HOW TO RAISE MONEY FOR A PROJECT (MODERN WAYS OF INVESTING)

What is CROWDFUNDING? 

Crowdfunding is a form of so-called group financing. This means that a larger number of individuals contribute smaller amounts of money to reach a target amount to fund a specific third party project. Simply put, it is an open call to the public to raise funds for a specific purpose, and it is usually done through online platforms (e.g. Kickstarter, HitHit, Starter, etc.). Backers who invest in projects are then entitled to various forms of rewards.

 

This article was written in 2022. If you are looking for up-to-date information on this topic, please contact us at office@arws.cz or by phone on +420 245 007 740. We will be happy to advise you.

Author of the article: ARROWS law firm (Mgr. Lukáš Nálevka, Mgr. Petr Hanzel, LL.M., office@arws.cz, +420 245 007 740)

What types of rewards can be offered through crowdfunding?

Crowdfunding is divided into financial and non-financial. Non-financial crowdfunding is reward-based, rewarding the funder with a service or product that they have helped to fund. Financial crowdfunding, on the other hand, entitles the backer to financial consideration.  Financial crowdfunding is further subdivided into credit crowdfunding and investment crowdfunding.

Credit crowdfunding is characterised by the fact that the backer (lender) and the project owner (borrower) are on equal footing. In fact, on the lender's side there are persons with the same status as the lender - in contrast to the bank, which has a superior position in normal lending relationships. In addition, investment crowdfunding gives the backer (investor) a right to a share in the project. An example is a public limited company that offers its issued shares for sale via a crowdfunding platform. In this way, the investor can acquire, for example, bonds or securities, which represent the investor's right to be paid a certain amount.

New legal regulation of crowdfunding

On 29 May 2022, Act No. 96/2022 Coll. came into force, amending certain financial market laws, in particular in connection with the implementation of the European Union's regulations concerning the Capital Markets Union, including Regulation No. 2020/1503 of the European Parliament and of the Council on European providers of group financing services for companies (the "Group Financing Regulation"), regulating a specific part of the crowdfunding market - financial crowdfunding.

The supervision of providers of crowdfunding services is now governed by Act No. 15/1998 Coll., on Capital Market Supervision, and is exercised by the Czech National Bank ("CNB"). The CNB is entitled to request information, require its disclosure, require the submission of records and reports or, for example, conduct on-site inspections. In particular, however, the CNB has acquired the core competence to grant a licence for the provision of crowdfunding services.

The activities of the service provider are primarily regulated by the Crowdfunding Regulation. Amendment to the Act

No. 256/2004 Coll., on Capital Market Undertakings ("CMU") regulates only certain sub-issues, such as the obligation for the project owner to ensure the proper content of the Key Investor Information Document ("KIID") in Section 90h of the CMU. The KIID is an essential aid for investors when considering whether to finance a crowdfunding project - it must therefore not contain misleading or inaccurate information. The same obligation to provide a KIID at the platform level is regulated for platform operators in Section 90j of the CCCT. Investors will use this information to decide whether to invest through individual loan portfolio management.

As group financing entails its own risks, the Regulation sets a maximum value for the total consideration for offers made by the owner of a specific project of up to EUR 5 million per twelve calendar months per project. Financing of larger projects will be governed by MiFID II, which is also reflected in the amendment to the CIFMD.

It should be noted that the Regulation also does not apply to consumer credit providers. Platforms that arrange consumer credit are subject to the Consumer Credit Act.

The Regulation establishes the separation of the roles of the platform operator and the person offering projects for public funding through the platform. The operator of the platform is therefore an intermediary who merely links the providers of funds with the owners of the projects to be financed. The platform is therefore open to the public with the sole aim of matching potential investors (funders) with businesses seeking funding. The platform operator cannot therefore upload its own projects for funding to meet the requirements of the Regulation.

The operator of the platform and the project owner must be separate in terms of assets and personnel - that is, the operator must not accept as its clients (i.e. project owners) any of its shareholders with a shareholding of at least 20 %.The Regulation imposes a requirement on the platform operator to be transparent and professional in the selection of platform bids in order to maintain a high level of investor protection, reduce the risks associated with crowdfunding and ensure fair treatment of all clients.

