Italy coming out first on equity crowdfunding? It could be done! Eventually…

I had the opportunity to partecipate today in Rome to the first open hearing, held by Consob (the Italian SEC) on equity crowdfunding.

The conversion into law of Decreto Crescita, has delegated  Consob to issue the regulatory framework on equity crowdfunding in Italy, with a very aggressive schedule, that would ask for completion of the work by March. Timing that, if met, would put Italy in the position of being the first nation in the world to have specific regulation, as I understand it.

In fact, while equity crowdfunding has existed for years in several countries among which UK and The Netherlands, it is not currently regulated, yet. In Australia, now crowdfunding has been successfully going on for seven years now, unregulated.

It  was a very good meeting, and  I found a sympathetic and open regulator, sincerely interested in understanding the phenomenon and listen to the voice of the industry. There were a couple hundred people and Alessandro Fusacchia, from the Ministry of Economic Development has stressed the importance of this specific regulation. Cornerstone of the startup legislation initiative launched by the Monti’s government.

The regulatory framework is key in-fact, because here ‘devil is in the details’. Initial success or failure of equity crowdfunding in Italy will largely depend on regulation being issued by Consob. It will determine the boundaries that would allow growth of an healthy, competitive and favorable environment for investors. But on the other hand must define an operational context that would make attractive this new asset class. That would drive capital into the Italian startup and venture ecosystem.

When launching the regulation, Consob, shall take into account the balance and trade-off between investor protection and market development. It will need to identify streamlined procedures and containing the costs and fees associated with crowdfunding. It will need to define the level of disclosureprovided by the issuer, rebalancing information asymmetries and dividing risks and responsibilities among the various actors involved in a crowdfunding campaign.

But the big challenge is that the topic is relatively new and requires a deep understanding of the digital age, its customs and related technologies. Because only thanks to the Internet and social networking the entire system can run efficiently, in an orderly, sustainable and scalable way.

It should be noted that legalization on crowdfunding is at the heart of Obama’s JOBS Act, a major piece of legislation geared to economic development and job creation in America. The United States – unlike Italy – have embraced equity crowdfunding in large scale, and this year it will be accessible to any company (start-ups and SMEs). It’s will likely find the next Google, but also fund the local dry cleaner. Not only SEC will launch equity crowdfunding (Kickstarter style), but also will allow what it’s called ‘public PPM’, that will fundamentally enable to post a PPM online. And is raising the current cap on the so called ‘Reg A’, raising it to 50 million dollars. Fred Wilson, said “if Americans take 1% of the $300 Trillion they have in savings it would create a $300 billion dollar market.”  In a recent study by Professor Steven Stralser the Thunderbird School of Global Management has estimated that over the next five years approximately 500,000 companies will be financed through crowd-funding in America.

One key element to understand is that crowdfunding works as it leverages the power of social media to ensure transparency and social control, the use of so-called “crowd intelligence”. To understand what I mean, just look at the experience of sites like Kickstarter (over 300 million raised last year and no fraud), or the decade-long experience of ecommerce platforms such as eBay or Amazon. The combination of feedback mechanisms and ratings  coupled with pervasiveness of social media is the most powerful tool for social control that enables crowdfunding to operate as efficiently in providing investor information and protection.

It should be noted that current crowdfunding campaigns are mainly subscribed within entrepreneurs social networks. Subscribers are in larger part among friends, colleagues, customers, suppliers and acquaintances of the issuers. All connected with their social networks on Facebook, Google, Twitter, Linkedin. It has been discussed in the US (the proposal is not passed) a possible rule that whereas a minimum proportion (eg 20%) of your contacts on social networks does not subscribe the offer, it will not pass and the campaign would be off.

Also regarding documentation and due diligence required to portals Consob will need to find the right balances and take full advantage of digital and multimedia for access to documentation, ensuring transparency and efficiency to the market.

On Kickstarter entrepreneurs put their own face on their project, on video, in addition to standard documentation such as a business plan. Nothing prevents the regulator / market to make full use of graphics, video, interactivity, multi-channel, graphics, infographics, social networks, crowd intelligence services of third parties for marketing, legal, investor relations, accounting and even reporting and certification to solve problems in regulating and protecting all actors involved.

