Crowdfunding or crowd funding

What is crowdfunding?

Crowdfunding is a modern and increasingly established method of alternative fundraising, especially for startups and small and medium-sized enterprises. The essence of crowdfunding is to bring together investors (individuals and legal entities) who have free capital with businesses seeking to finance their activities. As the term ‘crowdfunding’ itself implies, crowdfunding generally involves a large number of investors in the financing of individual projects. This type of financing also allows access to finance for a group of entities that find it difficult or almost impossible to obtain bank financing.

The most common forms of crowdfunding

Crowdfunding can most commonly be divided into four basic categories:

• Donor crowdfunding: In this model, investors contribute money without expecting any reward. This type is often used to fund charitable and social projects.
• Reward crowdfunding: contributors receive some form of reward, which can be a physical product, service or other form of compensation. This model is popular among creative projects and startups.
• Investment crowdfunding: investors take a stake in a company or project to which they have contributed. This model is similar to the traditional investment process, where contributors expect a financial return.
• Loan crowdfunding: this model allows contributors to provide loans which are then repaid with interest. It is an alternative to traditional bank loans and microfinance.

Crowdfunding legislation

Crowdfunding legislation is harmonised across the European Union. The basic legislation governing crowdfunding is Regulation (EU) 2020/1503 of the European Parliament and of the Council of 7. October 2020 on European crowdfunding service providers for business and amending Regulation (EU) 2017/1129 and Directive (EU) 2019/1937 (the “Crowdfunding Regulation“), which has been applicable in the European Union since 10. November 2021.

Crowdfunding is further regulated by the Commission’s implementing and delegated regulations, which are a set of regulatory and implementing technical rules further regulating certain provisions of the Crowdfunding Regulation.

Finally, the European Securities and Markets Authority (” ESMA “) also provides interpretative opinions on the legal regulation of crowdfunding.ESMA“).

In particular, the Crowdfunding Regulation regulates:

• requirements for the provision of crowdfunding services,
• the organisation of providers of crowdfunding services, and
• the authorisation of providers of crowdfunding services, including the supervision of their activities.

Our partner Tomáš Demo also commented on the topic of crowdfunding regulation in the Investing show on TA3 television:

Crowdfunding actors and crowdfunding platform

In crowdfunding, three types of entities meet:

• crowdfunding service provider – is a legal entity authorised by the relevant regulator to manage or operate a so-called ‘crowdfunding service provider’. A crowdfunding platform through which supply and demand meet between project owners and investors,
• project owner – any legal or natural person seeking to raise capital to finance the performance of its activities through a crowdfunding platform; and
• investor – is any legal or natural person that provides financing to project owners through a crowdfunding platform.

As is also clear from the above, the key concept for the Crowdfunding Regulation is therefore the “crowdfunding platform”, which is defined as a publicly accessible online information system operated or managed by a crowdfunding service provider.1 The provision of crowdfunding is thus defined in the Crowdfunding Regulation exclusively as crowdfunding that is carried out in an online space.

Loan and investment crowdfunding

The Crowdfunding Regulation regulates two types of crowdfunding:

• loan crowdfunding, which facilitates loans from investors as lenders to project owners as borrowers, at an agreed interest rate; and
• investment crowdfunding, whereby transferable securities are placed through a crowdfunding platform and the so-called ” investment crowdfunding“, whereby transferable securities are placed through a crowdfunding platform and the so-called “investment crowdfunding“. The crowdfunding platform involves the placement of accepted instruments for crowdfunding purposes issued by project owners or special purpose vehicles and the acceptance and forwarding of investor instructions to acquire these transferable securities and so-called “securities”. accepted instruments for the purpose of crowdfunding.

Loan crowdfunding and investment crowdfunding are activities through which a crowdfunding platform matches the interests of investors and project owners for funding (crowdfunding services).

A loan under the Crowdfunding Regulation has the following characteristics:

• has a due date,
• the project owner’s commitment to repay the borrowed funds is unconditional,
• the loan is interest-bearing, and
• the project owner is obliged to repay the principal of the loan together with interest in accordance with the repayment schedule.

Investment crowdfunding involves the provision by the crowdfunding service provider of two investment services and activities defined in MiFID II[2]:

• Receiving and forwarding instructions, and
• Placement without firm commitment.

Both of the above services relate to transferable securities[3] and the so called. accepted instruments for the purposes of crowdfunding which are specific instruments defined and defined in the Crowdfunding Regulation. This defines them as ‘shares in a private company limited by guarantee which are not subject to restrictions which would effectively prevent their transfer, including restrictions on the manner in which such shares are offered or advertised to the public’. The National Bank of Slovakia (hereinafter referred to as “NBS“) states that it “does not consider shares in limited liability companies, limited partnerships, public partnerships or cooperatives to be such instruments.”[4] The list published by ESMA[5] also shows that there are no instruments that would qualify as accepted instruments for the purposes of crowdfunding in the Slovak Republic.

Authorisation to provide crowdfunding services

Only the following may provide crowdfunding services (i) legal persons which (ii) are established in the Union; and (iii) have been authorised to carry on activities under the Crowdfunding Regulation . Povolenie podľa prechádzajúcej vety udeľuje v Slovenskej republike NBS, a to po splnení podmienok stanovených v Nariadení o crowdfundingu.

A provider of crowdfunding services with an authorisation granted by the NBS may subsequently, after submitting the relevant notification, also provide crowdfunding services in other Member States of the European Union.

