Legal implications of equity-based crowdfunding

As a lithium-exploration company in the UK successfully completes a £1.4 million crowdfunding round, believed to be the first of its kind by a British mineral exploration company, Gavin Poole from the mining and minerals team at Stephens Scown LLP explores the legal implications of crowdfunding.
February 14, 2020 2 mins Read
By Gavin Poole
Gavin Poole
Gavin Poole

In October 2019 Cornish Lithium welcomed more than 1,200 new investors following its £1.4m crowdfunding round via Crowdcube.

The company, which plans to investigate the possibility of combining geothermal energy and lithium extraction in Cornwall, will drill its first exploration holes with the funds raised.

Equity-based crowdfunding involves members of the ‘crowd’ investing in shares in a company. In 2017 the value of equity-based crowdfunding in the EU (excluding UK) was 211 million Euros, a rapid growth from just 18.2 million Euros in 2012.

Legal issues to consider

Despite the various attractions of equity-based crowdfunding, including its flexibility and lower risk compared to debt finance, there are various legal issues that companies should be aware of.

Will you need to change your constitution?

Most crowdfunding platforms will have bespoke articles of association which participating companies are required to adopt. This is attractive in some ways because you don’t have to go through the extensive negotiation which often accompanies third-party investment, but equally there is the risk that you lose a measure of control over the company.

What about shareholders’ agreements? If there is an existing shareholders’ agreement this will need to be disclosed to the crowdfunding platform. You will need to consider whether the shareholders’ agreement restricts the company’s ability to raise investment, and whether the investors will be required to sign up to the shareholders’ agreement (assuming it is in a suitable form for them to do so). It is also important to consider how the fundraising process generally – including any changes to the articles of association – will impact upon the terms of the shareholders’ agreement. It may be necessary to terminate or vary the shareholders’ agreement prior to raising funds from the crowd.

Do you hope to attract further investment?

It is important to consider whether raising funds by equity-based crowdfunding now will make your company less attractive to potential investors further down the line.

Will there be different classes of shares?

The company will need to decide whether it wants to offer a different class of shares to investors to those held by the founders. Some crowdfunding platforms are very prescriptive about the class of shares that are to be offered to investors. Typically, a company may not want the crowd to have voting rights, for example, although bigger investors might expect to have voting shares and some platforms use a nominee structure which does confer voting rights on the crowd.

Are you ready for the additional strain of corporate governance?

Whilst crowdfunding platforms typically take some of the hard work out of post-raise administration (such as providing share certificates to investors and providing the company with the relevant information for its statutory registers) there may nevertheless be administrative and compliance implications for the company to consider. What happens if a member of the crowd chooses to sell their shares? Giving notice of general meetings, for example, is much more complex if you suddenly have hundreds or even thousands of members. You will also need to think about how you are going to communicate with the crowd, which will understandably expect to be kept regularly informed about the company’s progress.

Are there any potential reputational risks?

Equity-based crowdfunding is still an emergent, relatively new concept, and the first two successful UK exits only happened as recently as 2015. Difficulties may arise further down the line where members of the crowd start to become disillusioned at a lack of dividends or their inability to readily resell their shares. The crowdfunding platforms are likely to bear the brunt of such frustration, but nevertheless this is something that fundraising companies should consider prior to a raise.

As with any form of third-party investment, it is important that companies carefully review the legal and commercial factors prior to engaging in crowdfunding. Taking legal and accountancy advice at the outset of any fundraising venture helps to confirm whether it is the right decision and avoid the risk of nasty shocks arising further down the line.

Gavin Poole is a corporate partner at Scown LLP. The firm has more than 70 years’ experience representing mining and minerals clients and its specialist team is recognised by independent guides to the law Legal 500 and Chambers. Gavin can be contacted on 01872 265100 or email solicitors@stephens-scown.co.uk.  For more information visit www.stephens-scown.co.uk

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