Protecting the crowd: Platforms must lead the due diligence charge

Luke Lang
Follow Luke
Residents Celebrate Viareggio Carnival
Once pitches are open to investment, they’re exposed to another layer of scrutiny in the form of tough questioning from the crowd (Source: Getty)

The issue of due diligence could become a talking point again once the FCA completes its scheduled review of the crowdfunding rules it introduced in 2014.

While we’ve not seen evidence that further regulation of investment-based crowdfunding will be recommended, as the industry matures, it’s time for crowdfunding platforms to step up and work together to self-regulate the sector under the existing FCA rules.

The industry needs to set a standard of due diligence, disclosure, reporting and consumer protection that all parties – including entrepreneurs, investors and regulators – can understand.

The FCA’s approach is to provide a flexible, principles-based regulatory framework that supports the needs of all stakeholders. The crowdfunding rules are not prescriptive as to the level of due diligence required, leaving it to platforms to determine what is appropriate for their particular asset class.

Read more: Why crowdfunding must take due diligence more seriously

This is an effective approach and doesn’t mean that the rules are light touch or that the industry is regulated at arm’s length. It does, however, present a potential information gap for investors that platforms should take the onus on themselves to fill.

Many of our investors are largely unaware of the level and depth of analysis and verification we conduct before allowing a business to raise funding. We need to be better at communicating this. For example, at Crowdcube we have an extensive process that involves a team of lawyers, financial and business analysts and compliance experts. Ninety per cent of businesses that make an application are not approved.

Once pitches are open to investment, they’re exposed to another layer of scrutiny in the form of tough questioning from the crowd. The diversity of the investor base, and their breadth and depth of knowledge, is vital to collectively discuss and judge the merits of the business’s model, its market opportunity and whether it’s worthy of their hard-earned money.

Platforms should constantly review and improve their due diligence processes and the information presented to investors. It’s important that the crowd can easily understand the checks a platform carries out, as well as what it does not do, so they can do their own research if necessary.

One way of ramping transparency up a notch is by formalising the due diligence principles and process in a public charter, which clarifies exactly what investors and entrepreneurs can expect. This is something we’ve recently launched at Crowdcube.

Read more: Who's responsible for greater transparency in equity crowdfunding?

Transparency should also be extended to a standardised measurement of how crowdfunded businesses perform post-funding, including investor returns, losses, follow on investment, down rounds and more general business progress. This transparency is crucial for investors to assess crowdfunding attractiveness as an asset class in the long term.

Going forward, a more unified approach, with providers joining forces with each other to agree a common foundation of due diligence, has to be the goal. Ultimately, I’d like to see the establishment of an industry standard that sets out the required operating principles; one that safeguards the crowd and protects the industry while ensuring that British businesses continue to benefit from improved access to finance.

City A.M.'s opinion pages are a place for thought-provoking views and debate. These views are not necessarily shared by City A.M.

Related articles