The basic conditions for obtaining a licence to provide crowdfunding services are that the following requirements are met in particular:

• Prudential (capital) requirements. Crowdfunding service providers must continuously comply with financial guarantees, which must amount to at least EUR 25 000 and to one quarter of the fixed overheads for the previous year, if the crowdfunding service provider also facilitates loans. The crowdfunding service provider may meet these requirements through its own resources, an insurance policy or a combination thereof.
• Staffing requirements. Persons responsible for the management of a crowdfunding service provider must demonstrate that they are of good repute and have sufficient knowledge, skills and experience to manage a crowdfunding service provider.
• Organizačno-technické požiadavky. Poskytovatelia služieb hromadného financovania musia vypracovať postupy a opisy systémov, ktorými sa bude riadiť ich činnosť, ako napríklad:
  • opis mechanizmov riadenia a vnútornej kontroly poskytovateľa služieb hromadného financovania na zabezpečenie súladu s Nariadením o crowdfundingu, vrátane riadenia rizík a účtovných postupov;    
  • a description of the systems, resources and procedures of the crowdfunding service provider to control and protect the data processing systems;
  • a description of the crowdfunding service provider’s internal rules to avoid conflicts of interest; and other.

Obligations of the provider of crowdfunding services

In accordance with the Crowdfunding Regulation, a crowdfunding service provider is obliged, inter alia, to:

• make an assessment in relation to the non-professional (retail) investor, in particular to assess whether the investment is suitable for them. To this end, the crowdfunding service provider shall assess the investor’s investment experience, investment objectives and understanding of the risks associated with the investment,
• provide potential investors with a Key Investment Information Document prepared by the project owner,
• publish annually the failure rate of projects offered through the crowdfunding platform; and
• advise investors that their investments are not covered by the Deposit Protection Fund or the Investment Guarantee Fund.

How long does it take to get a crowdfunding license?

Before actually applying for a licence (authorisation to provide crowdfunding services), the entire application must be thoroughly prepared. Depending on the specific business model and the range of services to be applied for, this pre-licensing process can take a couple of months.

In the case of an application for authorisation to provide crowdfunding services, the NBS is obliged to assess whether the application is complete within 25 working days of receipt of such an application. If the application is not complete, the NBS shall set a deadline by which the application must be completed.

Only upon receipt of a complete application is there a time limit of 3 months to assess whether the applicant meets the conditions set out in the Crowdfunding Regulation and to decide whether to grant or refuse the application.

For whom does it make sense to apply for a crowdfunding license?

The crowdfunding platform’s revenue comes from the fees of its users. The crowdfunding service provider does not directly lend its funds or act as an issuer of securities. Therefore, when considering setting up a crowdfunding platform, it is necessary to consider, among other things:

• Whether the entrepreneur wants to manage the funds himself on his own behalf and on behalf of investors,
• Whether the entrepreneur is interested in collective or individual portfolio management,
• Whether the entrepreneur wants to enter directly into the investment or is content to act as an intermediary, and
• What resources does the entrepreneur have and how is their financial plan built.

At the same time, it is always necessary to comprehensively compare and assess other available regulated structures, not only from a legal but also from a tax perspective, with the relevant adviser dealing with the issue. Only after such an assessment (feasibility study) can it be evaluated whether a crowdfunding licence is a suitable solution for a particular business model.

Crowdfunding vs. peer-to-peer (P2P) lending

Crowdfunding and peer-to-peer (P2P) lending share a similar goal – financing projects or needs of individuals and businesses through online platforms. However, there are important differences between them in terms of the legal framework.

In P2P lending, individuals most often borrow funds from other individuals, while such a model is not legally regulated in Slovakia, neither by the Regulation on Crowdfunding, nor is it subject to consumer credit regulation. However, the regulation of P2P lending may be different in other Member States.

A common feature of P2P lending and crowdfunding is the existence of a platform that, in the role of intermediary, links the interests of investors (lenders) on the one hand and borrowers on the other, with these two groups entering into direct contractual relationships.

How can Highgate help you with crowdfunding?

If you are interested in providing crowdfunding services under the Crowdfunding Regulation, we at Highgate can help:

• assess your business plan and its compliance with relevant legislation, including tax analysis,
• prepare an application for authorisation to provide crowdfunding services, including the necessary by-laws and other annexes,
• to provide comprehensive representation throughout the licensing procedure before the NBS, up to the actual granting of the licence.

Highgate has a long-standing interest in financial regulation and capital markets, an area in which crowdfunding regulation clearly falls. Our expertise in this area is evidenced by our recent success in the prestigious Law Firm of the Year 2024 competition, in which Highgate, in addition to winning the Tax Law category, also won the Capital Markets category.

If you have any questions about the legal regulation of crowdfunding, please do not hesitate to contact our experts:

• Peter Varga, e-mail: peter.varga@highgate.sk
• Roman Baranec, e-mail: roman.baranec@highgate.sk

Alternatively, you can discuss your specific questions with our partner Peter Varga, who specialises in financial regulation and tax law. Book a consultation here:

---

[1] Art. 2 par. 1 lit. (d) Crowdfunding Regulations.

[2] Directive 2014/65/EU of the European Parliament and of the Council of 15. 2014 on markets in financial instruments amending Directive 2002/92/EC and Directive 2011/61/EU (“MiFID II“).

[3] Transferable securities as defined in Article 4(1)(a) of Directive 2009/65/EC shall not be transferable securities as defined in Article 4(2) of Directive 2009/65/EC. 1(44) of MiFID II.

[4] Cited on the NBS website here: https://nbs.sk/dohlad-nad-financnym-trhom/dohlad/trh-cennych-papierov/crowdfunding/ (cited on 13.7.2024).

[5] Available online here: https://www.esma.europa.eu/sites/default/files/library/esma35-42-1305_crowdfunding_tables.pdf (cited on 13.7.2024).