WITH traditional forms of finance squeezed since the credit crunch, the alternative finance sector has grown significantly over the past few years. In particular peer-to-peer finance, either lending or equity crowdfunding, has seen enormous growth. Investors and entrepreneurs have turned to digital platforms in their thousands, with tens of millions raised through crowdfunding last year, representing a vast increase from 2012.
However, the rapid growth of the industry has led to concern over the protection in place for the SMEs using crowdfunding platforms to access finance and the individuals investing with them. The FCA held a consultation on its regulatory approach to crowdfunding over the internet and the promotion of non-readily realisable securities by other media and issued a long-awaited policy statement on 7 March.
The FCA’s main recommendations include requiring firms running the loan-based platforms to have plans in place so that loan repayments continue to be collected even if the online platform gets into difficulties.
New prudential regulations will also be introduced over time so that these firms have capital to help withstand financial shocks. This is important as consumers who lend money through these firms will not be able to claim through the Financial Services Compensation Scheme.
The new rules will provide the same level of protection to investors whether they engage with firms online, or offline as a result of direct marketing or telephone selling.
The FCA is now proposing that inexperienced investors in equity schemes will have to certify that they will not invest more than 10% of their portfolio in unlisted businesses and be given access to clear information, which allows them to assess the risk and to understand who will ultimately borrow the money.
The new regulatory framework is important for finance directors and CEOs of small companies because of its potential impact on their access to finance through crowdfunding platforms. One particular benefit of equity crowdfunding platforms is that they make it easier for individuals to invest in an Enterprise Investment Scheme (EIS).
EIS was designed by the government to make investing in start-up businesses more attractive to investors by offering a unique set of tax breaks. The tax benefits to the individual are numerous, for example 30% income tax relief: a £1m investment limit means that up to £300,000 of income tax can be mitigated each year.
Capital gains deferral, rising portfolio values and property markets are creating capital gains tax liabilities, but reinvesting gains into EIS shares allows them to be deferred until the shares are realised. This allows individuals to use government money as an interest-free loan until you sell the shares and the gain falls due and if the shares are held until death, no CGT is payable.
Softening the blow
EIS, as a general rule, qualifies for Business Property Relief, which means that after holding it for the two-year qualifying period, the value will be exempt from inheritance tax. If a loss is experienced on an EIS share, it can be offset against other capital gains or income to help soften the blow.
As the private sector is the key driver for economic recovery, EIS is designed to support companies by offering an incentivised approach to investing at the smaller end of the market. Currently, firms involved in film production, renewable solar energy, technology and telecommunications and healthcare can benefit from the scheme.
There are stipulations on the type of company that can qualify for EIS:
• It must be an unquoted company but quotation on alternative markets is allowed as these aren’t recognised by the EIS.
• It must have fewer than 250 full-time employees and must not be controlled by another company.
• It must be a small company where gross assets do not exceed £15m immediately before the share issue and £16m immediately after.
• It can either be a company carrying on the qualifying trade or the parent company of a trading group.
EIS has been around for several years and the benefits as an investment for higher-rate tax payers in particular, as well as to the SMEs that are seeking funding, are clear, but lack of awareness has resulted in limited take-up to date. The fact that crowdfunding platforms can bring this scheme to a wider audience is of benefit to FDs, but it is important to understand that the higher-risk nature of an EIS means it is not suitable for all investors.
I welcome the FCA’s proposals to provide more protection to investors, following independent financial advice, but would normally recommend that investors consider EIS as part of a diversified portfolio and that individuals spread the risk by using portfolio services which invest into a number of companies. ?
Matthew Phillips is managing director at Broadstone Pensions & Investments