Ask the alternative finance experts: What you need to know about investor protection in crowdfunding
David Walker, corporate partner at Memery Crystal, and Guy Rigby, partner and head of entrepreneurs tax and business services at Smith & Williamson, address some of the issues around investor protection in alternative finance.
Alternative finance is a high-risk investment sector. Are there any ways to minimise risk?
DW: All investments carry a degree of risk. But there are ways that this risk can be mitigated to a certain extent. The borrower or issuer should provide an appropriate level of information to enable a potential investor to make an informed decision. The investor should make sure they read and understand the key terms and risks attaching to the particular investment.
GR: Alternative finance is a new sector, primarily centred around technology-enabled crowdfunding, so investors should proceed with caution, using only regulated providers and taking a conservative approach to asset allocation. It’s early days, but investors should look for platforms that offer transparency in terms of lending activity, defaults and net returns. And don’t bet the farm…
How do I know that the company is real and the investment opportunity is not a scam?
DW: Much will depend on the nature of the investment. Most alternative finance investment opportunities will have been approved by an FCA authorised person. This will give some comfort that due diligence and background investigations have been undertaken on the company.
GR: There are many ways to check authenticity. Information is available from Companies House and the web is a rich source of information. If it’s difficult to find information, or if you are approached by unknown or unauthorised parties, steer clear. In some cases, typically for larger investments, it should be possible to contact the firm and speak to its advisers.
What other red flags should I look for when reviewing an investment opportunity?
GR: Entrepreneurs are an enthusiastic bunch, so early stage pitches often include a “hockey stick” shaped forecast, with (your) funds being spent in the early days and forecasts of untold riches flowing back over the next two or three years. This can often be illusory. Even great ideas can be difficult to commercialise, so consider the team’s track record, the likely objectivity of their forecasts, and the business’s stage of development. Seed and other early stage investors are often tempted by the size of the potential spoils, but history shows only a minority of these companies survive.
If a company I have invested in goes bust, will I lose everything?
DW: Potentially yes! Much depends on the nature of the instrument you are investing in, but typically investors will rank behind other secured creditors on any liquidation.
GR: While you may be able to benefit from a variable level of tax relief, there will still be a real loss. Tax breaks are designed to encourage investors and to mitigate risk, but should never be used to justify an investment.
What legislation is currently in place to protect my investments?
DW: Most investment opportunities available to the UK public will be financial promotions and must be approved by an FCA authorised person. The FCA’s new Crowdfunding Rules ensure that only certain categories of persons can invest in various types of investments. They also seek confirmation from a potential investor that they understand the nature of the investment they are about to make before they invest. Directors and companies can incur both criminal and civil liability if they misrepresent the nature of an investment/information given, allowing investors to recoup their loss.