THE GLOBAL SIGNIFICANCE OF CROWDFUNDING: SOLVING THE SME FUNDING PROBLEM AND DEMOCRATIZING ACCESS TO CAPITAL ALMA PEKMEZOVIC GORDON WALKER* ABSTRACT This Article provides a comprehensive review of the crowd- funding phenomenon. It argues that equity crowdfunding (“ECF”) and, to a lesser extent, peer-to-peer lending (“P2PL”) offer the pos- sibility of a global solution to the small and medium-sized enterprise (“SME”) funding problem. In the United States, the SME funding problem is exacerbated by the markedly diminishing rate of startup formation, a factor that injects a degree of urgency into resolving the optimal means to implement ECF. Here, as with the “fin-tech” revolution, the law lags behind technological developments. The second main argument is that ECF enhances access to capital for SMEs globally while simultaneously democratizing access to in- vestments for ordinary citizens. The Article begins by providing definitions, business models, and historical background before outlining the SME funding problem and new constraints on SME lending since the global financial crisis. ECF is placed within the so-called “financing escalator” and is distinguished from venture capital and angel financing. The global market for crowdfunding * Dr. Alma Pekmezovic, LL.M. (UCLA), Ph.D. (La Trobe) is a Lecturer at La Trobe University School of Law, Melbourne, Australia and a Research Fellow at Bucerius Law School, Hamburg, Germany. Dr. Gordon R. Walker, SJD (Duke) is a Professor of Law at the Law School, Hamad Bin Khalifa University, in strategic partnership with the Pritzker School of Law, North- western University, Chicago, Illinois, United States under the auspices of the Qatar Foundation, Doha, Qatar; Emeritus Professor of Law at La Trobe Univer- sity, Melbourne, Australia; and Visiting Professor at the University of Houston Law Center. Thanks to Professors Dean Pawlowic, Stephen Black, and Eric Chiappinelli of Texas Tech University School of Law for their comments on earlier drafts. 347 348 WILLIAM & MARY BUSINESS LAW REVIEW [Vol. 7:347 is reviewed in order to indicate growth trends in the sector. Some common legal issues associated with crowdfunding are presented before a review of crowdfunding globally. Dominant models in some Organisation for Economic Co-operation and Development (OECD) countries and the potential for crowdfunding to assist SMEs in the undeveloped world are explored. The conclusion outlines key considerations and choices for legislators considering the regulatory puzzles presented by crowdfunding. 2016] SIGNIFICANCE OF CROWDFUNDING 349 TABLE OF CONTENTS INTRODUCTION ............................................................................ 351 I. CROWDFUNDING AND P2PL: DEFINITIONS, BUSINESS MODELS, AND HISTORICAL BACKGROUND ............................................... 356 A. Definitions ......................................................................... 356 B. Crowdfunding Business Models ....................................... 362 C. Historical Background ...................................................... 364 II. SME FINANCING AND THE GFC ............................................. 366 A. The Financing Problem for SMEs .................................... 366 B. Sources of Finance for SMEs ............................................ 369 1. Public Equity .................................................................. 369 2. Private Equity ................................................................. 372 3. Venture Capital .............................................................. 374 4. Business Angels .............................................................. 379 5. Differences Between Venture Capitalists, Angels, and Crowd Investors............................................................... 382 III. THE GLOBAL MARKET FOR CROWDFUNDING ......................... 386 IV. COMMON LEGAL ISSUES ASSOCIATED WITH CROWDFUNDING ...................................................................... 389 A. Prudential Supervision ..................................................... 389 B. Taxation ............................................................................. 389 C. Money Laundering ............................................................ 390 D. Credit Regulation and Peer-to-Peer Platforms................. 390 E. Investor Protection and Cross-Border Access to Investments ..................................................................... 391 F. Designing an Appropriate Disclosure Regime for the Crowd ............................................................................ 392 G. Pre- and Post-Investment Problems: “Soft Facts” and “Peer Drivers” ...................................................................... 394 V. CROWDFUNDING REGULATION IN A GLOBAL CONTEXT ........... 