In accordance with Section 12A of the Capital Markets Act, the Capital Market Authority has come up with draft Capital Markets (Investment based Crowdfunding) Regulations to govern investment based crowd funding in Kenya. In this Article, MNO Advocates LLP attempts to reduce to bare bones the concept of crowdfunding and highlight the salient features of the draft regulations.
What is crowdfunding?
Almost every Kenyan is familiar with the word “harambee” and its usage, it is a term used to signify the culture of people pulling funds together to meet a particular cause. Crowdfunding takes almost a similar approach. Crowdfunding is an open call to provide financial resources to a particular cause on the internet. It is typically the practice of raising money from groups, typically through an online or mobile platform.
Crowdfunding takes place on crowdfunding platforms (CFPs), that is, internet-based platforms that link fundraisers to funders with the aim of funding a particular campaign by typically many funders.
Typically, three key agents are involved in crowdfunding: (i) the investors; (ii) the intermediary platforms known as the crowdfunding platform; and (iii) the issuers. The investors provide funding, the crowdfunding platform is the site on which the transaction takes place and the issuer/ campaign owner receives the funds.
Crowdfunding usually takes one of these four models or a hybrid of two of the models; donation based crowdfunding; debt or lending based crowdfunding; equity or investment based crowdfunding and reward based crowdfunding. Donation and reward based crowdfunding platforms are non-financial while debt and investment based crowdfunding platforms are financial.
Donation based crowdfunding is often used to fundraise for charitable goals. A good example of a donation based crowdfund in Kenya is the M-Changa platform where individuals fundraise money for causes ranging from medical bills to charity food drives. Since its start in 2012, the platform has seen over 48,206 fundraisers started. Reward based crowdfunding is used to allow entrepreneurs to market test ideas and market product. It is primarily used in middle and high income countries and are often used by early stage entrepreneurs. Debt based crowdfunding is used to finance personal and business loans, take the example of Zidisha that advances small loans for business, health and educational purposes.
Investment based crowdfunding on the other hand is the process of raising funds from a group of people on a crowdfunding platform in exchange for shares, debt securities or any other investment instruments approved by CMA. Investment based crowdfunding platforms are often used by startups as they allow individuals to invest in potentially high-growth companies.
Investment based crowdfunding is on a rise these days due to the increased market visibility for startups; the nature of investment based crowdfunding that makes it easier for entrepreneurs to access capital and the potentially significant return on equity with investment based crowdfunding. However, investment based crowdfunding is very risky and because of the high risk associated with it, it cannot operate efficiently in a jurisdiction without adequate regulation hence the draft Capital Markets (Investment based Crowdfunding) Regulations.
Salient features of the draft Capital Markets (Investment based Crowdfunding) Regulations
- Operation of an investment based crowdfunding platform
The Draft Regulations provide that the following platforms require a license to operate in Kenya: a platform established in Kenya; a platform located outside Kenya but actively targets Kenyan investors; or if the key components of the platform when taken together are physically located in Kenya even if any of its component parts, in isolation, is located outside Kenya.
Persons intending to operate a crowdfunding platform ought to note that an applicant for a crowdfunding platform license should be a company limited by shares with a minimum paid up capital of Kenya Shillings Ten Million.
Another key feature to note is that under the Draft Regulations a crowdfunding operator shall not cease to operate without prior adequate notice to the Authority that may impose any terms and conditions to ensure an orderly cessation of business of the crowdfunding platform operator.
With these provisions on the operation of an investment based crowdfunding platform, CMA seeks to make it slightly difficult for crowdfunding operators to enter or exit the market, and the move is aimed at protecting investors on crowdfunding platforms as it is very risky.
- Raising funds through a crowdfunding platform(CFP)
Startup entities with a good operating track record and micro enterprises incorporated in Kenya with a minimum of two years’ operating tracking record that have a good corporate governance record are eligible to raise funds through a CFP. However, public listed companies and their subsidiaries; entities with a poor governance record; entities that propose to use the funds raised to provide loans or invest in other entities and any other entity as may be specified by the Capital Markets Authority from raising funds through a crowdfunding platform are prohibited from raising funds through a CFP.
For every funding round on a crowdfunding platform, the platform operators are required to establish and maintain a trust account with a financial institution as the custodian. The Draft Regulations have also provided for fundraising limits for entities raising funds through a crowdfunding platform. For micro enterprises the limit is Kenya Shillings Twenty-Five Million, for small enterprises the limit is Kenya Shillings Fifty Million and for medium enterprises the limit is Kenya Shillings One Hundred Million.
The Draft regulations allow sophisticated investors or individual retail investors to invest on the Platform. However, for individual retail investors the investment limit is capped at a maximum of Kenya Shillings One Hundred Thousand.
A crowdfunding operator shall be required to develop a standardized offering document for entities offering securities on its platform. The document shall include: key information on the issuer; use of proceeds; nature of the existing or proposed business; two years audited financial statements; a signed certification stating that the offering document does not contain a misrepresentation and that investors have rights of action and withdrawal in case of a misrepresentation; business plan; the amount to be raised and the duration of the offer. A crowdfunding offering shall only be made available on the crowdfunding platform and the offering shall not remain open for more than sixty days.
A crowdfunding platform operator shall ensure that a warning statement is prominently displayed to all visitors to the site; to every investor and on all application forms for investing through the crowdfunding platform. The warning statement should warn and advise investors on the risks of investing through the platform; on how investing in the businesses hosted on the platform is very speculative and carries high risks; on that fact that investors may lose entire investment and must be in a position to bear the risk without undue hardship and that they should read the information carefully and seek independent financial advice before committing themselves. The crowdfunding platform operator should also ensure that every investor affirms to a risk acknowledgment form prior to acceptance of the offer in which the investor confirms.
In the unlikely situation where an issuer is unable to meet the prescribed minimum threshold for the targeted amount, the Draft Regulations suggest that offer shall be withdrawn and the CFP operator shall effect a refund of the monies to the investors within 48 hours. However, where the CF transaction is successful, the CFP operator shall make the funds available to the issuer within 24 hours after the close of the offer.
In conclusion, the Regulations are a step in the right direction because regulation of crowdfunding positively influences capital seeking entities to obtain financial capital for their ventures and it encourages investors to invest in a country. In jurisdictions where crowdfunding is not regulated, investors are discouraged from injecting their money into the economy because of the uncertainty around protection of their investment.
Aside from creating a legal framework for crowdfunding, the Capital Markets Authority ought to consider other mechanisms of encouraging crowdfunding in Kenya such as explaining how crowdfunding works to potential investors and issuers through seminars and conferences, creating an overview of good crowdfunding platforms for issuers and supporting quality crowdfunding platforms.
Please note that this article must not be construed as legal advice and for further information regarding Investment-based crowdfunding and professional advice thereto, kindly do not hesitate to contact us at [email protected] or visiting our offices on 8th Floor, CMS Africa House, Nairobi or on 3rd Floor, Ritah Plaza, in Kakamega.