I had the opportunity to express my considerations to Consob today and these are some of the things I feel are important to the success of crowdfunding here:

- First the rule ‘all or nothing’ that allows only offers fully funded through. The campaign ends only when the entire amount (or more) offered is subscribed. If the amount is not reached, the campaign fails. This rule allows a significant risk reduction of potential fraud.

- Offers may be made only on platforms authorized and under the supervision of Consob.

- The funds are only paid at the time of the offering period and during the campaign investors can cancel commitments.

- The use of escrow mechanisms provided by third parties with respect to collection platforms for the management of campaign funds, could provide assurance to all parties involved in the transaction.

- Entrepreneurs who wish to raise capital are subject to specific restrictions with respect to what they can communicate to the public. (For example, they cannot mention terms of the offer in the marketing campaign).

- There are specific rules requiring the portal to ensure that a prospective investor goes through essential elements of the offer. Portals must ensure that potential investors go through online video investor education material.

- Even portals have specific restrictions on marketing activities that can be carried out. For example they can only promote the general business of the portal but not specific offers or issuings. Entrepreneurs, platforms or third parties are not allowed to pay fees to bring subscribers to investors for registering to the platform.

- Potential investors will have to register to the platform,  in order to have full access to information. Portals will have to ensure that investors go through video education material and answer quizzes with specific questions to guarantee full understanding.

- The United States has placed a cap on the amount that each individual investor may invest as a percentage of their annual income.

- The issuer must pass through a legal check that includes founders and directors.

- All data should be made public on the website at least three weeks in advance of issue.

- Portals must provide mechanisms for the prevention and detection of fraud and all portals must be connected to a system of ‘portal check’ managed centrally.

- On the issue of ‘due diligence’ by portals in the United States, there will be  extensive use of third-party information. It’s clear that in order for the system to grow significantly steps must be taken to ensure an appropriate balance between minimum due diligence required,  potential liabilities and the protection of investors.

- The portals will be largely selective in the curation of companies to crowdfund, and this should not be considered as advice on investment.

- Large use of self-certification and in order to establish the compliance of investors.

- It must be possible for entrepreneurs to make follow-on investments through various campaigns.

In addition to these  issues, there are to Italian specific big problems that Consob will have to address.

The current law provides that only so called ‘innovative startups’ that have raised capital from a professional investor such as a VC. Such startups are defined by law and among definitions must be companies that do not distribute profits. On the other hand no provision has been made in the law for secondary markets or liquidity of the asset class. The holding period has been set extremely long (two years, quite long in high tech in my humble opinion).

The combination of these factors make it practically crowdfunding totally unattractive for investors.

Why would anybody put money in a risky investment such as an early stage startup, that cannot distribute profits and there is no way to sell shares. With a two year lock up. It’s absolutely key that Italian regulation allows for developing an healthy secondary market, providing for standardization and interoperability of data in order to make it competitive and widespread.

On the other hand Italian legislation (unlike the U.S.) requires that the collection and transmission of orders should by done by a bank or authorized financial institution. It would seem quite natural to allow trading of crowdfunded shares on online trading plaforms.

There is a second important point that I fell should be considered and that SEC is apparently choosing not to regulate. How do you manage the shareholder meeting in a small company, that could have hundreds if not thousands of micro-shareholders? The issue could be addressed in three ways in my view:

- Through some sort of mandatory proxy to a common representative of the crowdfund shares

- Through the creation of specific classes of shares / units (crowdfund shares) with specific rights and limitations;

- By limitations on voting rights.

I think that expecially in the case of startup, crowdfund shares should have some rights/obligations attached. Some sort of liquidation preference on other classes, particularly towards founders. Some kind of tag along rights, particularly connected to founders selling majority stakes.

Every innovation requires creativity, courage and dedication. But if you these ingredients are there and the business idea is distruptive and scalable enough. A bit of luch and major things can happen. This is stuff that could revive the Italian economy. There are arond 25.000 young wannabe entrepreneurs in Italy today. With some help they could build a new Mediterranean kind of Silicon Valley.

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3 commenti on “Italy coming out first on equity crowdfunding? It could be done! Eventually…”

  1. twintangibles scrive:

    Gianluca – great and extensive blog thanks for posting it.
    Your comments at the beginning reminded me of a series of discussions I had at a recent OECD conference. You suggest that equity crowdfunding in the UK is unregulated but I would disagree entirely, it is regulated and rigorously.

