The risks that may be posed by investment-based crowdfunding are common to those more generally related to investing in the types of securities that are offered (e.g. unlisted shares or bonds), or to those that may arise through other financial intermediation channels. These risks can also manifest themselves in the context of the crowdfunding business model (i.e. securities offered to investors, often non-professional ones, through an online intermediary).
These risks may include: investors losing part or all of their capital or not getting the returns they expect; dilution in the case of equity crowdfunding (if the company engages in further rounds of capital raising); inability to exit investments (e.g. for lack of a secondary market); insufficient information or inability to price correctly the securities invested in, or misinformation (both in the pre-investment phase and over the lifetime of the investment); conflict and misalignment of interests between issuers, platforms and investors; insolvency of the platform operators, in particular as regards the continuous servicing of existing claims (e.g. dividend and interest payments) and protection of clients’ assets; security of client data; platforms may be used for illicit activities; fraud (both for the investors and for the project) and related reputational risk for platforms.
Lending-based crowdfunding may also give rise to some of the risks listed above: investors may not have sufficient information or may be misinformed; insolvency of the platform operators; conflict and misalignment of interests; security of client data; platforms are used for illicit activities; fraud and related reputational risk.
Other risks may be specific to lending, and manifest themselves in the context of the crowdfunding business model (i.e. money handling and credit intermediation through an online platform). A non-exhaustive list of risks includes the following: credit risk for the lender (e.g. lender may lose the capital invested and the related interest); lenders may not be able to exit their investment in the absence of a secondary market for loans; borrowers may not have sufficient information to assess their ability to repay the loan, or borrowers may be misinformed.
For example, a misalignment of interest may arise due to the remuneration model of many crowdfunding platforms, which are based upon the completion of successful crowdfunding campaigns and are completely independent from the outcome of the funded project. A potential misalignment of interest may also emerge on the side of issuers if the company seeking funding is free to choose the method to evaluate the investment prospects that will be communicated to potential investors.
Due diligence must be independent for verifying that the information about the project to be disclosed to investors is complete. The pre-determined criteria used in the selection process must be also disclosed.
Platforms must be required to disclose any fees, payments or other monetary benefits that they receive from third parties other than the investors in connection with the services provided Platforms to be organised to avoid conflict of interests; Platforms ‘ officers and employees cannot have interests opposed to those of investors. Platform cannot offer advice on projects published on its website.
Business continuity requirements: Platforms must have effective mechanisms in place that ensure that, in the event of cessation of activity, essential services are provided to those projects that had successfully obtained funding. Continuity arrangements need to be in place so existing loans can be administered even in the event of a firm running a platform failing. Platform’s organisational duty to draft, publish online and enforce policies and procedures in order to ensure business continuity.
Information requirements & risk warnings by platforms Information on the platform itself, (especially on how the projects are selected) and on the loan. Warn the lender about the risks and provide to lenders: with tools to assess the possible loan amount they can afford given their income and expenses; the relevant elements enabling them to assess the economic viability of the project, in particular the business plan. General description of the nature and risks of a product, in sufficient detail so the client can take investment decisions on an informed basis. Platform must send a statement at least once a year of the investments and client money held by the firm for the client. All of these activities must be run by independent risk management so as to give enough confidence to the investors.