipova and Christina Lokaychuk.

“While the Central Bank is developing a new regulation, projects employ several scenarios to raise funds from multiple investors.

First, a project company may use debt funding, i.e. raise funds on a loan agreement. Such relations with a company are not about investment, as the loaner is entitled to receive the debt regardless of whether the campaign is successful or not. Apart from that, the existing regulation of loan agreements does not allow one to raise funds from an unlimited group of people (for instance, by placing a public offer.)

Second, a project company may conclude an agreement on profit sharing on an option agreement. In that case, the company, by the way of consideration for the received investment, undertakes to pay out the money to the predetermined or determined tune, should the conditions stipulated in the agreement arise (for instance, in the form of revenue share.) The amount of investment provided by the investor will be qualified as an option bonus, while the project company will have to pay taxes for the entire amount of the investment.

Third and finally, it may be a convertible loan. Under a convertible loan contract, the investor provides the project company the loan in exchange for the shares of the project company in the future (when the company becomes a joint stock enterprise, which is not necessary if it is incorporated as a joint stock company.) In order to ensure payout prior to the conversion, one should stipulate the interest rate in the contract, which will function as dividends. In that case, we see no problems in pegging the obligation of paying out the interest to the time when the project company obtains distributable revenue.”

Summarizing all of the above, while lawyers all over the world are looking for legal tools that could regulate relations between crowdfunding campaign parties, this process has to be about enhancing its development and security while retaining sufficient legal terrain, and not about the bare desire to create another formal framework.

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