397 A. Australia ............................................................................ 397 B. New Zealand ..................................................................... 403 1. Crowdfunding Under the Financial Markets Conduct Act 2013 ........................................................................... 408 2. Part 6 of the FMC Regulations 2014 ............................. 411 350 WILLIAM & MARY BUSINESS LAW REVIEW [Vol. 7:347 3. Licensing Requirements ................................................. 411 4. Required Disclosure Statements .................................... 412 5. Requirement to Obtain Investor Confirmation .............. 414 6. Issuers Must Not Breach $2 Million Aggregate Limit .....414 C. Crowdfunding in the United States: The New Registration Exemption ...................................................... 415 1. The Crowdfunding Exemption Under Title III of the JOBS Act ......................................................................... 419 a. Limits on Maximum Funds that an Issuer Can Raise ............................................................................. 419 b. Investment Caps.......................................................... 420 c. Registration Requirement: Channeling ECF Through Registered Brokers or “Funding Portals” .................... 420 d. Disclosure Requirements ............................................ 420 2. Regulation of “Funding Portals” or Intermediaries ...... 422 a. Electronic Bulletin Boards ......................................... 424 b. Material Misstatements and Omissions..................... 425 c. EGCs ............................................................................ 425 d. Intrastate Crowdfunding Exemptions ....................... 426 D. Crowdfunding in the European Union ............................. 427 1. The Development of Crowdfunding in the European Union ............................................................................... 429 2. The United Kingdom as a European Example .............. 431 a. The First U.K. Platforms ............................................ 432 b. FCA Regulation .......................................................... 433 c. Authorization Requirements for P2PL Platforms ...... 436 d. Restricting the Category of Investors Participating in ECF Campaigns .......................................................... 437 e. The U.K. Crowdfunding Association Code of Practice ........................................................................ 438 3. The Netherlands, Germany, Italy, and France ............. 440 E. Crowdfunding in the Developing World ........................... 442 1. Economic Growth, Democratization of Finance, and Women Entrepreneurs ..................................................... 443 2. Emerging Platforms ....................................................... 444 3. Key Enabling Factors ..................................................... 445 VI. REGULATORY COMPETITION AND GLOBAL CROWDFUNDING .....446 CONCLUSION ............................................................................... 456 2016] SIGNIFICANCE OF CROWDFUNDING 351 INTRODUCTION This Article reviews crowdfunding and considers its implica- tions for securities regulation and fundraising law.1 We consider the utility of crowdfunding for small and medium-size enterprises (“SMEs”) and the regulatory approach taken in OECD jurisdic- tions such as New Zealand, Australia, the United States, the Euro- pean Union, and the United Kingdom to equity crowdfunding (“ECF”) and, to a lesser extent, peer-to-peer lending (“P2PL”).2 These alternative forms of fundraising have grown as a result of technological innovation and the fallout from the global financial crisis (“GFC”) in 2008–09, which resulted in tightened bank credit and increased constraints on SMEs’ access to capital.3 Re- strictions on SME access to capital are especially prevalent in the early-stage risk capital market, and it is here that ECF and P2PL are attractive solutions. These new sources of entrepreneurial finance significantly ex- pand the sources of financing available to SMEs by permitting equity investing and lending from micro angel and retail investors who can now participate in venture capital or angel financing—i.e., early startup financing to fledgling companies with significant potential.4 Crowdfunding has the potential not only to improve access to finance for SMEs (thereby enhancing domestic re- source mobilization), but also to democratize access to invest- ment opportunities. Crowdfunding investment opportunities are 1 See, e.g., Neil Parmar, Crowdfunding is Opening Investment Doors, WALL ST. J. (Nov. 9, 2014), http://www.wsj.com/articles/crowdfunding-is-opening-in vestment-doors-1415569542