Other obligations are also imposed on platform operators, including for example the obligation to carry out an entry test on the knowledge of retail investors. They must also provide investors with documents containing basic information for each project and, in particular, warn them of the risks. Investors must also be given a four-day pre-contractual cooling-off period within which they can withdraw from the investment. Furthermore, the regulation provides for the obligation to disclose the default rate of loans and to prepare a risk analysis.

Platform operators must have in place prudential guarantees of EUR 25,000 or ¼ of the total fixed overheads for the previous year - i.e. costs that do not vary with business activity (e.g. rent or mortgage payments).  It depends on which of the amounts is higher. These guarantees protect the operator against risks such as loss of documents, misrepresentation, as well as omissions that lead to breaches of duties such as duty of care to clients, or losses resulting from disruption, system failure, etc.

Existing crowdfunding platforms previously authorised under national rules were originally required to obtain a CNB licence by 10 November 2022. In order to allow for a smooth transition to the new regime and to ensure continuity of services, this transitional period was extended until 10 November 2023 by the adoption of a Commission Act. The time limit for issuing the licence is 3 months, but only starts from the receipt of a complete application. The actual duration of the licensing procedure may therefore be several times longer. The advantage is the principle of the so-called single European passport, i.e. the possibility for Czech entities to provide crowdfunding services on the basis of a CNB licence in all EU Member States.

If a project successfully raises funds, a commission for the platform operator must be taken into account. The detailed terms and conditions are set by each platform within the limits of the law, but they vary in units of percentages of the amount requested.

What other ways can you raise money for your project?

Issuing bonds

A bond is a loan security that obligates the issuer (bond issuer) to the buyer of the bond to pay out money (repay the principal of the bond) including the relevant interest. Issuing bonds is therefore another possible way of raising finance. The person who buys the security (the investor) becomes the owner of the bond and is entitled to receive specified interest payments for as long as the bond is held.

The yield of the bond can be determined in particular:

• a fixed interest rate
• the difference between the nominal value of the bond and its issue price,
• a callable premium or premiums depending on the maturity of the bond, or
• a floating interest rate derived, for example, from other interest rates or interest yields, movements in exchange rates, financial indices or commodity prices.

The advantage for you as a bond issuer is that you can borrow funds at a lower interest rate or on more favourable terms than banks offer.

Each issuer must create so-called issue conditions before the actual issue, without which the bond cannot be issued. The terms and conditions of issue set out the rights and obligations of the issuer and the bondholders, together with other information about the issue. The issuer also keeps a list of the owners of the bonds it issues.

What types of issues can be made?

Bonds can be issued in a public underwritten offering, where the issue volume may not exceed EUR 1 million (a common choice for SMEs distributing on their own or advertising online), or in a private placement, where the number of investors approached must be less than 150 (bonds are placed among private investors, usually without advertising), or in a public offering with a prospectus approved by the Czech National Bank (there is no limit on the issue volume or advertising).

Bonds are most often issued as unsecured bonds, but it is of considerable importance for strengthening investor confidence if the bonds are secured (e.g. by way of a surety declaration of the issuer's owners or other persons, by a pledge of movable assets or real estate). In the case of secured bonds, however, it is necessary to use a so-called collateral agent, which, as a third party, guarantees to investors that the collateral in their favour will be properly realised if necessary.

Qualified Investor Fund (QIF)

As the founder of the fund, you are obliged to register in the list of qualified investor funds maintained by the Czech National Bank pursuant to Act No. 240/2013 Coll., on investment companies and investment funds. 

CIFs can be divided into self-managed with legal personality and non-self-managed.

A self-managed investment fund is an investment fund with legal personality. The management of the fund, together with its management and administration, is the responsibility of its founder. Regulatory requirements such as risk management or internal audit must be taken into account.

In the case of a non-self-administered investment fund, the administration and management is carried out by the investment company. This option is therefore suitable for those who do not want to deal with the administrative and regulatory burden of managing a fund.

It is also possible to invest your own funds, unlike crowdfunding platforms. Another advantage of CIFs is looser regulation, which brings freedom in terms of which assets to invest in and how.

A qualified investor must have sufficient capital to invest (at least CZK 1 million) and is also screened for knowledge and experience in investing.

Conclusion

There are therefore many modern ways of investing that allow you to raise money from people for your project. What is the right one for you - and how do you go about understanding its legalities in detail? You will be guided through these processes and procedures with due diligence by attorney Mgr. Petr Hanzel or Mgr. Lukáš Nálevka.