    But what I think you are highlighting is what I think is a different set of traditions that I have characterised in discussion as those that seem to emerge from a Common Law tradition versus the more Napoleonic Code tradition.

    That is to say in a common law tradition it seems that there is an approach to find mechanisms to enable innovation within existing legal frameworks and precedent. So, in essence, one finds a path way through what legal constraints touch upon the activity that is being proposed. Hence Seedrs and Crowdcube, two UK based equity crowdfunding platforms, have full FSA ( Financial Services Agency – the UK Banking and Finance regulatory body) compliance. It is this exploratory and incremental approach that has permitted these innovative platforms to progress so quickly.

    The alternative is the approach which seems to pervade jurisdictions based more in the Napoleonic tradition where actors feel they need specific legislation that specifically permits the activity being proposed before they act, in this case equity based crowdfunding, which is inherently stifling or delaying.

    Of course its not a hard and fast rule and just an interesting piece of whimsy, the French platform wiseed for example challenges it significantly for rigour. But I do think there may be something in a sort of psychological predilection towards behaviour based on legal tradition. I had a similar conversation with Jeff Lynn CEO of Seedrs recently who is both a lawyer and an American and he felt that the principle applied in securities law in the USA – hence their need for the JOBS act.

    Either way its good to see Italy moving towards equity crowdfunding and the benefits that it can undoubtedly bring.

    • dgiluz scrive:

      Thank you for your comment. I think you are right, there is definitely a different legislative background in common law and for example countries like Italy. But one thing is important to say. Also in Italy crowdfunding was technically possible and actually in fact there is one website that does ‘equity crowdfunding’ called Siamosoci. However the regulation is – as you say – pretty strict and mostly unfit to the new media. Most legislation around this was designed around the thirdies, that’s way specific regulations are needed (I believe) to really jumpstart this industry. Crowdfunding is fundamentally different from raising money in other ways and a specific regulation is necessary to address the new possibilities offered by digitalization and social media. What do you think on this matter?

      • twintangibles scrive:

        Thanks for the response Gianluca.

        I am not sure I would agree that specific crowdfunding legislation is required at present – certainly in the UK. I might argue that existing legislation could, and should, be adjusted to accommodate crowdfunding more readily but exactly how is not entirely clear as, it seems to me, that in such a rapidly evolving environment, to establish firm rules early on would be potentially restrictive and pre-suppose how this new funding mechanism might evolve and develop. After all one of the fundamental propositions of crowdfunding, as with all socially enabled activities, is to introduce new participants to a sector from which they have previously been excluded and that includes both investors and those seeking investment. So we will see different motivations, very different expectations of return, different considerations and different assessment of risk from these new participants. For that reason I would embrace the many different models of compliance that are already being used and tested and see which works best in this environment before considering or passing any new legislation.

        My sense, and fear, is that much of the legislation that is currently being considered is essentially constraining rather than enabling and is driven largely by fear. And when I say fear. If legislation is to be enacted then, in my view, it should be liberalising and enabling and driven by the sense of possibility. At present I see little evidence of that. Set against this, if my theory of some traditions require legislation to simply “permit” an activity is sound, I would endorse it. But you seem to suggest this is not necessary as it could already be accomplished in Italy without new legislation.

        One of the common complaints in this area, certainly in the UK and US, is the notion that the laws and provisions that do exist are framed supposedly to protect investors and do so by only allowing “sophisticated” investors to participate in these type of offerings This has the effect of preventing participation and the idea of infallible “sophisticated investors” has rather fallen into disrepute in recent times and the whole idea is increasingly seen as a discriminatory, exclusive and privileged concept that really does not bear scrutiny. History demonstrates that so called “sophisticated” investors often get it very very wrong.

        So, as social and collaborative technologies have progressively eroded the barriers to participation in so many other fields and empowered people to participate in activities and re-imagine themselves into roles that were once denied them, so it must be in investment.

        So, in sum and in direct answer to you question, until I see laws being proposed that are inclusive and expansive then I will be inclined to cast my vote against them, except in traditons that require that “permisson” to operate.


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