The Crowdfunding conundrum

Lack of access to capital is still a constraint on the ambitions of Britain's entrepreneurs despite the fact the economy is now growing after years of stagnation.

This problem is rooted in the structure of our current financial system, one that puts all manner of hurdles in the path of small British businesses. As Ed Miliband identified in his recent speech on banking reform, the market for small business lending is far too concentrated in the hands of our nation’s largest banks.

Into this uncompetitive market steps crowdfunding.

Crowdfunding is where a collective of individuals fund a project or enterprise together. Crowdfunding platforms are the brokers between investors and enterprises; they hold the invested funds and check the quality of an enterprise before investing them.   

Crowdfunding for small businesses can take one of two forms: equity or debt.  Debt crowdfunding has the most potential for thousands of small businesses. There are two reasons for this. Firstly, George Osborne allowed crowdfunded loans to be investments held within the new Individual Savings Account (ISA) from this July. This creates a large potential investor base.  

Secondly for many small businesses (and their owners) debt financing is a more attractive form of investment, because it doesn't require the owner to relinquish control over their company.   

Yet the opportunity for hundreds of thousands of people to invest their personal savings in the performance of small businesses can be a risky proposition.

The industry has responded with a self-regulating code of practice issued by the trade body, UK Crowdfunding. These principles commit member firms to certain basic standards. However, the City regulator, the Financial Conduct Authority (FCA), has taken a somewhat lax approach to regulating debt crowdfunding platforms. For example, the new rules do not require specific disclosures of information about borrowers. Instead the FCA's guidance states that platforms merely avoid misleading investors.

This raises an interesting debate: has the FCA allowed a new market to develop by limiting red tape or have ordinary investors been left unprotected? Avoiding a scandal at a major debt crowdfunding platform is vital to building investor confidence and for crowdfunding to become a viable alternative to bank financing. Yet further regulation to protect ordinary investors may stifle innovation and inhibit the growth of the industry.

For a Labour government in 2015, getting the balance right will be key to fixing the broken market for lending to small businesses.

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