The trendy 'alternative' image of crowdfunding has taken a hit lately with the high profile failures of two crowdfunded companies. So what are your obligations to potential investors?

By Farah Khalique

The trendy 'alternative' image of crowdfunding has taken a hit lately with the high profile failures of two crowdfunded companies - claims management company Rebus and Zano drone manufacturer, Torquing Group. So if you choose to finance your growing business via crowdfunding, what are your obligations to potential investors?

The simple answer is, not much. Companies should not make any false or misleading statements in their campaign, but equally they do not have to tell investors everything. They don't have to publish regular statements like a listed company to show how they are spending the money.

The onus is very much on investors to do their homework, which they really should given that one in five companies that raise money on equity crowdfunding platforms fails. Those that collectively invested more than £160,000 in fashion label Crumpet Cashmere - which collapsed just before Christmas - perhaps were unaware that director Zara Juricic's first cashmere company had gone under in 2014, owing more than three-quarters of a million pounds.

Jon Gill, partner at TLT Solicitors works with companies that go down the equity crowdfunding route. Investors have limited legal recourse when a company goes bust, even if the information provided on the crowdfunding platform turns out to be false and misleading.

"Certainly, investors have fewer legal rights than other investors like angels and venture capitalists, who would negotiate conditions of investment on a bespoke basis."

Crowdfunding might seem like a win-win for businesses, given the lax accountability to investors, but the failure of companies like Torquing Group show that sometimes it is better to be held accountable. Could these companies have survived and flourished with the knowledge and expertise of a business angel? These types of investors will keep a close eye on the business, and how their investment is being spent.

Plus, dealing with hundreds of investors can be a headache further down the line, if a company decides to pursue private equity investment with the aim of rapid expansion. Private equity firms want to deal with those running the company, not hundreds of small investors, so the company would need to be in a position financially to buy those shareholders out.

Gill says: "It would be legally difficult to force those shareholders to sell if they are being treated differently to other shareholders in the structure (e.g. the founders are retaining their shareholding).

The Financial Conduct Authority will publish its final review of crowdfunding rules later this year; it will be interesting to see what its verdict is.

Farah Khalique is a freelance business and financial journalist, with a keen interest in writing about non-bank financing solutions that can help SMEs grow their business. She has written extensively about banking scandals and has made TV appearances on Sky News and The Wall Street Journal Live to comment on topical issues including money laundering and bankers’ bonuses. Follow her on Twitter.